LAS - Lentuo International Inc

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LAS  - Lentuo International Inc

 

It is another US-listed Chinese company.You might get bored and try to avoid investment in this space due to a lot of exposed frauds in Reverse-merger space. But I think this one is different. The fear of fraud creates a buying opportunity.

 

I wrote about FFHL (Fuwei Film )  http://cornerofberkshireandfairfax.ca/forum/index.php?topic=3222.0 last October in this forum .On one replied on my topic.It might due to my poor English writing skill . But anyway, I am lucky that FFHL went up around 400%  within just a few month (I sold all my position already) .  So if you take a closer look,  this Chinese stock space can give a very good reward/risk profile .

 

The Company is a non-state-owned automobile retailer in Beijing, it operated six franchise dealerships.

It went listing on NYSE on last December at $8 per ADR . But it is currently trading at $4 today.

 

Here is a research from HSBC ( sell-side analyst ) http://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=Z0wfJri3PW&n=288420.PDF

 

Lentuo is the cheapest player on China Auto dealership business. There are another two comparable competitors which are a lot bigger . They listed stock in Hong Kong market. Both were listed last year just a few month prior than Lentuo. Both are rich valuation at these price. A lot more expensive than Lentuo.

 

Zhongsheng Group (0881.HK)

Market Capitalization - US$3.5 Billion  - 98 Dealerships ( Many dealerships are not 100% own ) $35 Million per one dealership.

PE - 31 ( From Reuters )

Revenue 2010 = RMB24 Billion . RMB245 Million per dealership ( This is not 100% accurate because most dealerships were just built/acquire during the fiscal year) .

 

China Zhengtong Auto (1728.HK)

Market Capitalization -  US$2.1 Billion - 22 Dealerships + lubricant oil business and logistic business (other business is 6% of revenue and 12% for total Gross profit)  I use 88% multiply by mkt capt to obtain what investor value its dealership business . This is  $1.85 Billion .So US$ 84 M per dealership.

PE ~ 34 ( From Reuters )

Revenue RMB7.61 Billion (excluded other business revenue ) - RMB346 Million per dealership . Not 100% accurate due to same reason as above .

 

Lentuo (LAS)

Market Capt - $120 Million US - 6 Dealerships -  $20 Million per  dealership

Only trading around PE ~ 5 ( trailing PE Q4-2009 To Q3-2010 ) .

Trailing revenue is RMB2.91 Billion. RMB485 per on dealership.

 

 

I used trailing figure for Lentuo because it is more conservative. Acutally, management and analyst expect higher 2010Q4 revenue on YoY basis.

 

Base on these calculation it is cheapest among the three but also the smallest and the only one that listed in NYSE. But revenue per dealership is a lot better than its peer. So the HSBC research that claimed its single store efficiency is 3x higher than the market average is not over claimed .

 

At these price ,market thinks Lentuo is a fraud .But I think it is little chance it is .

1. Lentuo has HSBC as the underwriter for its ADR . HSBC is one of the most reputable bank in Asia and the world .This ensure Lentuo creditability also.

2. Lentuo went listing on NYSE via ADRs not reverse merger .But this is not the holy grail to say that it is not a fraud .I understand this.

3. Lentuo has a good reason to do ADRs listing. It needs capital because auto dealerships are capital-intensive business. And the management has a plan to expand outside of Beijing . While two biggest players ( Zhongsheng & Zhengtong ) are a lot bigger than Lentuo .So if Lentuo wants to compete in this space. It need to raise capital .Same as competitors did.

4. Company is well controlled by another major shareholder which is Newman Investment Limited . Newman is also Chinese investor. And they just bought the shares last year before public offering. And Newman has an agreement with Lentuo chairman ,Hetong Guo , which also own 50% of the company.Here is the agreement ( excerpt from Prospectus )

 

"Pursuant to an agreement between Mr. Hetong Guo and Newman Investments Limited, if our audited net income for the year ended December 31,

2010, or the 2010 net income, is lower than RMB160 million, Mr. Guo will transfer to Newman Investments Limited free of charge such number of

additional shares so that the shareholding of Newman Investments Limited will equal 1,510,841 shares multiplied by a ratio, the numerator of which is

RMB160 million and the denominator of which is equal to the 2010 net income"

 

So Newman Investment is not the same group as the chairman.This add up the better internal control in the company.

 

Given all these facts. I think there are very little chance that Lentuo is a fraud.

 

Another bad news

1. Beijing Regulation control on new car sales

- You can read on management on this issue on Q3 report here (http://www.businesswire.com/news/home/20110106005791/en/Lentuo-International-Reports-Quarter-2010-Financial-Results)

 

IMO,This is biggest risk .But by the figure management explain. It is not that much impact on the sale . Besides, Company plan to expand to another cities. This regulation might help prevent more opening new dealership in Beijing which is good in the long term .

 

2. Japan Tsunami impacts to make a shortage of car supply

- Most of the brand in Lentuo dealerships are manufactured in China. But some parts has to be imported also. I expect supply chain problem to be temporal, should not be more than one year. So it is just a short term problem.

 

Autodealership business does not have many moat around its.And it is capital intensive .Lentuo has negative cash flow between 2009-2010 which is nature of growing business in capital intensive industry. But at this valuation,it is too cheap to pass up.

 

Net income so far in 2010 (Q1- Q3 ) is $16.68 Million. And management guided Q4 rev to be about $176 -$182 Million range.