September 28, 2010 - 1:47pm EST by
2010 2011
Price: 7.00 EPS $1.22 $1.44
Shares Out. (in M): 35 P/E 5.5x 4.7x
Market Cap (in $M): 245 P/FCF 6.0x 5.0x
Net Debt (in $M): -80 EBIT 50 65
TEV ($): 165 TEV/EBIT 3.5x 3.0x

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Background & Business Model

Exceed Co (EDS stock, EDSWW warrants ex at 5.25, capped at 11.50) is a very cheap (about 5X PE and growing 20%+) Chinese apparel & footwear producer under the brand name "Xidelong".  Think Nike but at the inexpensive-value price point.  They started primarily as footwear but have evolved to about 50/50 footwear/apparel as of Q2 2010.

EDS went public through a SPAC (2020 China Acquireco - TTY) in October 2009 after abandoning a HK listing in 2008 and has been basically ignored by the market since then hovering around the SPAC price despite great results from the company particularly notable in the Q2 2010 results where they had 50% revenue growth YoY and got their receivables down some 30% from elevated levels Dec 31, 2009.

The business model is a bit different than Nike for example.  It is essentially a franchise system where the products are sold through local stores that are run by entrepreneurs with more knowledge of their region.  There is a sales fair held 3X (used to be 2X until this year) per year where Exceed shows off its upcoming line up of prototypes to about 2,000 visiting store owners and the store owners decide what they like and place orders for the coming season.  These fairs are responsible for some 80-90% of annual income.  Exceed manufactures the products in house or outsources and ships to the regional distributors which then ship to the end stores.  Exceed takes very little inventory risk as this is passed down to the local stores and distributors.  Exceed's largest use of cash from what I can tell is effectively financing these lower levels with trade credit at 120 days.  There seems to be quite a bit of two-way communication between the distributors and Exceed as Exceed sends people to inspect and help the stores as well as subsidizing store layouts and renovations (~15M in 2009).

They are focused in the 3rd and 4th tier cities on being the "value" option with shoes in the 300RMB price range ($40) compared to most Nike or Adidas shoes which are more like 600RMB ($80).  At the moment they have 4,000 stores and intend to add about 1,000 stores per year for the next few years.  The CEO said he thinks the saturation point for this model is about 10,000 stores but that's far in the future.  They spend 7-8% of sales on advertising and have signed up a number of celebrity endorsements as well as a relationship with the China Institute of Sport Science.  I am no branding expert but it seems like if they stick to their price point they will not have to fend off a giant like Nike and their competition is more the other HK listed Chinese companies which are currently ~3-10X larger than them.


Yes Yet Another "Cheap" China Story...

I realize there are many Chinese small caps trading at extremely cheap valuations like Exceed here.  Most of them deserve to be cheap and have nothing special about them and are probably frauds (see ONP, CHBT, UTA, DYP, ZSTN, FUQI, etc...).  It is definitely a very hairy area and not one to make 120% positions in your portfolio in but there are definitely ways to differentiate quality.  Personally I seem to be on a masochistic streak and have been sucked in by the low valuations and degree of difficulty (which we all know you don't get extra points for but it does keep the competition away...) in analyzing these Chinese small caps but I think EDS is one of the higher quality ones for multiple reasons.  I do not think EDS is going to be the next Nike but I do think it has a place in the world and in such a huge market it has a reason to exist.  Everything is worth something and I think EDS is worth considerably more than it's trading for right now.


Basic Financials

Stock price (@ sept 28 2010): $7.00 

Warrants: $2.35 (strike $5.25, expire Nov 2011, callable if stock over $11.50 for 20 of 30 consecutive days)




Q2 2010

Revenue ($M USD)




Adj Net Income





Shares outstanding (currently)

25M Basic (5.5m from 2009 earn out)

11M Warrants

-Potentially 9M more issued for earn outs in 2010 and 2011

=45M total FD shares if all earn outs earned and all warrants exercised.


Est FD EPS 2010: $1.21

Est FD EPS 2011: $1.44

Have $80M cash as of June 30, 2010 => current PE of about 3.5 net of cash.


Their 2nd tier shoe comps in HK are: 1361 (361 degrees); 1368 (Xtep); 1968 (Peak Sport).  These trade at an average 2010 PE of about 12X.

Their 1st tier shoe comps in HK are: 2331 (Li Ning); 3818 (China Dongxi); 2020 (Anta Sports).  These trade around a 2010 PE of 20X.

Exeed's gross margins are lower at about 30% compared to 37-40% of its peers due to its less well established brand name but the trend has been for higher ASPs for Exceed.

The business isn't especially capital intensive, their main use of cash as they grow seems to be for working capital to finance their distributors.  They have not had issues with bad debt in the past - the sales cycle is pretty short and the mark ups are high for shoes & apparel so it's hard to hide serious issues there.  A significant fraction of their net income will be free as cash to the equity.


Quality Checking and Other Important Points

If a Chinese shoe company that is trading at a PE of 3.5X net of cash growing at 20% is appealing, then take your complicated DCF model with 100 carefully crafted inputs and multiply it all by what I call the Chinese Indicator function (for non Math Geeks, an indicator function is either 0 or 1): "Is it real?"

Of all the Chinese companies I've looked at I would say this is in my top 2 of most comfortable saying all is well in this regard.  For one I visited the campus in early September and they were happy to take me and a couple friends on a tour of the facilities.  It is a very large nice campus finished in 2007 including dorms for all the workers.  The workers seemed very happy from what I could tell and well taken care of including basketball courts to play on.  The management was also happy to show us copies of their tax filings (both VAT and income) and they both matched the SEC filings.  Photos from my trip are posted here: (EDS is the last couple pages): https://www.dropbox.com/gallery/10022514/2/Travels/2010%20Sept%20China%20Trip?h=5ed6f9

Another significant factor is that New Horizon Capital is an investor (came in at the same time as the SPAC) and effectively bought out Goldman when the person in charge of that investment left to another fund.  I'm still not 100% clear on the story behind the Goldman investment but the important point is that NHC is a very well respected HK PE firm run by Winston Wen, the Premier's son.  There is always an issue for US-listed Chinese companies that they can just disappear from their US-listings and not face legal recourse but I'm fairly certain that if you rip off the Premier's son there is some recourse, you cannot "get off on a legal technicality" in China...



Low valuation, continued good results.
Potential warrant exchange (no indication but the CEO said he thought there was an overhang and it would just make sense, they do not need the extra cash from the warrants) which could reduce FD shares by 5M potentially.
Could use their excess cash to pay a dividend or buy back shares to differentiate themselves from all the low quality Chinese small caps with similar valuations but who do not stand up well to channel checking.
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