Sinotel Technologies - ADR gains momentum

Since our previous report in August, a couple of developments have taken place. First and foremost there was a new contract win worth RMB15.3 million to provide 3G Distribution & Management System to China Unicom. At first glance, the figure seems small relative to its order book but it serves as a significant milestone in our opinion. The 3G Distribution & Management System basically keeps track and assist in managing China Unicom’s 3G sales and distribution channels between them, the distributors and exclusive third-party vendors across 31 provinces. This opens doors for Sinotel in terms of the opportunity to work with China Unicom’s 31 branches nationwide when deploying the system.

A second significant news update is the submission of American Depository Receipt (“ADR”) application to the US Securities Exchange Commission. ADRs represent ownership in the shares of a non-US company and trades in the US financial markets. It enables US investors to buy shares in foreign companies without undertaking cross-border transactions as ADRs carry prices in US dollars, pay dividends in US dollars and can be traded like the shares of US-based companies. Each ADR issued by the depository bank (The Bank of New York Mellon in this case) represents a fraction of a share, a single share or multiple shares of a foreign stock. For example, if the ratio is 1 ADR to 10 Sinotel shares in SGX, for each ADR a US investor purchases, 10 Sinotel shares will be delivered to the investor by buying from the open market of the Singapore Stock Exchange without a need to issue new shares.

We are very bullish on this event as ADRs provide increased liquidity to its shares, attract foreign investors and allow the company to carry out future fund raising activities when required. This greatly complements the Group’s participation in the prestigious Rodman & Renshaw Annual Global Investment Conference on 11 September 2009. This conference is expected to draw more than 2,500 investment professionals from around the world and Sinotel will have the opportunity to participate in the corporate presentation and daily networking sessions. We do not see any difficulty in the application of ADR to US SEC as, at this level, it is relatively straightforward and mainly requires that the company be listed in one or more stock exchanges in a foreign jurisdiction. We believe that with the approval of the ADR and the increased awareness derived from its roadshow in the US would give significant upside to Sinotel’s current share price.

Lastly, the Company has recently (4 September 2009) announced a placement of upto 28m new ordinary shares at a placement price of S$0.5052 per share. The placement will be placed to interested investors of which Providence SOGF Limited is one. The placement shares at full subscription represent 10% of Sinotel’s existing issued and paid up share capital of 280m ordinary shares. When completed, the placement will increase the issued and paid up capital to 308m. This has reduced our EPS forecast for FY09 from 10.72 SG cents to 9.27 SG cents.

Maintain BUY call at fair value estimate of S$0.93. Sinotel’s share price when we issued our report in August was only S$0.275, it has run up to S$0.585 since and we attribute the main reason to the announcement of the ADR. With the ADR just round the corner, we are pricing Sinotel closer to its US listed peers such as China Grentech Corp Limited and Telestone Technologies Corporation (Fig 2), which are currently trading at a PE of 13.53x and 6.66x respectively. With US investors likely to come in, the view that Sinotel is priced at a discount versus its peers is not unlikely. We thus move our PE to 10x FY09 forecasted earnings. This gives us a fair value of S$0.93, maintaining our BUY call. From the last traded price of $0.585, this represents an upside potential of 59%. As mentioned earlier, we view the ADR as a significant catalyst to the recent run up in share price, approval of which provides US investors a channel to purchase Sinotel shares that is still trading at a significant discount versus its peers.

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Sinotel Technologies - BUY at a fair value of S$0.33

Relatively strong earnings growth. The Group announced growth in revenue of 36.1%, from RMB 104.4 million in 2QFY2008 to RMB 142.1 million in 2QFY2009. Its half-year revenue has increased by 30.9% from RMB 182.3 million in 1HFY2008 to RMB 238.7 million in 1HFY2009. The Group attributes the growth in revenue to the increase in contribution from their “Wireless Network Solutions” and the revival of their “Distribution Solutions” from the commencement of sales of 3G network cards in July 2008. The increase in the Group’s wireless network solutions were due mainly to the securing of more contracts in Shanxi province as well as the increase in the contribution from its Emergency Mobile Communication System, introduced last year.

Growth in profits albeit a decline in margins. Gross profits were reported to increase from RMB 47.0 million in 2QFY2008 to RMB 56.6 million in 2QFY2009 depicting a 20.5% growth. Despite earnings growth, the Group’s gross profit margin fell by –5.2ppts from 45.0% in 2QFY2008 to 39.8% in 2QFY2009. The decline in profit margins was brought about by sales of equipment to the telecommunications operators. The telecommunication operators have, in 2008, changed their procurement policy to one that encourages central bulk purchasing for certain contracts based on their overall or provincial requirement. Contracts of such nature command lower margins, as there are no other services such as design and installation services required. The Group’s net profits for 2QFY2009 and 1HFY2009 increased by RMB 5.4 million or 15.0% and RMB 9.8 million or 16.1% compared to the corresponding periods in 2008. Net profit margins fell from 34.6% in 2QFY2008 to 29.25% in 2QFY2009. Net profit margins for 1HFY2008 was 33.3%, falling to 29.5% in 1HFY2009. The fall in net margins were due mainly to significantly higher general and administrative expenses as well as a moderate increase in finance costs due to increased borrowings.

The road ahead. We still believe that Sinotel, amidst this frenzy of telecommunication operators’ capital expenditure spending, is well positioned to benefit considerably. Despite the economic slowdown, China’s telecommunication industry has proven its resilience through progressive growth due mainly to the introduction of 3G this year. We believe that a few factors will seek to ensure the industry will continue to perform well: The number of cities targeted to have 3G networks for this year alone (more than 200 key cities) and massive upgrading projects running concurrently across the country to handle increased subscriber base. These all require significant capital expenditures by the (3) three telecommunication operators, benefiting equipment/solutions providers like Sinotel.

The Ministry of Industry and Information Technology (“MIIT”) in the PRC has expressed the Chinese Government’s intention to spend close to RMB 280 billion on 3G upgrading networks in the next three (3) years, inclusive of the RMB 150 billion to be spent in 2009. To date, the three (3) telecommunication operators have spent more than RMB 80 billion collectively, which is in-line with MIIT’s estimation done at the beginning of the year.

Reiterate BUY rating at a revised fair value estimate of S$0.33. We maintain our BUY rating with a revised fair value estimate of $0.33, from a peg of 3.5x to FY2009’s earnings. We have also increased our revenue forecasts for FY2009 and FY2010 slightly, taking into consideration the recent contract wins. Our previous price target of S$0.27, pegged to a 3.0x FY2009 PE, has been achieved and we believe, with the bullish sentiments for China’s telecommunication industry for the next few years, Sinotel, as one of the major beneficiaries, should see further contributions to its revenues as seen in the number of projects clinched in the last few months. A quick look at its immediate peers (Exhibit 2), we can see that Sinotel is already trading at a significantly lower PE value as compared to the rest with the average trailing PE for its peers at 16.61x and forward PE of 11.39x. Average peer price to book value is at 1.39x whilst Sinotel sits at 0.93x.

Sinotel Technologies - Maintain BUY; TP: S$0.33

Revenue in 1Q09 increased by RMB18.7m or 24.0% to RMB96.6m compared to 1Q08. This was mainly due to the increase in contribution from the Emergency Mobile Communication (EMCS) and sales of 3G cards.

Overall gross profit for 1Q09 was 41.2%, a marginal decrease of 0.9ppt compared to 1Q08.

General and admin expenses for 1Q09 increased by RMB1.4m or 25.0% to RMB7.2m due mainly to the increase in depreciation of RMB3.3m, arising from the fixed assets additions in the third and fourth quarters last year.

The bank facilities available to the Group as at 31 March 2009 were RMB65m, of which RMB33.7 m was utilized.

There are some positive developments for Sinotel during 1Q09, particularly (1) rapidly growing telecommunication industry in China, (2) swelling order book and (3) new credit facilities secured. China's telecommunication industry is undergoing a rapid expansion and upgrading activities since the official issuance of 3G license in January 2009. As the industry is in its growth stage, there are a lot of business opportunities for Sinotel. The capex for wireless network enhancements in China is estimated to be RMB33-50 billion. Its order book, currently standing at RMB390m, is expected to swell. In addition, the new credit facilities secured by Sinotel recently ease our concern over lack of capital to finance its growth plan. On valuation front, we peg at 4x PER FY09 (previous 3x) to derive a target price of S$0.330. Maintain BUY.