Thursday, February 14, 2008
Xinhua Bookstore (811)
I found Xinhua bookstore an interesting stock when it was listed last year, simply because I enjoy reading books and naturally I was attracted to buying a bookstore share. But the price took off far too early and by too much. It's only very recent that I found the price worthwhile to 'read' the prospectus.
The stock has quite some attractions. Xinhua is the largest bookstore chain in Sichuan and it distributes textbooks for all primary and secondary schools in the province. I don't know the details but I always hear complains about those HK bookstores distributing textbooks making too much profit, so I reckon it may be a good business too in China. And most Chinese parents are willing to mortgage anything if they can to finance education of their children. They never skim on education. In addition, Xinhua, if properly managed, may expand to become a nationwide bookstore chain like those in North America.
But the facts turn out a little different.
1st, the retail operation, i.e. its 190+ bookstores, makes up less than 20% of turnover and doesn't make profit. The management has put it nicely that it generates plenty of cash flow. This in fact is 100% true. The arrangement with book suppliers is that no settlement is made until the books are sold. And nearly all of the books purchased can be returned if not sold after a certain period. On the sales side of course it's COD. So no inventory risk, cash received upfront, and suppliers settled in months. Yet the business still barely breakevens. What's wrong?
I think the tough terms with suppliers are out of necessities, i.e. nobody is buying books, or more precisely, nobody is paying for books. Books are intellectual properties, which in chinese term means 'trash' and nobody cares. Like CDs and DVDs, I can imagine a huge supply of pirated books in the market driving down prices of all books. Worse, there's electronic books all over the internet and younger generations may never need to touch a book, let alone pay for one. Sharing is all wonderful, isn't it? Why pay for anything if it's free on internet?
One direction Xinhua can take to like go asset light but strong on logistics like Amazon. But I bet even Amazon will have a tough time in China with this level of piracy.
Nevermind, the bread and butter business of Xinhua is textbook distribution. This made up more than 80% of sales and all the profit for the IPO track record period. Segment profit was quite high at 20% given what Xinhua did was to pass the books from suppliers to schools and students. However, there's no competition because this area is heavily controlled by the central government (no surprise) and only selected bookstores are granted exclusive distribution right. Xinhua thus has been the sole distributor in Sichuan for decades. Monopoly leads to excess profit, although it's probably true that the bookstore network also functions as distribution points which are now cost-free to the distribution business, i.e. real margin should be lower.
Xinhua also has got another sweetener: it's not required to pay any VAT nor profits tax (from 2006), as the central government wants to encourage the good habit of reading to increase the quality of its citizens. So it has to be sure no bookstores will go belly up.
With all the help Xinhua's net margin grew from 10% in 2005 to 13.5% in 2006. Profit in 2006 was $300m with sales of $2.2b (marginally up from $2b in 2004).
So far so good even if Xinhua has to bear the unprofitable bookstore operation. But the government's policy is changing and it's trying to open up the distribution market for competition in all provinces. The distribution right will go through a tendering process like any government contract would. In fact, Sichuan was a trial province and Xinhua won the last tender which will last till spring term 2008, which is now.
Now comes the perplexing part. Will Xinhua win the next distribution right? It should since it has the most established infrastructure in place already. But what's the point of the reform if it's the same old Xinhua over and over again? Xinhua also states in its prospectus that it will try to bid for neighbouring province's distribution right. This is more interesting as other provinces' Xinhua (it's a common trademark shared nationally by all state owned or ex-state owned bookstores) will have no choice but to bid in Sichuan as well, just in case it loses in its home turf. And it helps neither of them if they end up winning the other's right, in which case they might just swap back the right!
So it doesn't look to me that this reform is going anywhere. One thing for sure though is that all these biddings will drive down the margin of all future right!
A more likely development is for Xinhua to expand by M&A, issuing shares and taking over neighbouring Xinhua one by one. If policy allows this seems a better expansion route. But the current low share price will be hard to appeal to others.
In fact the Xinhua management seemed to concur and found more creative use of its IPO proceeds (~1/8) in investing in Chengdu City Commercial Bank as a strategic investor. A bookstore can be a strategic investor of a bank? You bet. I remember even if one sells in the 1st month of IPO, he's still a strategic investor, and his sale is considered a strategic sale!
Because of all these confusions about Xinhua's future I won't bother even it's cheap. Plus I try to avoid any business that can prosper only because of status, privilige, or government protection.
DISCLOSURE: I don't hold 811 at time of writing.
p.s. i apologize for there may be a lot of typos as somehow the spellchecker isn't working.
The stock has quite some attractions. Xinhua is the largest bookstore chain in Sichuan and it distributes textbooks for all primary and secondary schools in the province. I don't know the details but I always hear complains about those HK bookstores distributing textbooks making too much profit, so I reckon it may be a good business too in China. And most Chinese parents are willing to mortgage anything if they can to finance education of their children. They never skim on education. In addition, Xinhua, if properly managed, may expand to become a nationwide bookstore chain like those in North America.
But the facts turn out a little different.
1st, the retail operation, i.e. its 190+ bookstores, makes up less than 20% of turnover and doesn't make profit. The management has put it nicely that it generates plenty of cash flow. This in fact is 100% true. The arrangement with book suppliers is that no settlement is made until the books are sold. And nearly all of the books purchased can be returned if not sold after a certain period. On the sales side of course it's COD. So no inventory risk, cash received upfront, and suppliers settled in months. Yet the business still barely breakevens. What's wrong?
I think the tough terms with suppliers are out of necessities, i.e. nobody is buying books, or more precisely, nobody is paying for books. Books are intellectual properties, which in chinese term means 'trash' and nobody cares. Like CDs and DVDs, I can imagine a huge supply of pirated books in the market driving down prices of all books. Worse, there's electronic books all over the internet and younger generations may never need to touch a book, let alone pay for one. Sharing is all wonderful, isn't it? Why pay for anything if it's free on internet?
One direction Xinhua can take to like go asset light but strong on logistics like Amazon. But I bet even Amazon will have a tough time in China with this level of piracy.
Nevermind, the bread and butter business of Xinhua is textbook distribution. This made up more than 80% of sales and all the profit for the IPO track record period. Segment profit was quite high at 20% given what Xinhua did was to pass the books from suppliers to schools and students. However, there's no competition because this area is heavily controlled by the central government (no surprise) and only selected bookstores are granted exclusive distribution right. Xinhua thus has been the sole distributor in Sichuan for decades. Monopoly leads to excess profit, although it's probably true that the bookstore network also functions as distribution points which are now cost-free to the distribution business, i.e. real margin should be lower.
Xinhua also has got another sweetener: it's not required to pay any VAT nor profits tax (from 2006), as the central government wants to encourage the good habit of reading to increase the quality of its citizens. So it has to be sure no bookstores will go belly up.
With all the help Xinhua's net margin grew from 10% in 2005 to 13.5% in 2006. Profit in 2006 was $300m with sales of $2.2b (marginally up from $2b in 2004).
So far so good even if Xinhua has to bear the unprofitable bookstore operation. But the government's policy is changing and it's trying to open up the distribution market for competition in all provinces. The distribution right will go through a tendering process like any government contract would. In fact, Sichuan was a trial province and Xinhua won the last tender which will last till spring term 2008, which is now.
Now comes the perplexing part. Will Xinhua win the next distribution right? It should since it has the most established infrastructure in place already. But what's the point of the reform if it's the same old Xinhua over and over again? Xinhua also states in its prospectus that it will try to bid for neighbouring province's distribution right. This is more interesting as other provinces' Xinhua (it's a common trademark shared nationally by all state owned or ex-state owned bookstores) will have no choice but to bid in Sichuan as well, just in case it loses in its home turf. And it helps neither of them if they end up winning the other's right, in which case they might just swap back the right!
So it doesn't look to me that this reform is going anywhere. One thing for sure though is that all these biddings will drive down the margin of all future right!
A more likely development is for Xinhua to expand by M&A, issuing shares and taking over neighbouring Xinhua one by one. If policy allows this seems a better expansion route. But the current low share price will be hard to appeal to others.
In fact the Xinhua management seemed to concur and found more creative use of its IPO proceeds (~1/8) in investing in Chengdu City Commercial Bank as a strategic investor. A bookstore can be a strategic investor of a bank? You bet. I remember even if one sells in the 1st month of IPO, he's still a strategic investor, and his sale is considered a strategic sale!
Because of all these confusions about Xinhua's future I won't bother even it's cheap. Plus I try to avoid any business that can prosper only because of status, privilige, or government protection.
DISCLOSURE: I don't hold 811 at time of writing.
p.s. i apologize for there may be a lot of typos as somehow the spellchecker isn't working.
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