Cashing in on a hot commodity…
Getting a cell phone is the easy part—but where’s the connection?

by Siu-Yee Ng

China is a great place to visit. Some may disagree with me. Some people have a misconception about China: communist rule is bad and it’s a backward country with no indoor plumbing. And even I was one of those people who worried about traveling to China.

I was born in Hong Kong and visited China often as a child. I came to America at a young age and have been spoiled by the many amenities we take for granted here. I like having indoor plumbing, a telephone, a television, and the freedom to say and do what I want.

I’ve been back to visit China several times, usually staying anywhere from two to three months. I’ve seen different sides of China. The hustle and bustle of making money. Men and women in business suits carrying briefcases rushing to meet clients. Cell phones ringing everywhere I went.

And then there is the other side—days spent chilling out in front of the television with a nice cold beer or having friends over for a friendly game of cards. Life didn’t seem so different.

Despite communist rule, people are wheeling and dealing in China. Granted, there are still obstacles to operating there—but the country holds a vast number of opportunities. And in a minute, I’ll tell you how you can cash in.

A growing nation

In terms of landmass, China is the third largest country in the world. You can just imagine the amount of infrastructure it’ll take to connect it all. One sector I like in China is telecommunications. Since this sector has been battered in the U.S., you may wonder why it’s different in China.

Simple. China is a huge country, and in many places still lacks telecommunication lines to support large numbers of customers. Demand is high but supply is low, driving up cost.

This was definitely an inconvenience while visiting family in Taishan. Because of the limited number of phone lines, I was forced to make calls at a local convenience store. For some families, the problem wasn’t the money, but the lack of available phone lines.

But companies like AsiaInfo Holdings (ASIA:NASDAQ) are providing telecommunications network integration and management solutions in China. AsiaInfo’s software products and network services help its customers build, maintain, operate, manage and continuously improve their Internet and telecommunications infrastructures.

This will hopefully create more efficient lines, in turn decreasing costs. And maybe in the next decade we’ll see a telephone in every Chinese household.

Anticipating West Nile

AsiaInfo began operating in Texas in 1993 before moving its operations to China in 1995. It was not until 1996 that the company began generating significant network solutions revenues. Software solutions revenues started rolling in in 1998.

AsiaInfo debuted on March 3, 2000 amid the frenzy of the IPO hoopla. Five million shares were offered at US$24, and the stock closed up 314% on the first day. It’s hard to believe that this stock is currently trading at around US$4. What’s happened since then, and is this a buying opportunity?

Historically, AsiaInfo has relied heavily on sales to China Telecom and its provincial subsidiaries. This accounted for 80%, 35% and 45% of its revenues net of hardware costs in fiscal 1999, 2000 and 2001, respectively. The company is trying to change this.

By March 31, 2002, only 15% of its backlog net of hardware costs was attributable to China Telecom. China Unicom accounted for another 26%, China Mobile accounted for 45% and China Netcom accounted for 4%.

Territorial expansion

AsiaInfo continues to grow through its investments and acquisitions. On April 27, 2001, the company acquired a 14.25% equity interest in Intrinsic, a company organized in the Cayman Islands and engaged in wireless Internet applications and development through its two wholly-owned subsidiaries in China.

The company is also the majority owner of Marsec, a network security business that focuses on high-end security services.

And on February 6, 2002, AsiaInfo acquired Bonson, a leading provider of operation support system solutions to wireless telecommunications carriers in China.

To fairly depict AsiaInfo’s new services and products, the company reorganized its operations into three strategic business units earlier this year: network infrastructure solutions, operation support system solutions, and service application solutions.

AsiaInfo recognizes two principal types of revenues: from network solutions and from software solutions. In 2002, the network integration solutions unit is expected to generate 70% to 80% of their total network solutions revenues, and the operation support system solutions and service application solutions units are expected to generate 90% of their total software solutions revenues.

Making money

Software solutions revenues have accounted for an increasing portion of total revenues net of hardware costs over the past several years, increasing from 7% in 1997 to 39% in 2001 and 40% for the first quarter of 2002.

At March 31, 2002, AsiaInfo’s revenue backlog net of hardware costs was US$51.4 million, a 16% increase over the previous year. Software solutions accounted for 50% of net revenue backlog, a 72% increase over the prior year and an 11% sequential increase. Bonson accounted for 27% of the total backlog net of hardware costs and 31% of software backlog.

Gross revenues were US$28.5 million in the three-month period ended March 31, 2002, representing a decrease of 20% compared to the same period in 2001. This decrease was due to recording a lower amount of hardware pass-through costs.

This change reflects the company’s increasing focus on higher-margin software solutions and does not significantly affect its gross profit because hardware-related revenues generally approximate the costs of the hardware.

Revenues net of hardware costs were US$17.1 million in the three-month period ended March 31, 2002, representing an increase of 20% over the comparable period in 2001. Total software revenues for the quarter were US$6.8 million, an increase of 16%. Bonson contributed 12% to the quarter’s total revenue net of hardware costs and 13% of software solutions revenues.

Long holidays

Although net revenues grew over the same period in 2001, the company did experience a sequential decline in net revenues during the first quarter of 2002. Software solutions revenues were US$6.8 million, up 4% compared to the preceding quarter, and total net revenues were US$17.1 million, down 15% compared to the preceding quarter.

This was attributable to the seasonality of business in the first quarter of each year due to the long public holidays in China, and to a slowdown in network infrastructure spending resulting from the announcement last year of the restructuring of certain state-controlled telecommunications companies in China, including China Telecom.

But what really dragged the stock down were its second-quarter 2002 results. AsiaInfo actually met its guidance. Operating profits for Q2 came in at US$3.8 million. That’s a 118% increase from the prior year and a 252% increase from the preceding quarter. Net income for Q2 increased 40% from the same period in the previous year, and 154% from the preceding
quarter.

Results like these should lift the stock. But here’s the problem: net revenue backlog decreased 12% sequentially in Q2. China’s reorganization of its telecom sector has been slower than expected. And this has caused some service providers to delay infrastructure expansion and improvement projects.

In effect, AsiaInfo anticipates a lower-than-expected Q3 revenue. This in turn has led the company to lower its full-year guidance.

But there is some good news. AsiaInfo remains profitable and is currently trading close to book value. Institutions continue to buy at these levels. Remember, China’s telecom industry still has a lot of ground to cover. Once restructuring is completed, orders will again flood AsiaInfo’s desks. If you’re looking to diversify and to add a global investment, AsiaInfo is a good bet.

Buy AsiaInfo Holdings (ASIA:NASDAQ) under US$4.50.

For more information on AsiaInfo Holdings, Inc. please contact: 4th Floor, Zhongdian Information Tower, 6 Zhongguancun S. St., Haidian District, Beijing 100086, China, tel. +86-10-6250-1658, fax +86-10-6250-1893, www.asiainfo.com.