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Just four years ago, I swore off Chinese small cap stocks altogether. The risks were too high, the businesses too opaque, and the volatility too much to handle. But that was then, and this is now. And I believe I’ve found a Chinese small cap worth investing in.
Let me introduce you to Bitauto
Bitauto (BITA) was born in 2000 by William Bin Li. Li was just in his twenties—and for a while, ran the company out of his apartment for no pay —but he understood that combining an emerging car-buying market with the Internet could prove lucrative.
Over the years, Bitauto has evolved markedly—from an ad business, to a CRM platform, to a financer. It has had no problem growing sales: revenue more than tripled from 2013 to 2015, topping out at over $600 million.
Today, Bitauto has three main reporting segments.
1. Advertising and subscription business: This combines two of the backbones of Bitauto’s core business. The first is advertising revenue that company gets when auto dealers choose to advertise on bitauto.com and taoche.com—the latter being the company’s used-car site, and the former being a new-car site. The ad business has slowed markedly lately.
The subscription revenue arrives via the company’s EasyPass (EP) platform. In essence, this is an a customer relationship management (CRM) tool that allows dealers to build a website, publish promotional and pricing deals, and communicate with potential customers.
2. Transaction services: By far the newest offering, Bitauto dipped its toes in the auto-financing market in 2014. By partnering with Chinese-based Yixin Capital, Li looked to help Bitauto capitalize on a profitable opportunity, while also helping streamline a customer’s on-line experience and make them more likely to purchase a car from a Bitauto-associated auto dealer.
3. Digital marketing solutions: While the advertising business above gets it revenue from the actual placement of ads on its sites, this division gets its money by helping auto-dealers come up with ad campaigns. Sometimes, that means advertising on bitauto.com or taoche.com—which is a double-win—but it often involves third-party advertising as well.
Because the company recently reorganized into these three divisions, consistent historical performance is difficult to come by. Here’s what we do have, via the company’s first quarter release.
Image source: Created using Infogr.am. Data Source: SEC filings .
The two divisions that will determine the fate of this Chinese growth stock
Bitauto is not—and will not be—the only player looking to capitalize on the growing Chinese auto market. Autohome (ATHM -0.11%), for instance, is a larger company going after the exact same market as Bitauto. Whatever Bitauto can do to for sustainable competitive advantages now will pay huge dividends in the future.
For all of the different products Bitauto offers, my thesis is built around two parts of the company that I believe will give them this advantage.
The first is the EP platform, which is now classified as the “subscription” half of the “advertising and subscription” division. The vast majority of Chinese citizens are new to the Internet—something many American investors may not appreciate. As the company put it in its annual report:
“Internet usage in China is limited among the general population. China has a relatively low penetration rate compared to most developed countries… Many of our current or potential customers…may have limited experience with the Internet as an advertising and marketing medium .”
The EP platform streamlines this whole process. It takes what is a dizzyingly complicated experience of navigating and trying to sell cars on the web and makes it very easy. That means that switching costs are very high if an auto-dealer ever wanted to stop using the platform and transition to something else.
The second part of the company I’ll be watching is the burgeoning transactions platform. While still in its infancy, it clearly has shown explosive growth over the past year. It went form just 4% of all revenues in the first quarter of last year, to nearly 19% in just one year’s time.
Like the EP platform, I think that offering a transaction solution to auto-dealers, Bitauto is again making switching costs very high. If all of your transaction data is with one company, can you imagine the headache of transferring all of the data to a new application?
What investors need to keep an eye on is if management can balance growing revenues from the offering while not making overly risky loans to customers who have no hope of paying them back. While there’s no evidence to suggest this is currently a threat, I believe it’s prudent for investors to keep this in mind.
I’m not alone
Last month, some of the biggest names in China showed that they, too, believe in Bitauto. JD.com (JD 0.12%), Baidu (BIDU -0.86%), and Tencent (TCEHY -0.55%)—along with a private equity firm that Li has a stake in—invested a total of $200 million in Bitauto.
While Tencent and JD already had an ownership stake in the company, this was Baidu’s first foray with Bitauto. While Bitauto didn’t necessarily need the cash—it had almost $580 million in cash and equivalents on the books—it further intertwines these major players.
As it stands today, Baidu now owns 3.2% of shares outstanding, with Tencent owning 7.1% and JD.com owning 23.5%. In addition to these three, American-based AutoTrader owns over 10% of shares outstanding. And perhaps most importantly, Bin Li upped his 14.7% stake in the company by purchasing shares via the private equity firm. That’s an impressive level of skin in the game.
What it all means
The combination of this skin in the game, the endorsement of Chinese heavy-weights, and a business model that I see having significant staying-power have convinced by to dip back into Chinese small cap stocks.
Having said that, Bitauto shares still make up less than 2% of my real-life holdings. The risks of opacity and a quickly-changing market are still there and if the company continues to do well, I’ll have plenty of opportunities to buy in later.
