Time to buy eFuture

We think the Chinese supply-chain management and services play eFuture (EFUT) has bottomed, and Chinese shares in general will soon bottom out. It’s about time to get in as the second half of the year is a lot stronger than the first half, for eFuture.

We had prepared a long article but that got lost to some electronic glitch. It was too long anyway to publish as a single article, we will provide you with a couple of main points and will write more shortly.

eFuture is now cheap for a long-term growth play.

  • It has a market cap of $30M, just 1.5 times this years sales
  • It is debt-free (in fact, it has a nice stash of cash at hand, 9M according to Yahoo)
  • It generates significant cash-flow

In 2006, it went to the Nasdaq for $6 per share, and quickly zoomed to above $40. Two years later, and the company is more than twice as big.

Enterprise software is a nice business model

  • It’s knowledge intensive, with big up-front cost, but once created it can be reproduced at close to zero marginal cost
  • EFUT has a nice model in that it gets the licence fee first, and after a year it gets a monthly fee in a software as a service (SaaS) model. So the first is a driver of the latter
  • The turn-over in clients is usually very low as the switching cost are usually large (installing, learning, partnering etc.)

This happened last year:

  • Sales contracts in 2007 increased 135% to RMB129.3 million from 2006. Total new orders increased 147%
  • 2007 service fee income was RMB26.5 million, an increase from RMB6.6 million of 301% over 2006 to 892 from 361 in 2006.
  • 2007 gross profit was RMB38.1 million, an increase from RMB25.0 million of 52% over 2006
  • 2007 gross margin was 45%, compared to 52% in 2006
  • 2007 EBITDA was RMB21.1 million, an increase from RMB11.0 of 92% over 2006
  • 2007 net loss was RMB27.5 million, a decrease from net income RMB8.1 million of 439% over 2006
  • 2007 adjusted net income (non-GAAP) was RMB18.1 million, an increase of 67% over 2006.
  • Diluted losses per share were RMB10.23; non-GAAP adjusted diluted earnings per share were RMB6.74.
  • The net loss in 2007 was primarily due to one-time conversion expenses related to a US$10 million convertible note completed in October 2007.
  • They predict that sales in 2008 will grow between 65 and 74% [20F]

And 2008 got under way to a flying start:

  • In the first quarter of 2008, our new sales contracts increased 102% to RMB18 million from RMB8.8 million in the first quarter of 2007. Total new orders increased 350% to 117 order from 26 in the first quarter of 2007.
  • Service sales contracts increased 663% to RMB8.6 from RMB1.1 million in the first quarter of 2007. It is our policy to provide free maintenance for our products in the first year of operation. After the first year, we start to charge maintenance and support fees. This allows us to expand partnerships with existing customers by delivering more value.
  • During the first quarter of 2008, we placed a strong emphasis on integrating our acquisitions completed in 2007 into a single platform and smoothly incorporating new cultures into our company. This organic growth strategy has translated into a 10% increase in gross margins, if we exclude amortization of the acquired technology. [20F]

It’s also nice to know that Adam Yan, founder and CEO holds a 12.9% stake. [20F]

They are not only growing organically, but have a sensible take-over policy

  • It enables them to expand geographically and into new market segments and clients
  • It enables them to acquire new competencies and specialist personnel
  • It enables them to cross sell solutions from the acquired company’s products and to the acquired companies clients
  • It enables them to acquire economies of scale and scope
  • It can provide integration problems (both in products and organizational), but in the first part of 2008, typically the quiet part of the year, the company has focussed on these issues.

The correction in Chinese shares is in it’s tail end.

With an economy growing still at 10% and a very substantial correction (>60%) taking the Shanghai index to less than half it’s top in less than a year.

It does look nasty, doesn’t it? It looks like the graph of some terrible recession, or some gigantic bursted bubble. Well, the latter has certainly happened, but if you consider the fact that the economy is still growing by 10% you’ll also realize that the fundamentals are improving very fast. It’s also oversold.

There seems to be the beginning of awareness amongst the authorities that the bleeding has to be stopped.

  • China said it will increase the size of public investment funds and spur growth of institutional capital to develop the country’s financial markets, signaling it may accelerate approval of new mutual funds, the China Security and Regulatory Commission said in a statement on its Web site Aug. 16.

We know that the authorities can quickly turn things around with what is often almost a token measure (decrease margin requirements slightly, for example). With the first whiff of optimism returning to the market, we could see a rapid bounce. The abating of the commodities and the strengthening dollar could very well provide the necessary impetus. We think the time is ripe.

Looking at the chart you’ll notice that the big sell-off in June coincided with that of the Shanghai index sliding from 3500 to 2500.

We are now well into the second half of the year, which is seasonally by far the best part for the company

Earlier writings on some of the fundamentals