Telestone's capability to generate cash flow is poor. Although its revenue and net income have grown three-fold over the past 3 years, its cash position didn't improve at all. Everything the company earned in the past has been used to finance the ever growing A/R. In any quarter, it has no more than a few million dollars on hand.
China Grentech's financial position is even poorer, obviously forced to take on quite some debt in order to finance its huge A/R. It is highly likely Telestone may soon follow suit. The company appears to have prepared itself for this scenario, having secured some credit facility.
Admittedly, the collection risk is small, as it is unlikely any of its customers will not have the ability to pay. However, I would not want to own a business that lends money to its customers interest-free for such a long time horizon.
Another company with similarly long A/R days is E-house China Holdings Limited (EJ). It has also demonstrated high volatility, although to a lesser degree. E-house is expected to report EPS growth of 164% in 2009; however, the stock only trades at around 12x forward P/E as of Feb 25th.
In summary, with these major risks, it is quite difficult to hold Telestone as a long term investment, particularly at its current price. The value of such a business must be discounted significantly. I believe most buyers are in the stock simply to chase the short term momentum, which in part contributes to the stock's high volatility.
It is possible that, at some point, when the momentum runs out, Telestone may be a good target to short, given the substantial risks. It may not be the right time yet, but I will keep the name on my radar.
Disclosure: No positions
About the author: Southhill PartnersView the Original article
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