China to limit teen gaming; two Chinese stocks remain interesting

Although it is related to Chinese gaming, this event doesn't effect the undervalued and attractive properties of Gigamedia's stock, in my opinion. The company trades for 22x this year's earnings and just 15x next year's earnings despite incredible profitability and growth. The company has profit margins of 32% and operating margins of 24.5% -- and don't forget its 29% return on equity! It is also growing at an impressive clip - operating income has increased from just $3 million in 2004 for $22 million during the past twelve months. Sales are expected to grow 77% this year, sales and earnings are expected to increase by more than 35% next year, and analysts expect 40% annual growth over the next five years. In addition, the stock has three "added bonuses": The balance sheet is very clean with two times as much cash as debt, the short position in the stock is rather significant giving the stock an added catalyst on any good news, and the company has met or exceeded earnings estimates each of the last four quarters.

Ninetowns isn't really related to Chinese gaming but I've still seen the company sell-off on negative headlines pertaining to a variety of elements of the Chinese economy before. Ninetowns is a small ($138 million market cap) enterprise software provider. Its software is used for import/export declarations and approvals over the internet. This stock is much more a value play than a growth play. Ninetowns carries about $120 million in cash on its balance sheet -- roughly $3.42 per share. Therefore, investors are only "truly" paying about 50 cents per share for the company ($3.95-$3.42). Although the company is expected to lose two cents per share this year, it earned 17 cents per share last year and is expected to earn seven cents per share next year. Even though these figures are shaky, especially when judging the company by its total share price, when you consider that just seven cents creates an enterprise value/earning ratio of less than 9 it quickly becomes apparent that the stock is very cheap. Basically, if an acquirer bought the stock at current levels, it would be paying just less than $14 million after backing out the cash. For this price, the acquirer would be receiving $16-20 million in sales per year and a profitable business. Not bad considering its comparables set fetches an average price to sales ratio of nearly 3.

Although I'm unsure about how this news will affect Chinese stocks, I think that both Gigamedia and Ninetowns are interesting stocks, especially if they were to pullback. Gigamedia offers significant growth at a rather cheap price and Ninetowns looks perfect for an acquisition with its cash-rich balance sheet and (usually) profitable business.