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Read a StockWatch profile on OptionsXpress (OXPS)
Read a StockWatch profile on Origin Agritech
(SEED)
OptionsXpress -- a buyout candidate that can also stand
alone:
OptionsXpress (OXPS, $19.40) is not only one of the fastest-growing
online stockbrokers, it has niche market, a fairly inexpensive stock, a great
looking chart, impressive margins and the lowest subscriber acquisition costs in
its industry.
That, and it's a potential acquisition candidate in a consolidating space.
A good niche:
Chicago-based OptionsXpress has carved out a very profitable niche with its
tools, research and services that cater specifically to the options crowd. Its
accounts are arguably more valuable than the average online trading account for
several reasons. Due to monthly contract expirations, option traders tend to
trade very regularly. And they tend to be a more sophisticated lot, with large
balances.
With just 140,000 accounts, OXPS has a lot of growing to do before it can be a
threat to the ETrades (ET) and Ameritrades (AMTD) of the world. Then again, it's
targeting the right opportunity for long-term growth -- the options market.
We note that options trading volume has increased an average of 22% over the
past 10 years, and it's up 24% this year, while Nasdaq and S&P volumes are up in
the single-digits, at best.
We talked to CFO David Fisher recently, and we wanted to know if the
company would eventually suffer from the negative stigma that options seem to
have. Many retail traders that use online accounts simply think that options are
not for them, and are simply too risky and potentially dangerous.
"Options trading isn't mainstream, but it's heading that way," Fisher
replied. "The fact that we are doing so well given the fact that a lot of people
still have that negative perception of options makes us think that the growth
has just started."
Growth ahead
The most recent quarter tells a story of growth: OXPS's new accounts increased
67% in Q3 vs. the same period last year. Customer assets are up 90% over that
time frame. Revenue rose 70% from the same period a year earlier, and profits
rose 157%.
On the company's most recent conference call, management said that the unusual
strength of its Q3 will serve to temper the strong seasonal gains the company
usually sees in Q4 --so this quarter's comps might not look as pretty as Q3. But
most analysts are still high on the company for next year, and expect revs to
increase 35%, with EPS growth of 32%.
We think that next year's growth could even beat analysts' consensus if
the company is successful in what we call its "Trojan Horse" strategy.
The company does a good job acquiring new customers due to its options focus.
But some account holders soon realize that OptionsExpress has very
competitive pricing, and services that rival the big boys of the industry.
Sector strength
Aside from being a good story, we think OXPS is in a pretty good market sector
right now. Recent deals in the industry, with ETrade making a rejected bid for
or Ameritrade, and Ameritrade agreeing to buy TD Waterhouse, have served to
increase interest in the sector.
The risk to all of these stocks -- OXPS, ET and AMTD is that the trading
environment could slow down. But we note that the volume of options trading
seems to be tied to volatility, most commonly measured by the VIX index. And
we note that the VIX's moving average has been trending up since August --
possibly a good sign for OXPS.
Value
Valuation wise, OptionsExpress trades at about 19.5x forward earnings. That's
significantly higher than ET at 14.7x forward earnings, and AMTD at 18.7x. Yet
on a PEG ratio, OXPS trades at 0.6, vs. a PEG of around 0.7 for ET and AMTD. And
in our opinion, OXPS should be getting a higher P/E ratio than its peers,
based on three factors we think really stand out -- its margins, low subscriber
costs, and its takeout potential.
-- OXPS's pretax margin is 62% -- higher than any company in our recent
memory. And Fisher told us that those margins still have room to go higher.
-- Even though the company is posting strong growth, it's spending $89 per new
sub this year. We note that in recent industry deals (ETrade's purchases of
BrownCo and Harris Direct) it paid thousands of dollars per account.
-- As far as its takeout value goes, we think that OXPS would be a potentially
accretive deal that would provide value for a larger company that wants to
leverage OXPS's options tools, technology and expertise. We think it's also
good size to be acquired, with a cap of $1.2 bln. Of note, ETrade's CEO said on
Oct. 21 that he would be interested to doing deals similar to his company's
recent acquisitions of BrownCo and Harris Direct. The Brown deal was for $1.6
bln. The Harris Direct deal was $700 mln.
Nice to newbies
One potential issue we had with OXPS before we talked to management was that the
service has no account minimums. New subscribers can start up a new
account with $100, if they so choose. We wondered if there was a huge difference
between the company's median and mean account sizes, as a result of an influx of
tiny accounts that do nothing but cost OXPS money to keep open.
Our fears proved unfounded. The CFO says that the mean and median account sizes
are extremely close to each other. He adds that the company doesn't have a huge
number of small accounts -- he wouldn't provide a number, but said the
distribution of the company's account sizes is a bell curve. He added that OXPS
does not lose money on small accounts, due to the efficiencies of its
technology.
Other positives
To date, we note that OXPS has grown organically -- not a single acquisition. We
think the company is likely to do so in the future, without the need for big
deals. It's worth noting that neither the CFO or CEO have sold stock to-date,
and that the CEO was actually buying a bit in May. The CFO told us he has no
reason to assume costs will increase as a percentage of revenue in the
near-term. And we were told that the company doesn't need to raise additional
capital, and has no plans to do so.
Conclusion
Bottom line, we think OptionsExpress is a solid company with a strong chart. The
stock looks good technically above the $17.50 to $18 area, and it seems to be a
good candidate for a position trade -- one we'd think about holding until year's
end. We would consider a stop-loss below $17.50.
Origin Agritech -- A tiny SEED that should achieve
strong growth:
For those who saw the run in organic fertilizer company Bodisen Biotech (BBC)
last week, a somewhat similar, low-priced Chinese stock targeting opportunities
in the agriculture market is Origin Agritech (SEED, $9.21), one of the
fastest growing, most profitable and best-known genetically modified seed
companies in China.
SEED is a low-float name we'd consider at its current price, as we believe that
more institutional investors are giving this one a look, there is possible EPS
upside, especially in the out years, and it's simply a name that will benefit
from being "discovered" by the crowd that seeks growth at low multiples. We
would not hold it below $9, however, based on technicals.
We believe that China was a net importer of food for the first time in 2004.
That apparently has the state pushing hybrid seeds and other technologies that
will help boost domestic crop yields. Origin is one of the best-known seed
brands -- if not the best-known brand-- in China, with more than 5 mln farmers
using its products. Yet it controls less than 4% of a fragmented $2 bln market
that it has an opportunity to consolidate.
Origin claims that its high-quality seeds achieve a 95%-plus germination rate.
Therefore, the company can charge twice as much as traditional seeds, while
still saving farmers money. Due largely to TV and government promotion, the co
says it has 90% repeat buyers. And the company claims that it outsells global
agriculture powerhouses Monsanto (MON) and Syngenta (SYT) by a factor of 10-to-1
in China, even though both multinationals entered the Chinese market more
than a decade ago.
The seed business in China is a highly regulated industry, where there
are some hefty barriers to entry. It apparently takes 6-10 years to develop and
sell hybrid seeds in China, and a few more years to develop regionally-specific
varieties. What's more, it takes as long as three years to go through mandatory
government testing of the seeds, and a year to obtain government licenses. So we
think that SEED has its market sewn up in the near-term. The company could see
eventual competition from larger biotech companies, but that might not happen
for years.
Looking ahead to next year, we like that SEED is dependent on many small
customers instead of a few large ones; the government seems to have an interest
in boosting SEED's market; and the company gets a deposit in advance from
70-80% of its customers a full one planting season ahead of time, which
should lead to predictable sales and earnings.
Also, the company seems to be aggressively expanding its product lines.
It just started to expand into the rice seed market this year (would've thought
they would be in that market sooner, given that China leads the world in rice
production). And SEED is planning to introduce about 40 new products through
2008, up from a dozen or fewer products on the market today. One of the products
that's in the works is a hybrid cottonseed, which could find demand among
farmers who sell to Chinese textile industries.
Taking into account expected dilution from warrants, an anticipated management
milestone payable in shares, and the company's after-tax earnings guidance
provided in SEC documents, Origin should be able to boost EPS ex items by about
37% to $0.63 in FY '07, ended June, up from about $0.46 in FY '06. That implies
a fwd PE of about 14.9 times, and a PE/G ratio of 0.4x, when 0.6x or less
seems to be a low price for a Chinese growth stock.
The reason that we are looking at the out years to try to value this company is
that SEED is in the process of changing to a fiscal year-end. Therefore,
we've found it impossible to value the company based on calendar-year multiples,
based on the public information available. In SEED's case, we don't want to make
assumptions based on outsized EPS and revs growth the company posted in '04. In
'03, the company was essentially selling seeds two quarters out of the year, and
management expanded to selling in three quarters in '04 (co has next to no sales
in July thru Sept.), so we don't think that those growth rates are sustainable.
Bottom line: The only logical way we've found to look at this is to
essentially trust management's fiscal-year guidance.
While the organic growth is good but not stellar, the company's guidance does
not assume any acquisitions. Some of our contacts on this are saying that
upside to the EPS numbers could come from buying privately held companies in
China at or near net asset value, and gaining rapid efficiencies. Our
understanding from a recent conference call that was quite difficult to
understand is that SEED thinks it can acquire companies for 6 to 8x earnings,
and double the margins of many of its acquisitions in rapid fashion. So EPS
growth could be in excess of 40%.
Based on our analysis, we would expect SEED to have somewhere around $12 mln in
cash on its books by the end of the year, an amount that we would speculate is
sufficient to keep the company from doing a secondary stock offering next year.
The only reason we could think of for the company raising more cash is to do a
sizeable acquisition.
Conclusion
There's no hiding that SEED is a risky low-float, small-cap story. The
company is incorporated in the British Virgin Islands, which essentially
keeps the company from being double-taxed in the U.S. and China. Yet that also
makes it next to impossible for shareholders to sue in the event of fraud,
for example. The company is not posting quarterly results right now, which
makes analysis difficult, although we would expect the company to post 10-Qs
starting in '06.
And the formation of the publicly traded company was a bit unconventional, as
well. SEED was essentially put together when China Acquisition Corp. (CACQ),
essentially a shell company with management, bought Origin, the operating
company. Although Origin's management team stayed on, we fear that there could
be one-time expenses of $1 mln or more as a result of the merger of the
operating and non-operating companies.
All of that said, we think that SEED is worth the risk for aggressive traders,
although we reiterate that we would limit risk and would not be willing to hold
it below $9.
