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Wednesday, September 28, 2005

China Expert Technology (CXTI) comments, assessment

CXTI has some characteristics of being capital intensive, but that's really because of the small number of projects and their current state of progress. They have high margins (28% net margin in 2004). The business generates cash. The cash cycle isn't terribly long. But to grow at a fairly fast pace (which I believe is important in order to gain competitive experience, references, and economies of scale), they'll need cash: probably $10 million this year, which could add another 6 million shares or so resulting in perhaps $8 million in profits on $30 million in revenue. That would definitely be acretive to earnings and free cash flow.

One question is: How much is the "one year of maintenance" really going to cost? Will it end up being very large? We can see results for about 6 months after the first project completed. Q2 gross margin went down to 43% from 46% in 2004 (I know, GM shouldn't be affected, but we all know how people squeeze 10 pounds of excrement into all sorts of places when they only have a 5 pound bad).

And then there's the revolving door for auditors (Telford Sadovnick, PKF, BDO), the CEO resignation, the VP resignation, and the CFO replacement. This 8-K/a has some details about the prior people.

My guess is that there are issues with revenue recognition and maybe other things.

Given the long term growth rate of China, it's worth a lot to be a major player at this point in time in government IT. A successful business can do a lot of things wrong without changing that outcome just as a failure business can do a lot of things right without changing things. I think a lot of things could happen to chip away their profits both from unexpected costs after the projects and from possible issues with revenue recognition. On the surface, CTXI will have $10 million profit on $25 million shares, making them worth perhaps $6/share. The stock is selling at $2.20. Selling additional shares to raise $10 million to gain $30 million in business would only make the shares more valuable. The company seems to have a good position for the Chinese city goverment IT market.

Is it an investment? Well, I bought a few shares, but it's not a full or even a half investment. This is one of those cases where I might jump in if something looks like it's going wrong and the stock drops (like BakBone Software).

Hi Bruce, would like to hear your comments on the CXTI finance deal ($6MM convert deb + warrants).

Looks like a toxic convert at first glance; I'm curious how the company accounts for this in its fd share count in the future. Do you know?
I'm going to post an entry for it so it doesn't get lost in the comments.
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