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REXLot Holdings, Profit Warning Scares Provide Great Opportunities For Onlookers
Corporate Digest | 24 April 2015
By: Louis Kent Lee
Articles (199) Profile

REXLot Holdings (REXLot) is a leading player in the China lottery market stream with a comprehensive value chain that encompasses the upstream and downstream segments.

We previously covered REXLot (stock quote, HK : 0555) in December 2014. In fact it was one of our stock picks for 2015, and it still is.

In fact, the recent announcements made by the company that saw it issuing a profit warning may be alarming to many onlookers.

Deeper peering on our end however revealed an immense opportunity that is a one-time event and does not disrupt our long-term view of this stock.

Profit Warning Due Primarily To Impairment

In January 2015, a circular was issued by the Chinese government pertaining to unauthorised online lottery sales have been causing tension in the Chinese lottery sector., REXLot’s internet arm, which is one of the top three most popular specialised lottery platforms in China, was affected by the issued circular.

In fact, other major internet lottery players, like Taobao, Weixin (both which do not have an official internet licence), and even (one of the only two licensed internet lottery sales provider) was affected, and saw temporary suspension of their internet lottery sales after the Chinese New Year holidays.

This resulted in REXLot taking the conservative approach to deconsolidate sales related to all internet lottery sales (approximately HK$950m), and also went on to impair goodwill and intangible assets of the web operation units (approximately HK$848m).

This led to REXLot recording a net loss of HK$104 million in FY14, compared to a net profit of HK$869 million in FY13.

Revenue: actual plus impaired add back

In our research calculations, our own estimated revenue for FY14 would have been around HK$2,403 million.

Adding the internet lottery sales segment back to its actual reported revenue for FY14 (HK$1,689 million) as a result of the deconsolidation would see some HK$2,639 million, much better than we expected.

Therefore, reversing the impact, net profit would’ve easily surpassed FY13’s figure.

A point to note is that REXLot’s cash generation abilities from its operations have always been stellar. In fact, compounded annual growth rate (CAGR) of REXLot’s net profit shows a strong 26.6 percent figure between FY08 to FY13.

Return on equity and return on assets have also been consistently between the range of 12 percent to 15 percent from FY09 to FY13, and REXLot is backed by a super strong balance sheet with a net cash position on its balance sheet.

Mobile Electronic Platform Grows Steadily

REXLot was the first approved mobile electronic lottery platform (ELP) developer in China. The 2012 pilot test in Liaoning saw the start of commercial operations in July 2012.

On the back of the successful roll out, REXLot bagged contract wins in 2 more provinces in 2H13. REXLot currently has a total coverage of 10 provinces for its mobile ELP.

REXLot announced that it has won the contract to develop Sports ELP for Guangdong Sports Lottery Centre. We find this very encouraging and the win endorses our view on REXLot’s competitive advantage in the mobile ELP arena.

Track record is of utmost importance when provincial lottery centers sign with mobile ELP developers.

The Guangdong Sports Lottery Centre award win is a huge boost to our view on REXLot as this is the first sports mobile ELP licence to have been granted.

We see further potential forward for this segment. As of FY14, this segment contributed approximately 16 percent of total revenue and 13.2 percent of total EBITDA.

Do note that some HK$133 million was carved out from REXLot’s mobile ELP revenue for FY14 (Reported: HK$269 million) as it was referral operations done through the internet platform.

Our Conclusion Is Still Unwaveringly Bullish

REXLot’s computer ticket games segment, which constitutes approximately half of its total revenue is still growing despite fears of a slowdown.

This segment commands a rough 50 percent market share in China with REXLot having presence in 17 provinces, and we continue to view this segment as a cash cow for REXLot, while it focuses on growth elsewhere.

Although there is a temporary hiatus on REXLot’s internet segment, the fact that the special audit done recently across the lottery centres still saw REXLot’s mobile ELP operations remaining normal makes us believe the near term regulation risk on mobile ELP is limited.

Management believes that the suspension on internet lottery sales would not be a prolonged suspension.

We expect it to return to the black for FY15 and it is currently (at the time of writing) boasting a dividend yield of close to 6 percent.

Louis is a qualified accountant with the ACCA, and is the Research Editor at Shares Investment magazine.

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