Paul Goodwin edits the Cabot China and Emerging Markets report, which is really the only surviving China-focused newsletter I can think of from a big publisher (most publishers had such a letter during the China bull run in the mid-late 2000s, but many of them disappeared in recent years as China got to be as much a “fear” topic as a “greed” one).
He’s been teasing his No. 1 China Pick recently, and many readers have asked about it, so although we already revealed this “secret” stock in a teaser solution that ran in the Friday File for the Irregulars back in March, I thought we should take another look today… and also get the name out there for the rest of the gang in case you’re curious.
Goodwin actually acknowledges the collapse in Chinese stocks of a few years ago, and the weakness that shook out the newsletter ranks, though he does so in effectively bragging that theirs was the only China-focused newsletter to survive that downturn (which is probably close to being true, I know of several China letters that closed, and others that broadened their focus or changed their names to get a “fresh start”). Here’s how he puts it:
“All the other China-focused investment advisories collapsed in the downturn because they didn’t understand the trends or the sectors or how to take advantage of and profit from investing in little-known U.S.-traded China stocks with huge earnings growth potential.
“That’s why their readers lost money and canceled their subscriptions and these publications were forced to fold their operations… while we continued to make our readers a bundle.”
Well, according to Hulbert Cabot China and Emerging Markets had an awful time in 2008 and in late 2011 just like almost any other China-focused or emerging markets stock picker, and their five-year record is pretty much flat… but they have done very well over the past year to bring that long-term average up to “flat” as markets hit records and enthusiasm returns and as folks started betting on China again, the newsletter (again, according to Hulbert) posted a 45%+ return over the last twelve months.
So they are not magical, but they have been survivors in the emerging markets space… so I guess that’s worth something.
What are they pitching now? Here are the clues:
“Just like my top auto, entertainment, Internet, and social networking picks that doubled our readers’ money four times in 2013, my No. 1 China stock now matches the same profit profile.
- The stock is a fast-rising star in a global $204 billion industry.
- It’s a new stock that’s already up 98% in three months.
- It registered 198% earnings growth for its first quarter.
- Analysts expect it to register another 203% next year, clobbering the S&P 500 by more than $20 to $1.
“What I like most about this company is that:
- It doesn’t have a single U.S. competitor and never will,
- China only licenses two companies to profit in this fast-growing sector, and
- It’s outperforming its No. 1 competitor nearly 100 to 1.”
So who is it? One more bit of clues:
“My No. 1 recommendation is one of only two companies authorized by the Ministry of Finance to provide online lottery and sports gaming to the nation’s 3 billion people.
“Talk about a wide moat!
“When you consider that it’s outperforming its No. 1 competitor by nearly 100 to 1, you can see why we are placing our bet here and why I want you in on the action.”
OK, so we’re going to ignore the fact that they goofed on the population — China doesn’t have anywhere near 3 billion people, thankfully, but the 1.3 billion or so they do have is a plenty big market for pretty much anything.
So what’s the company?
Thinkolator sez this is 500.com (WBAI), which did have an IPO of new American Depositary Shares late last year — the IPO was priced around $13 (above the $10 they had expected previously) and actually opened and traded at $20, after which it pretty quickly doubled. Since the beginning of the year it’s been pretty volatile, it was around $43 when we first “uncovered” the stock from Goodwin’s teaser pitch in March and is now at about $35 (it also trades in the mostly closed A share market in China, each US share equals 10 shares in China).
And yes, 500.com is a lottery company — they operate online sports lotteries that are licensed by the Chinese government, and it looks like their actual revenue is effectively a commission from the regional lottery operators for the sales they make.
They’re one of two major sports lottery companies, but the other one is not a pure play. The other operator is Taobao, which is part of Alibaba — itself expected to probably be among the largest IPOs in history when it finally lists … that won’t be for a little while, so if you’re enthused about Alibaba the easiest way to own a chunk of it is through Yahoo, which owns 24% of Alibaba, or through Softbank (SFTBY) — we talked more about Alibaba and those “back door” investments into the company a few weeks ago here.
But 500.com is comparatively small, quite focused, and it’s one of the market share leaders in a country where gambling is well entrenched culturally — it’s also been an IBD favorite at times, which isn’t a surprise (Cabot and IBD are both largely growth/momentum focused). You can see their 2013 earnings numbers in this press release, which does include all those mouthwatering growth numbers (they’ve nearly doubled earnings year over year, and analysts think they’ll keep growing at better than 50% for at least this year).
They have controlling shareholders who have a special class of shares, and for those of us outside the country who have no idea how the lottery system works the whole business is pretty opaque, so to a large degree these shares are a leap of faith based simply on a focused business that sells a high-margin product and is growing like crazy. There are worse things to take a leap of faith over, and if the analysts are right you’re only paying 25X 2015 forecasted earnings for a company that’s expected to grow earnings by 150-200% this year and another 50% next year … so that ain’t bad, but it’s not for the faint of heart.
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Nomura put out an analysis a couple weeks ago suggesting Chinese sports-betting firms as a play on the World Cup, since those gambling (legally) on this event in China would likely do so online given the time difference (games played overnight in China, when physical lottery locations are closed). On the flip side, the momentum has faltered for this stock in recent weeks and Zacks (which mostly uses quantitative indicators) put this on its “Strong sell” list several times in recent weeks. The two analysts who officially cover the stock, including the one who did the underwriting for the two offerings, both put a “hold” on the shares.
What else is hitting the shares? And why are they now at $35 versus the $50+ or so a few months ago? Well, the stock peaked out in early March in the low $50s and has been moving gradually lower since, in concert with some other high-momentum high-growth names, but it certainly didn’t help matters that a few weeks after the stock peaked they filed for a larger secondary offering and the lockup for insider sales on the initial IPO expired… and then there was an allegation, in early May, that the company did not have regulatory approval to offer online sports lotteries. (The company vociferously denied the allegations, and the analysts stuck with them… at least so far — quick summary of that situation here, 500.com’s response press release is here).
The first quarter, announced about six weeks ago, was pretty impressive — big growth sequentially in users and great year-over-year growth in revenue and profits, though they didn’t grow profits sequentially as some folks might have expected (they said this was due, in large part, to the fact that lottery operations were closed by the government for eight days for the New Year holiday).
I’m continuing to keep half an eye on this one, though I’m not jumping up and down to buy it still — I don’t have much sense of how much they’ll have to spend, if anything, to get those gaudy sales growth numbers to continue (so far their marketing and technology investments have grown sharply, but still more slowly than revenues have grown, which is a good sign).
They are obviously trading at heady growth expectations even after falling from their peak — and already trading at about 15X revenue, so investors are putting a fair amount of weight on those admittedly hefty profit margins… but clearly this could be a spectacularly successful company and be worth 30-40X earnings IF they can keep growing at nearly 100% a year as the analysts estimate, and the market they’re in ought to have plenty of room for growth given the cultural penchant for gambling and the popularity of sports gambling. And despite that growth, the company is not particularly beloved or well-followed on Wall Street, as taken from the “hold” rating and the fact that the transcript of their last conference call reflects no questions from analysts (I haven’t checked to see if that’s accurate). How much you want to discount that for regulatory risk, competitive risk, or simple opaqueness of a Chinese business with controlling shareholders, well, that’s up to you.
And of course, we already know that the lottery is a really, really good business… so good that it’s illegal in most places when the government isn’t involved. It’s important to keep regulatory risk in mind for these kinds of government-connected entities, their only real value is that they’re a government approved online retailer/reseller for sports gambling, so their sales could change dramatically if the regulations change (this isn’t just a fear related to the approved/not approved dispute of a few weeks ago — a real loss of approval hit in 2012, when they had to suspend some operations for a few months and took a big cash hit while they applied for new approvals).
So this stock is certainly not as risky an investment as an actual lottery ticket, and it is posting huge growth numbers — but there’s plenty of stuff you can’t see behind the scratch-off foil.
Sound like the kind of online gamble you’d like to make in China? Let us know with a comment below.