Hurray! HRAY
December 29, 2005 - 9:41am EST by
2005 2006
Price: 8.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 200 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Hurray! (HRAY) is statistically one of the cheapest U.S.-listed technology companies on an earnings basis. The company trades at a 24% forward earnings yield (4x forward earnings net of cash).

HRAY is the leading provider (by revenue) of 2.5G WVAS (wireless value-added services) to China Unicom (the second leading wireless carrier in China) and a leading provider to China Mobile (the leading wireless carrier in China). Please see my write-up on a competitor KONG for some background on the Chinese wireless market.

As background, HRAY was formed in 2002 and is based in Beijing. The company went public in February 2004 and is currently trading below its IPO price of $10.25. In June 2004, HRAY acquired Beijing Enterprise, a vendor of WVAS to China Mobile for $18 million.

At $8.9, HRAY is trading at a 24% forward earnings yield (based on 2006 ending cash), using Street estimates for F06.

Price (12/29/05) $8.89
F05E EBIT $19 m
F06E EBIT $25 m

Cash at 3Q05 $78 m ($3.5 per share)
Cash at YE06E $95 m ($4.2 per share, adjusted for two recent investments)
Debt None

FDS 22.5 m
MC $200 m
EV at 3Q05 $122 m
EV at YE06E $105 m

F05E EBIT/ EV 15.6%
F06E EBIT/ EV 20.5%

F06E EBIT/ EV06E 23.8% (~4x forward earnings, net of cash)

HRAY earns interest on its cash, which should roughly offset the small amount it pays in taxes (7.5% enterprise tax rate in 2006, rising to 15% in future years). Recently, HRAY announced it will invest in two music businesses, paying $7.6 m cash for a 60% stake in Freeland (closed in December) and $4.3 m cash for a 51% stake in Huayi Brothers (to close by end of January 2006).

HRAY’s return on capital is above 50%. HRAY’s EBIT margins are typically in the range of 30-33% (consistent with many Chinese Internet companies, which have considerably lower labor costs relative to their U.S. peers).

Recently, there has been some weakness in sales to China Unicom, its primary customer. In 3Q05, WAP revenues to China Unicom were $5.9 m, down 9% q/q and 8% y/y largely due to China Unicom offering some WAP services for free (to attract first-time users). Despite the near-term weakness from China Unicom, HRAY’s overall revenue in 3Q05 was $16.5 m, up 10% q/q and 31% y/y. Gross margin in 3Q05 was 51%, down from 60% in 2Q05 and 61% in 3Q04. The decline in gross margin was due to the lower gross margin for 2G services. Note that revenue of 2G services continues to grow y/y but that gross margin for 2G has been in decline, especially recently (e.g. due to increased marketing expenses for SMS, IVR and CRBT). Importantly, gross margin for 2.5G services (the growth area) was 62%, roughly the same as the prior quarter and prior year. Overall, EPS was $0.22, flat with the prior quarter and down from $0.29 in 3Q04.

As the leading provider of 2.5G services to China Unicom and third leading provider of overall 2.5G services (behind KONG and TOMO), HRAY is well positioned to take advantage of the growth in the Chinese wireless market and the accelerating shift to 2.5G. The China market is migrating to 2.5G, a process which should take several years and which is driving wireless content as 2.5G phones come with higher processing power and more functionality like camera, color screen and Internet capability. Currently, about 30% of the subscriber base in China has upgraded to 2.5G. With 2.5G just ramping up, wireless data applications should follow and eventually rise from under 5% of subscribers currently to a level closer to Korea (15% of subscribers) or Japan (30% of subscribers). According to iResearch, the overall China WVAS market is expected to grow from $650 m in 2004 to $1.2 B in 2007 (CAGR of 23%). The China 2.5G WVAS market is expected to grow even faster, from $150 m in 2004 to $464 m in 2007 (CAGR of 46%). In particular, China Mobile is expected to upgrade South East China region to 2.5G in 2H06 and China Unicom continues to launch 2.5G in select regions (reaching 15+ m subs as of late 2005).

As background, HRAY launched 2.5G services for China Unicom in September 2002 and started billing users in early 2003. HRAY had 4.2 m 2.5G subscriptions at the end of 2004, up from 1.6 m at the end of 2003. In 3Q05, 2.5G revenue was $16.5 m, up 10% q/q and 31% y/y. Virtually all 2.5G revenue is from WAP services. Of 2.5G, WAP was $9 m, up 2% q/q and 9% y/y; MMS, which was launched in 2Q05, was $0.4 m; and, Java services were insignificant. Note that the vast majority of its 2.5G service revenue is subscription based (instead of per-use) with typical subscriptions lasting three to six months.

In addition to the potential growth from the shift to 2.5G, HRAY has a differentiated strategy, which reduces business risk and could disproportionately benefit the company in the future. The strategy includes: 1) maintaining its leading position with China Unicom, 2) building a vertically integrated music business, 3) having broad distribution (through direct relationships with handset manufacturers, etc.), and 4) growing its position with China Mobile. Importantly, the company appears to be executing quite well in each of these areas.

An area of competitive advantage is its leading position with China Unicom, the second largest wireless carrier in China. Although its agreements with China Unicom are non-exclusive (and HRAY must obtain approval from China Unicom for pricing and services), the agreements with China Unicom are generally for two to three years, longer than the typical one-year agreements with China Mobile. Not only does HRAY have the leading share of China Unicom’s 2.5G revenue, but it actually helped China Unicom build its 2.5G WAP portal. In 2002, HRAY began helping China Unicom to designing and building its 2.5G WAP portal and is the sole provider of software for China Unicom’s WAP portal (including nine of its provincial offices). Using its proprietary VASPro software, HRAY built the first phase of China Unicom’s WAP infrastructure and services platform in June 2002, which supported 0.5 m users. In 2003, Phase II supported 1.5 m users. In 2004, Phase III supported 5 m users. As of late 2005, Phase IV is now supporting 15 m users at China Unicom. Further, HRAY is developing a 3G version of its VASPro software, which it expects will also be adopted by China Unicom and which should enable HRAY to maintain its leadership position. Another sign of HRAY’s leadership is that it has typically occupied the first position on China Unicom’s WAP portal for over ten categories or sub-categories, including pictures and ring tones (the two most significant categories by revenue). The higher a position on the WAP menu, typically the more exposure the service gets from users.

HRAY is building a vertically integrated music business, which could be another source of competitive advantage. About 35% of HRAY’s revenue comes from music-related applications, and it is estimated that about 50% of WVAS revenue in China is music-related. In 1Q05, HRAY signed licensing agreements with three record companies: Warner Brothers, EMI and Ocean Butterflies Music. Further, HRAY recently announced it will invest in two music businesses, paying $7.6 m cash for a 60% stake in Freeland (closed in December) and $4.3 m cash for a 51% stake in Huayi Brothers (to close by end of January 2006). Importantly, the Freeland investment should be immediately accretive to HRAY’s earnings (i.e. Freeland’s 2005 net income is around $1 m). Freeland and Huayi both produce and distribute music and videos for a portfolio of artists in China. Freeland is the leader in online music in China and their portfolio of artists includes “Zhu Zhi Ge (Song of Pigs)”, “Lao Shu Ai Da Mi (Mice Love Rice)”, “Mei Er Ai Wo (Girl Love Me)”, and “Hui Lai Wo De Ai (Come Back My Love)”. Huayi is more known for its movie production and their portfolio of artists includes Yu & Quan (“Best Album of 2005 in China” award at the CCTV-MTV Music Awards in July 2005).

As may be noticed from the above list of popular artists, the Chinese music market is highly fragmented with over 100 different music labels. In addition, the Chinese music market is primarily local, with little interest in American and other international artists. For example, MTV in China showcases about half of its music from local regions in China. By owning local music content, HRAY can benefit by selling associated ring tones, ring back tones, and digital downloads (both on mobile phones and online) in addition to traditional sales, such as from music stores. Content providers are demanding increasingly higher revenue sharing with WVAS providers (from 14% of revenues for ring tone downloads to as high as 50% of revenues for MP3 downloads), which also benefits major content owners like HRAY.

Unlike competitor KONG (which is basically married to China Mobile), HRAY has built a broad distribution network in the last year, using arrangements with handset manufacturers, Internet marketing and direct media advertising to reach users. The alternative distribution network generated $3.6 m (24% of total WVAS) in 3Q05, up from zero a year ago. Importantly, this network mitigates the risk of China Unicom or China Mobile dramatically changing or reducing exposure to HRAY.

Importantly, HRAY is also making in-roads with 2.5G services at China Mobile. In June 2004, HRAY acquired Beijing Enterprise (a top five provider of WAP services to China Mobile), which started its relationship with China Mobile. Since that purchase just 18 months ago, HRAY has continued to grow its position and now believes it is the #3 or #4 provider of 2.5G WAP services to China Mobile (in terms of revenue). In 3Q05, WAP revenue from China Mobile was $2.9 m, up 32% q/q and 78% y/y. Total revenue outside of China Unicom (that is, from China Mobile, China Telecom and China Netcom) was $5.2 m (34% of total revenues), up from 32% of total revenue in the prior quarter and 21% of total revenue in 3Q04.


Customer concentration: 66% of revenue (including software and system integration) in 3Q05 was from China Unicom. However, HRAY has built a broad distribution network over the last year. China Unicom represented 82% of revenue in 2004.

Competition: as the WVAS market in China is still relatively new, a dominant competitor could eventually emerge. TOMO has the highest revenue in the WVAS industry and its growth could arguably accelerate.

Potentially lower revenue sharing or other one-time actions by wireless carriers: Wireless carriers could gradually demand higher revenue sharing from top WVAS providers, perhaps 30% of revenue or more. In fact, China Unicom has recently required HRAY to offer some free services on its WAP portal (to entice first time WAP users). Further, state-owned wireless carriers have the ability to suspend or limit the services or brand names of WVAS providers.

Regulation: the Chinese government has the power to levy fines, confiscate income, revoke business licenses, shut down services. In 2004, acting under the guidance of China’s Ministry of Information Industry, China Mobile started enforcing customer service policies and stopping the distribution of obscene material. Though these enforcements led to fines and a temporary industry slowdown in WVAS (in 2004), it accelerated industry consolidation, helping the larger WVAS providers like HRAY.

Potentially lower revenue sharing with content providers: Content providers could also gradually demand higher revenue sharing from top WVAS providers. This risk is mitigated by HRAY building a vertically integrated music business.

Potentially shortened product cycles: products cycles for both online gaming and mobile applications have been shortening due to changing technology and increased competition. Shorter product cycles mean future R&D could generate lower returns.

Related party transactions: foreign investment in telecommunications and Internet services in China allow for a maximum of 50% foreign ownership in value-added telecommunications and Internet services in China. In order to comply, HRAY implemented a structure - similar to those used by other companies such as SINA, SOHU, NTES, LTON and TOMO - by entering into various agreements with affiliated companies incorporated in China.

Move to 3G: The eventual move to 3G (in several years), could lead to increased competition, as online portals (SINA, SOHU, Tencent, and online gaming companies (SNDA, NTES, NCTY) try to enter the mobile content and services space. In fact, the Chinese government could restructure the wireless industry in 2006, prior to issuing 3G licenses, which could be a disruption for WVAS providers. Further, the move to 3G could also lead to free WAP portals, which could focus on selling advertising and, if successful, could alter the current business models used by leading WVAS providers (Note: WAP represents about half of 2.5G revenue). As background, 3G is not expected to gain material traction (like 10% of wireless subscribers) until 2008 or 2009.


Growth in China wireless market and continued shift to 2.5G: As mentioned, mobile phone users are about 25% of the Chinese population and could grow by 50-70 million subscribers a year. That would imply about 550 million subscribers in 2008 (penetration of 35-40% of the population), up about 50% from the current base of subscribers. Urban markets such as Beijing (~90% penetration) and Shanghai (~80% penetration) are already highly penetrated, so growth will increasingly come from smaller cities.

Industry consolidation: Due to regulatory actions, it’s estimated that roughly one-third of competitors have disappeared or been acquired over the last 12 months. This trend is expected to continue, especially as the industry continues to mature.

High insider ownership: Management and Directors own about 51% of company’s shares. CEO Qindai Wang (owns about 9%) was President of AsiaInfo Technologies (China) and, before that, was with Nortel Networks in China.

Large cash position (over $3 per share and growing) could be used for accretive and strategic acquisitions or to repurchase shares.


Stock trading at very low multiple of forward earnings, net of cash
Growth in China wireless market (especially with shift to 2.5G)
Continued leadership in 2.5G market segment with China Unicom
Broadening of distribution network to handset manufacturers and China Mobile
Industry consolidation
High insider ownership
Large cash position used for accretive and strategic acquisitions or share repurchases
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