China Techfaith: Currently An Immensely and Incredibly Undervalued Stock
November 7, 2012
In this article I will argue that smartphone and social gaming developer and distributor China Techfaith Wireless (CNTF) is an immensely undervalued stock, whose value is being almost completely ignored by the market, and, as such, might be the next recipient of a "going private" proposal (at a 400% premium to current share price which would be at about $6 -$7 a share).
When the internet bubble burst in 2000-2001, and the tech sector swooned almost 80%, the market capitalization of several companies actually fell well below the net cash on their balance sheets. This led to a number of them receiving "going private" proposals from management or offers from opportunistic buyout firms. Those who had the foresight to purchase these stocks before the offers were on the table were rewarded handsomely.
We are currently experiencing a similar opportunity in the stock market, only this time it is in regard specifically to certain small-cap Chinese stocks listed on the U.S exchanges. This is no doubt due in large part to the number of frauds and subsequent delistings in this sector over the past several years. Research firms such as Muddy Waters exposed the risks of these companies, especially those that gained access to U.S. financial markets through reverse mergers or RTOs. As a result, many investors have become skeptical of all Chinese companies. This has led to investors painting virtually all small-cap Chinese companies with the same brush, regardless of revenue growth, management credibility, or balance sheet strength.
In recent months, CEOs of legitimate Chinese companies have become keenly aware of this phenomenon. With the shares of their companies often at multi-year lows, and frequently trading below cash, management realizes that the market is not valuing their business properly. As a result, many have engaged in "going private" proposals in recent months, as Seeking Alpha contributor Markus Aarnio has highlighted. Our mission is to try to identify the most likely company to receive the next "going private" proposal or takeover bid. I believe that company is China Techfaith.
Huge Stash of Cash
China Techfaith has over $252 million in net cash on the balance sheet. That is well over 5x its current market capitalization. I know of no other stock on any exchange that trades at less than 1/4 of its cash. Additionally, this cash balance has risen both sequentially and year over year, so cash burn is not currently a concern. So assuming Techfaith's cash and business operations are not a complete fraud, there is a massive opportunity here (more on this later).
Last year, the Chairman and CEO, Defu #$%$, purchased a total of 263,000 shares, and now owns 1/3 of the company. Pursuant to his purchases, #$%$ said, "I believe TechFaith is undervalued. I decided to increase my ownership based on my confidence in the Company's market position and my belief in its continued growth prospects." At the time, Techfaith's stock was trading in the $4s. This was immediately prior to the rampant fraud exposed in so many Chinese names that caused the widespread and indiscriminate selloff in the sector. I'm betting that Mr. #$%$, like so many other Chinese small-cap CEOs in recent months, is seriously thinking of making a tender for the remainder of Techfaith shares.
Techfaith recently filed suit against smartphone goliath Samsung for patent infringement. As most investors are aware, patent plays have received an enormous amount of attention lately, with tons of speculative money flowing into the sector. Just recently, Vringo defeated Google, AOL, and other heavy-hitters in a highly anticipated court decision and was awarded hundreds of millions in damages. VirnetX (VHC) was just awarded $368 million in a high stakes claim against Apple. Moreover, the China Patents Committee has already acknowledged that TechFaith's mobile phone patent is effective and relevant. Does Samsung, a Korean company, really want to risk litigation in China against Techfaith on its home turf? Samsung, already suffering from a patent defeat at the hands of AAPL, may be eager to settle with Techfaith. In fact, rather than wasting weeks in court and hundreds of thousands in attorneys' fees, why not just buy the company? Offer a 400%-500% premium ($7-$8 a share) to the current share price, and Samsung would be getting Techfaith's entire business and patent portfolio for free!
Too Good to be True?
A company with close to $5.50/share in the bank, trading at around $1.50 with an enormously valuable patent portfolio, large CEO stakeholder, low cash burn, trading at a fraction of sales, selling millions in Android smartphones, launching a mobile game initiative, and involved in social media, -- the cheapest stock in the world, or too good to be true? The biggest worry an investor might have is that the company is an apparition, like the now delisted RINO, CCME, or SNOFF. However, I believe this is extremely unlikely and that these concerns are unfounded for multiple reasons. First, the Chairman and CEO owns close to a third of the company. Rather than selling shares, he has been adding to his position. Secondly, the company has a relationship with Google, which does its own due diligence before licensing its Android operating system. Also, a company with skeletons in the closet is unlikely to pursue claims against a behemoth like Samsung, as those skeletons would surely be exposed during negotiations, discovery, or in the courtroom. Additionally, famous short seller Zack Buckley recently stated at the Value Investing Conference that shorting Chinese frauds has been "played out", i.e. most of them have already been identified and delisted. Finally, China Techfaith was not an RTO like so many of the delisted Chinese companies; the lead banker for its IPO was tier-1 firm Merrill Lynch.
And....I have researched this exhaustively....there is currently no stock anywhere on any market anywhere in the world selling for just 1/4 its cash value.
So, in conclusion, rather than "too good to be true," I proclaim China Techfaith to be "the cheapest stock in the world."
Sentiment: Strong Buy