Company Description

Established in 1997 and public since 2003, Comba Telecom ("Comba") develops communications products that enhance coverage of mobile signals in China and internationally.  Comba operates in four segments: wireless enhancement, antennas and subsystems, wireless access and services.

• Wireless Enhancement (33% of revenues): Products receive radio signals from base stations, amplify them and re-transmit them to areas where base station signals cannot reach
• Antennas and Subsystems (27% of revenues):  Products consist of antennas and tower mounted amplifiers
• Wireless Access (8% of revenues): Microwave products enable transmission b/w points where physical cable infrastructure is absent and WLAN products offer access point and access control solutions (i.e. hotspots)
• Services (32% of revenues): Consultation, commissioning, network optimization, project management and after-sales maintenance services

Major customers include China Mobile (52% of revenues), China Unicom (24% of revenues), China Telecom (9% of revenues) and International (15% of revenues).

Investment Thesis

Industry Attractiveness

• Comba's operations are levered to the wireless penetration and adoption in China as well as data usage
• China is the world's largest wireless market with over 860 million subscribers and its subscriber base is growing by approximately 8-10 million subscribers per month
• Introduction of smartphones is driving data usage and it is estimated that China is about three years behind the US in terms of smartphone penetration
• Comba relies heavily on the capex spend of the major telco operators; major 3G buildout was completed during 2009/2010, as a result, more capex dollars will be spent on enhancing and optimizing the network, benefitting Comba's various divisions

Superior Market Positioning

• Comba is the leading market player in China with an estimated 25-30% market share, twice its nearest competitor
• Comba has the biggest scale with a national footprint, ~230 sales offices across China vs. 28 for its closest competitor
• Company has the highest R&D spend resulting in technology lead/innovation vs. competitors, resulting in higher pricing power and higher margins

Differentiated Business Model

• Unlike its competitors who are only components suppliers to major telco operators, Comba is a turnkey solutions provider offering integrated products and services touching all of its customers' needs across their capex cycle
• Services segment, which provides higher margins (~40-50% gross margins) and a recurring revenue source, is expected to grow to 40% of overall business from current 30%
• Due to services segment and technology lead, ~50% of sales come from direct negotiations with clients vs. centralized procurement/bidding process where decisions are mainly based off of product costs

Operational Track Record

• Comba has been able to maintain its gross margins within the 37-39%range over the last 5 years (even during 2008/2009 period), despite most of its competitors dropping to 25-30% gross margin levels
• Given fixed cost structure, there are increasing economies of scale benefits
• Operating margins increased from 11% in 2006 to 17% in 2010

Sustainability of Margins

• Services
  • Services has grown from 15% of revenues in 2006 to ~30% in 2010, experiencing a 60% CAGR
  • Services is not only important because of its high gross margins relative to the components business, but it provides a recurring revenue source and allows the company to regularly interact with customers to identify their wireless needs, increasing Comba's stickiness to its customers
  • An important metric to measure how efficient their growth in this sector is revenue/service employee, where it increased from HKD220,000 in 2008 to HKD315,000 in 2010, thus growth is not generated only from adding number of people in the segment, but productivity/employee has also increased
• Scale
  • Clients tend to favor companies with a national footprint (easier from procurement standpoint and more efficient to roll-out same type of solutions providing a more stable and consistent service to its subscribers)
  • Comba's broad product portfolio and integrated solutions provider benefits the telecom operators, who are focused on supply chain consolidation / simplification
  • Scale leads to operating leverage (i.e. smaller players who don't have a sales office in a specific region need to make additional capital investments in property and people to generate sales, while incremental sales for Comba to go straight to the bottom line)
  • Comba's broad array of products also protects it from fluctuating business cycles as its various products and services are geared to the full build-out cycle of a telecom operator's network, resulting in higher visibility of its earnings
  • In addition to economies of scale which results in better bargaining power against its suppliers (i.e. longer payment periods), Comba's broader product options and larger volumes allow it to turn its  inventory at a much faster turnover rate, improving its cash conversion cycle and resulting in  higher ROIC

Alignment of Interests

• Management and insiders own 45% of the stock
• Besides exercising some expiring options, which make up a small % of the outstanding shares, management has not sold a big portion of their stock 

Valuation

• Comba is currently trading at 10x LTMP/E for a company that is expected to earnings by 20% in 2011
• Balancing the company's growth prospects with the risks highlighted, I value the company at 15x P/E (lower than historical average), resulting in a share price of ~HKD7.58 over a 2-yr hold, >50% premium vs current trading price
• Acquisition of ADC Telecommunications, a US based comp, by Tyco in July 2010 was made at a 24x P/E and 12x EBITDA

Risks

• Competitive sector creating downward pressure on ASPs and margins
• Revenues rely on capex program of major telco operators
• Revenue concentration of top 3 telco operators in China comprise 85% of sales
• Due to the nature of the sales cycle, company has extensive working capital needs with long receivable days and collection periods