INTERNET: Baofeng Slides on Earnings, Ridiculous Valuation

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Bottom line: Baofeng Technology’s meteoric rise and current crash reflect the irrational trading mentality in China’s stock markets, where price manipulation is rampant and shares are still likely to face an additional correction of up to 30 percent.

Aggressive buying, selling power Baofeng stock

I wrote about online video player maker Baofeng Technology (Shenzhen: 300431) in June when it was breaking numerous records during China’s stock market boom, so now it’s only fair that I follow up with what’s happened since the market began to correct last month. Not surprisingly, Baofeng’s stock has been leading the correction, having fallen by the daily 10 percent limit in the last 5 sessions.

Analysts are crediting a weak earnings report released last week for the sell-off of Baofeng stock, after the company said its profits tumbled 70 percent in the second quarter. But it’s probably more accurate to blame the ridiculous valuation for Baofeng shares, which even after the 50 percent drop over the last week are still trading at a meteoric price-to-earnings (PE) ratio of 250.

Baofeng’s shares nicely represent the irrational behavior driving China’s stock market at the moment. The company’s revenue totaled just 217 million yuan, or about $33 million, in the first half of the year — up an unimpressive 27 percent from a year earlier. (Chinese article) The company’s 70 percent profit tumble was even less impressive. And yet even after all that, the company still is worth 14.3 billion yuan, or more than $2 billion.

To put that in perspective, that market value is similar to that for the US-listed Weibo (Nasdaq: WB), even though the leading microblogging platform’s revenues are about 6 times bigger and growing significantly faster than Baofeng’s. The fact that Baofeng can get such a lofty valuation despite its small size is exactly why many US-listed Chinese tech firms are now privatizing, with an eye to re-listing in China.

Stock Market Superstar

Baofeng became a stock market superstar following its March IPO on China’s Nasdaq-style ChiNext board. It shattered all records when sold shares for 7.14 yuan each, and then saw its stock rise by the daily market limit of 10 percent on 27 trading days afterwards, breaking a record previously held by a traditional company called Lanzhou LS Heavy Equipment (Shanghai: 603169).

At their height in June, the shares reached just over 307 yuan, representing a remarkable 43-fold gain from their original IPO price as China’s broader stock market also doubled in the space of a year. Never mind that there was little reason for the rally and stocks probably should have been sagging, since the nation’s rapidly slowing economy is almost certain to put a damper on company profits.

Fast forward to the present, when China’s stock market is undergoing a correction that would probably be much more severe if not for major intervention by a nervous Beijing. Despite the intervention, Baofeng’s shares have lost nearly two-thirds of their value from their peak, and are still trading at a ridiculously high valuation.

One new report points out that a fund controlled by a company called Qianhe Capital managed to accumulate around 10 percent of Baofeng’s shares during the second quarter. (Chinese article) It’s unclear if Qianhe has sold down its stake by now, and my guess is that it probably has. But Qianhe’s aggressive buying was almost certainly a big factor driving up the shares by so much earlier, despite the clear lack of fundamentals to support such a high price.

All of this nicely summarizes what’s happening in China’s stock market, and the forces that are causing such wild gyrations lately. It’s unsophisticated investors like Qianhe that are driving up prices through their aggressive buying based purely on the belief that shares will continue to rise.

Some might consider such buying manipulation, but that distinction doesn’t seem to exist for China’s young and inexperienced securities regulator. In the meantime, Baofeng’s executives would be smart to stop watching their company’s share price for the next few months. That’s because the price — and China’s broader stock market — are still likely to see major declines that could shave off another one-third to half of their value.

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