The Motley Fool called KongZhong Corporation (KONG) the best small cap stock for 2007 back in December. They noted that KongZhong is the second-largest wireless value-added service (WVAS) provider in China, their business was "growing like a giant gorilla", and their statement about China’s WVAS potential was enticing for any investor:
The market for WVAS in China is huge; the country’s total number of cell phone subscribers has increased from 85 million in 2000 to more than 425 million today. That’s more than twice the number of cell phone users in the entire United States.…
On an operational level, the company’s (KongZhong) operating income margin of 22.8% and net
income margin of 25.9% beat those of all three of its major competitors, TOM Online (Nasdaq: TOMO), Hurray! Holdings (Nasdaq: HRAY), and Linktone (Nasdaq: LTON). Combine this growth and margin superiority with a rock-solid balance sheet of zero debt and $3.40 in net cash per share — 42% of the current $8.10 stock price — and you’d think KongZhong’s stock would trade at a premium multiple to its competitors.
However today shares of KongZhong are trading around $5.50, down 23% since this morning due to a horrible earnings call. It appears the best small cap stock for 2007 is now one of the worst performers for the year.
But was the Motely Fool that far off and is it now the time to take a chance on China’s No. 1 WVAS play?
KongZhong Corp. (Nasdaq: KONG) reported a disappointing Q1 07 as far as Wall Street is concerned. Net income for the first quarter of 2007 was $2.13 million, or $0.06 per share, compared with a net income of $8.61 million, or $0.24 per share, in the same period of 2006, the company reported after Monday’s close. That’s in line with expectations. However total revenues for Q1 07 decreased 28% from the same quarter of 2006 and decreased 15% sequentially to $20.13 million. Then the real downer is that KONG is expecting revenue of $16 million to $18 million for Q2 07, while analysts polled by Thomson Financial expect revenue of $21.2 million.
Yunfan Zhou, CEO of KongZhong said: ”The first quarter was a challenging quarter for us given the tough WVAS operating environment, and we expect that the tough operating environment is likely to continue for some time. Our total revenues were in line with the guidance. We are happy that we achieved double-digit quarter- over-quarter growth in mobile advertising revenue. We believe we are making good progress in our wireless Internet business.”
Just a few months ago, it was all about China and finding the right Chinese stock. Every investor in America was hungry to catch the wave on the growing Chinese economy — how quickly the world changes. If the CEO of KongZhong is telling us that China’s WVAS is not going to be this wonderful waterfall of money, then it’s time to take a realistic look at what KongZhong can achieve. That’s why the bears are attacking this stock today, taking it down to just a few cents above its 52-week low of $5.40. You can’t blame the guys at Fool.com and if anything, investors who thought about investing in KongZhong, should now really think about getting in while the stock is at a bottom. Does that mean this is the magic entry point and you are guaranteed a instant ROI? Of course not, but KongZhong is not going out of business, and WVAS and cell phone users in China is going to keep growing, just not at the record pace Wall Street wanted.
If anything, cell phones make sense for China, huge growth isn’t going to occur as fast because people aren’t running out to buy computers and laptops as quick as they are cell phones. This isn’t rocket science here folks, China is an emerging economy, and to think KongZhong won’t make a comeback is crazy? Of course KongZhong will come back and more cell phones are being sold there everyday. Hate the stock today, I hate it with you. But we all know everyone loves a comeback kid, and if KongZhong can start moving in the right direction, the stock will move right with it. Their outlook is still for $16 million to $18 million for the second quarter, sure its not $21.2 million, but it also isn’t a negative or a horribly small figure.
It’s easy for me to roast on the Fool for calling KONG the Best small cap stock for 2007 today. But in a few months, they may be able to turn the table on me and say, "told you so".
Frank Lara Jr.
Frank Lara Jr. can be reached at [email protected]; he does not own securities in the companies he covers.
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