Opportunity to Profit from the growing China Trade Surplus – Global Sources (GSOL)

According to the official Xinhua news agency, China exported $97.45 billion of goods in April and imported $80.57 billion. While such large trade surpluses are causing much friction between China and its trading partners abroad, there is one company which is benefiting from the growing export volume.

The company is Global Sources (GSOL), a Hong Kong based company listed in NASDAQ, its business is simple – linking Chinese manufacturers (suppliers) to international buyers.

Here is its official company description:

The company provides sourcing information to volume buyers and integrated marketing services to suppliers. It helps a community of over 560,000 active buyers source more profitably from complex overseas supply markets. With the goal of providing the most effective ways possible to advertise, market and sell, Global Sources enables suppliers to sell to hard-to-reach buyers in 230 countries.

The company offers the most extensive range of media and export marketing services in the industries it serves. It delivers information on 1.8 million products and more than 150,000 suppliers annually through 13 online marketplaces, 12 monthly magazines, over 100 sourcing research reports and nine specialized trade shows which run 22 times a year across seven cities.

Suppliers receive more than 10 million sales leads annually from buyers through Global Sources Online (www.globalsources.com) alone. Global Sources has been facilitating global trade for 36 years. In mainland China it has over 1,600 team members in 44 locations, and a community of over 1 million registered online users and magazine readers for Chinese-language media.

BUSINESS FUNDAMENTALS

A business with strong growth potential

In FY2006, net income increased by 108% with main driver derived from tradeshow business which grew by almost 200%.

For online and print, organic growth alone I believe it shall be able to maintain 15-20%. Real potential is in tradeshow business with 2 strong drivers:

1. Moved its flagship ‘China Sourcing Fair’ venue from Shanghai to the new Asia World Expo in Hong Kong which significantly increased the available booth space. (total of 3,500 booth sold in 2005 vs. 13,000 in 2006)

2. Introduction of more shows.

For example, in 2007 GSOL has introduced the following new shows

• China Sourcing Fair: Dubai June 2007
• China Sourcing Fair: Underwear & Swimwear: April and October 2007, Hong Kong

An extremely loyal management team

(year of service with GSOL)

Apart from the CEO who is the founder, the management team has been with the company for 21 years on average. I would say it’s difficult for competitor to gather a team like this who has such strong operational experience in China.

Besides, there is a reason for me to believe the whole team is working hard to create a home run in 2007 as this is a very rare strategic window with all factors acting very positively towards GSOL. (China story, China trade surplus, internet story, China domestic consumption story so on and so forth). With 21 years' of loyalty they deserve their fair share of reward !

Growing China Export Volume

The growing imbalance in export/import is to the benefit of GSOL, though there is no breakdown of the source of online revenue I believe majority of it shall be outbound, i.e., Chinese manufacturers using GSOL service to export overseas.

A very strong cash generation engine

Day sales outstanding (DSO) improved from 20 days to 17 days from 05 to 06. Tradeshow and online services are both paid-in-advance cash business. No worry about account receivable!

Strong sales team on the ground

They have 1600 (75% of total headcount) sales and customer servicing people on the ground in mainland China to service its manufacturer clients. This can create a higher level of stickiness comparing to EBAY you would have nobody to call in China in case you need help. According to company information they visit over 40,000 clients every month! This is not something new entrant can imitate in a short period of time.

NEW CATALYSTS FOR 2007

Growth through acquisition of HC International

In Dec 2006 GSOL has acquired 13% of HC International. (HK GEM listed 8292.HK)

HC’s main business is in operation of its B (domestic)-To- B(domestic) online trading site www.hc360.com

Currently GSOL’s business is more in B (domestic)-To- B(international), HC would be a complementary business to GSOL and help expand its domestic revenue.

By June 2007, GSOL would have a right to buy an additional 35% of HC and trigger the requirement for a general offer as required by HK listing regulation.

According to HC company disclousre, HC CFO has already resigned, is it a hint to the acquisition result?

Following chart is how GSOL segments its competitors (extracted from its 2006 annual report) :

Alibaba IPO shall be a STRONG PUSH

According to news from China, Alibaba.com – the largest B (domestic)-To- B(domestic) trading site in China, is planning for a listing in Hong Kong in Q3 2007.

Alibaba is 40% owned by Yahoo and remaining shares majority owned by Alibaba’s founder Jack Ma, a celebrity in China’s internet industry.

Alibaba’s valuation would not be priced cheap. Average P/E for China internet stock is around 36, while EBAY is 37. With a China story and Mr. Jack Ma’s personal brandname I guess 30% premium can be warranted and that would give Alibaba a P/E of 48, versus GSOL at 30.

Re-valuation of GSOL

If HC acquisition is successful and GSOL can turnaround the money losing hc360.com business. Let's do a Sum-of-the-parts re-valuation of GSOL.

Assumptions:

1. As there is no breakdown of P/L of each individual revenue stream from the GSOL annual report, I can only equally allocate the net profit to each segment based on revenue.

2. HC net profit margin is assumed at 8%, which is 50% discounted from GSOL’s 17%. I believe domestic buyers can afford less on GSOL's service and hence the domestic revenue stream shall be less profitable. Besides, it takes times to fully integrate HC with GSOL though there can be great leverage with GSOL’s existing platform both from technical and human resources point of view, but it won’t be fully realized in 2007.

3. Online and Print each grows at 15%, Tradeshow at 30%.
4. PE of 20 for Print, which is ~40% premium over industry as GSOL produce high value added trade catalog vs. ordinary print business
5. trade show valued at industry PE of 14
6. Online valued at 48x PE, my estimate for Alibaba
   

With HC’s 2006 revenue at RMB291M (~US36M) that would contribute 0.068 EPS to the combined online revenue, and Sum-of-the parts valuation would price GSOL at US$26.7. An upside of 43% from current price of around $18

If HC acquisition failed, GSOL would still worth $23 giving 23% up side.

GSOL’s Q1 result will be announced on 22^nd May. Let's keep a very close eye on its development.

Disclosure: I own GSOL at the time of writing this article.