Description

Tongxin International (formerly Asia Automotive Acquisition Corp.) is the largest independent provider of Engineered Vehicle Body Structures in China.  The Company began life as a SPAC, and received shareholder approval in April 2008 for the purchase of its operating business.  Tongxin has a strong management team, outstanding growth prospects, and an attractive valuation.  The business currently trades for 9x 2008E earnings (<4.5x 2008E EBITDA).  Tongxin has a clean balance sheet, and trades for roughly 7x 2008E earnings net of PF (for warrant conversion) cash.  Management expects to grow its top line at 25-30% annually for the next several years.

Engineered Vehicle Body Structures is a fancy name for truck cabs.  The Company’s product mix is 10% stampings (i.e. doors and other sheet-based parts), 50% unpainted cabs, 20% painted cabs, and 20% finished cabs (complete with interiors, etc.).  The assembly process consists of stamping, welding, and assembly.  All dies and molds are designed and manufactured internally, a competitive advantage.  The Company operates out of three geographically dispersed manufacturing facilities.  Tongxin has a 7% market share, and its primary competition is from vertically integrated manufacturers that do their own stamping, painting, and assembly of cab structures.

The China growth story is familiar to everybody.  With respect to transportation (and by extension, commercial vehicle demand) specifically, the Chinese government has committed to spend $250bn by 2020 to upgrade the country’s road network.  Economic growth requires movement of goods, and a material portion of this movement will take place by truck.  The Chinese commercial vehicle market has been growing at a 15% CAGR between 2001 and 2007, in spite of a major government intervention to discourage fixed asset investment in 2005.

Tongxin has been growing its top line at a CAGR > 20% since 2004.  Over that same time period, EBITDA margins have expanded from 4.4% to 23.8%.  Margins should be sustainable, as the business has two primary cost advantages.  First, Tongxin has cost escalators that give it the ability to pass on 100% of the increase in the cost of steel (its primary raw material input) to customers.  Second, the Company has a long-term labor agreement (or, more accurately, the Chinese counterpart of a labor agreement) that gives it a fully variable piecework-basis cost structure as related to labor expenses.  The US-based senior management team believes that there are additional manufacturing efficiencies, primarily related to reduction of scrap, which can be implemented at the manufacturing facilities.

As mentioned, the core business has been growing at >20% annually and expects to continue doing so for the next several years.  On top of this growth, management has been assessing a longer-term move into the $3bn aftermarket (replacement/collision) parts business in Europe and North America.  Its Chinese manufacturing base would provide it with a material cost advantage in this market.  Management also expects to close an acquisition within the next 12 mos, and is currently assessing four potential acquisitions candidates with net income in the $4-12mm range.  Each of these acquisitions would be immediately accretive to earnings, and would be complementary to the existing product line and customer base.  Finally, Tongxin has a 50/50 JV (which will be fully consolidated for accounting purposes) to produce passenger buses.  This JV will produce roughly 1000 buses in 2008, 25% growth over the 800 produced in 2007.

The two top US-based managers (from the SPAC side of the deal) have a combined 70 years of experience in the automotive industry.  Collectively, they have worked in both the vehicle and components segments of the automotive industry, have executed $250mm aggregate direct automotive M&A activities in Asia, and have served on boards for multiple Chinese JVs.  To the extent you are interested, I would highly recommend speaking with Rudy Wilson, the COO.  He is very accessible.  The primary focus for these two in the near-term will be finalizing one of the proposed acquisitions, getting the Company SarBox compliant (late 2009 time frame), raising the company’s profile with investors, and providing a limited amount of operational support.  Operating management continues under Tongxin’s long time founder and CEO Zhang Ruanxiang.

Assuming conversion of all outstanding warrants, Tongxin will have 17.2mm fully-diluted shares and $44mm in cash.  I expect the company to generate $104mm and $125mm in 2008 and 2009 revenue, respectively, with operating EPS of $0.87/shr and $1.05/shr in 2008 and 2009, respectively.  Thus, net of roughly $1.40/shr in cash the business trades for 7x 2008E EPS.  Suffice it say that there is material upside in this sort of multiple for a business growing its top line in excess of 20% with expanding margins.

AAAC has traded OTC since its IPO, but expects to receive a NASDAQ listing within the next few months.  This should markedly increase the somewhat anemic trading volumes.

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