Comtech Group, Inc.: The talk of China
When people in China talk to each other, they use cell phones—a lot. According to the Chinese Ministry of Information Industry (MII), 487 million people were using mobile phones by April of this year, 100 million more than the number of people using fixed lines. The market is growing by 60 million new subscribers a year; 20% of owners replace their phones each year.
That has given a huge boost to Comtech Group, Inc. (Nasdaq: COGO), a Shenzen-based electronics module supplier to cell phone makers and other Chinese electronic equipment makers. In the second quarter, the company’s pro-forma net income was up 53% from a year earlier to $6.06 million, on revenues up 22% to $50.6 million.
As a result, the company’s stock has been hotter than Fergie ringtone downloads in the last couple months. From a 52-week low of $13.45 in early August, it hit a high of $21.85 on Oct. 11. The market cap of this company is now pushing the definition of “small,” having recently risen to just over $800 million.
Six out of seven analysts following the company have “buy” recommendations. One reason for continued optimism is that in 2008, China plans to begin rolling out a 3rd-generation wireless system and Comtech has been developing modules to feed the appetite of this fast, internet-enabled system. A May report by Roth Capital Partners notes that the company is “well-positioned to benefit from China’s 3G rollout and continued strength in China’s core electronics markets.”
A word of caution: do not confuse Comtech Group with U.S.-based Comtech Telecomm. Corp. (Nasdaq: CMTL). Google searches on Comtech Group bring up news of multi-million dollar deals signed by Comtech Telecomm. Despite similar names and markets, the companies are not related.
On the other hand, don’t be confused by the fact that COGO’s stock dropped from about $22 in 1996 to under $0.50 in 2003 before a huge recovery. Comtech Group found an unusual way of going public on Nasdaq: it merged with a defunct American motorcycle maker, Trident Rowan. That company ceased operations in 2000, but its owners kept its listing alive as a “shell company,” trading for pennies as it waited for an active company to merge with. That happened in May 2004, when Comtech merged and instantly became a public company.
Comtech Group started life in 1995 as a reseller of electronics components, such as semiconductors, into China. Several years ago, management decided to make it easier for customers to buy those components by creating a design business. It works with its customers to design customized modules for use in their devices, using the components from its suppliers.
The strategy has been a hit. Comtech Group has become an important partner in helping component makers, such as JDS Uniphase Corporation (Nasdaq: JDSU) and Broadcom Corporation (Nasdaq: BRCM), get their parts into China. It supplies modules to some 200 equipment makers in China.
Comtech Group has been announcing its own lucrative deals lately. On Sept. 25 it announced contracts with Chinese cell phone makers worth $10 million. On Oct. 31, 2006, its stock jumped 12% in one day when it announced a partnership to license software from Microsoft to use in portable media players, Internet protocol television (IPTV) set-top boxes, game consoles, global positioning systems and smartphones.
But the question worth calling your broker about is: how much higher can this stock go? Chinese stocks have become the current darling for investors looking for high-growth markets, and any investors should be wary of over-exuberance. Indeed, COGO has already reached the 12-month targets from most analysts. According to Thomson/First Call, those estimates range from $20 to $23.50, with a median price of $21.
Piper Jaffray, for example, issued an “outperform” rating on Sept. 25, when the stock was at $16.70, with a 12-month price target of $22.
Piper Jaffrey analyst Michael Walkley has not altered his “buy” recommendation, although he has not yet put a new price target on the company, believing there is still strong potential for growth ahead. He believes it’s fairly priced with a price/earnings ratio of about 40. Although competing cell phone component supplier China Grentech Corporation Limited (Nasdaq: GRRF) trades at a P/E of just $18, Walkley believes that Comtech’s design expertise and strong relationships with many Chinese equipment makers put it in a unique position. “Comtech Group has a more interesting business model,” says Walkley.
Comtech Group also has a highly diversified customer base. Only a couple of its largest customers bring in as much as 10% of its revenues. And Walkley says that his interviews with Comtech Group’s customers show it enjoys excellent relationships with them.
Further, Comtech Group raised $84 million in a secondary offering in April, giving it cash for acquisitions. Its first, announced Aug. 1, was a $20 million cash and stock deal to buy Keen Awards, which designs custom display panels for cell phones in China.
For these reasons, plus the potential of IPTV market growth in the next couple years, COGO still has potential. A scheduled Nov. 8 conference call to discuss 3rd quarter earnings will give a clearer signal about the company’s progress in its new markets. If those results continue to ring true to expectations, Comtech Group could be well on its way to becoming a large-cap stock.
