` China Information Technology Inc. (CNIT) Rapid Growth Prospects in China s Digital OOH Advertising Industry 150 East 58th Street 20th Floor Equity Research Stock Information (09/15/2017) Exchange-Nasdaq Price(USD) 1.23 Price Target 3.02 52-Week Price Range 0.57-1.30 Market Cap 49.48M Enterprice Value 56.25M CNIT Stock Performance in 2017 Compared to Nasdaq 60% 50% 40% 30% 20% 10% 0% -10% CNIT vs Nasdaq composite(^ixic) -20% 1/2017 2/2017 3/2017 4/2017 5/2017 6/2017 7/2017 8/2017 CNIT Nasdaq CNIT Range of Implied Share Price by Valuation Range of Implied Share Price Investment Highlights CNIT s Revenue and Net Income Growth is on the Right Track as Expected China Information Technology reported strong Q2 results on Aug 21, 2017, with revenue of $5.7 million vs. $3 million in Q2 of FY2016, representing 94% YOY growth. The Net Income was $ 35,000 vs. GAAP Net Loss of $7 million of FY2016. CNIT reaffirmed its FY 17 guidance across the board, the CEO projected that, as a result of these trends, CNIT would achieve or exceed its projection of 2017 revenue of $17 to $19 million - about 90 percent of which will be derived from equipment sales - and earn adjusted net income of $3.2 to $3.6 million. Large Sales of Cloud Based Terminals at Anchor Cities in China By competitively expanding cloud based terimals to Anchor cities in China, CNIT plans to continue gaining market share in the Out Of Home Advertising market. In the last 4 months, CNIT has signed 12 regional contracts for the sale of 50,500 terminals to be installed in total, expected to generate $16.1 million sales and service revenue. This contract will not only contribute substantial revenue but will also strengthen our exposure as one of the leading providers of cloud-based equipment and systems in China's four tierone cities- Beijing, Shanghai, Guangzhou, and Shenzhen. Current price $1.23 Target Price $3.02 Discounted Cash flow LTM P/E LTM EV/EBITDA 52-Week high/low 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 Key Financial Data Year 2017E 2018E 2019E 2020E EPS $ 0.07 0.15 0.28 0.48 P/E 16.3 7.2 3.8 2.2 Revenue(M) 18.0 27.0 40.5 60.8 EV/Revenue 2.8 1.9 1.2 0.8 EBITDA 2.9 6.4 11.7 19.9 EV/EBITDA 17.3 7.9 4.3 2.5 Strategic Partnership with China's Largest Hotel Internet Service Operator CNIT Partnered with AMTT Digital Service Group, China's largest hotel internet service operator serving 1 million hotel rooms and over 3,000 premium hotels and resorts across the world. The first step of the partnership calls for AMMT to install approximately 30,000 CNIT cloud-based elevator ad terminals at AMTT's current and potential customer hotels as well as integrate those facilities' existing 5,500 display terminals in conference rooms, ballrooms and lobbies into CNIT's cloud-based network via CNIT's proprietary Taoping USB device. $3.02 PT Our PT is based on DCF Model and Comparable Companies Model. We value CNIT using an LTM Price/Earnings multiple ranges from 31x to 50x and an EV/EBITDA multiple ranges from 29x to 38.7x. We calculate the Company s WACC at 10.9%, derived from a 6.7% pretax cost of debt, 2.93% normalized risk-free-rate, and a beta of 1.44. Xuan Luo, CFA Xuan.luo@dgipl.com Zheng Chen Steven.chen@dgipl.com Disclaimer: This equity research report is for Dragon Gate s clients only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. It does not constitute a personal recommendation or consider the particular investment objectives, financial situation, and needs of any specific recipient. All information expressed in this document was obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness. All information and opinions are current only as of the date of this report, and are subject to change without notice. All Rights Reserved. Tel: +1 (646) 801-2803. Email: research@dgipl.com. 1
Business & Branch Overview CNIT is a provider of proprietary Cloud-App-Terminal technology for Internet-of-Things (IoT) platforms, digital advertising delivery system, and smart advertising display terminals throughout China. The company operates in two segments, Cloud-based Technology (CBT) and Traditional Information Technology (TIT). It offers an end-to-end digital advertising solution enabling customers to efficiently and cost-effectively direct advertisements to specific interactive advertising display terminals across China. Right now, CNIT s market strategy has enabled them quickly having broad coverage of products and services to meet growing market demand and achieve fast revenue growth potential. Covered Next Target Anchor Cities Build Up Central Network Sharing National Resources In the last 4 months, CNIT has signed 12 regional contracts for the sale of 50,500 terminals to be installed in total, expected to generate $16.1 million sales and service revenue. This contract will not only contribute substantial revenue but will also strengthen our exposure as one of the leading providers of cloud-based equipment and systems in China's four tier-one cities- Beijing, Shanghai, Guangzhou, and Shenzhen. Market Bundled Product to Hotels, Resorts, and Serviced Apartments CNIT Partnered with AMTT Digital Service Group, China's largest hotel internet service operator serving 1 million hotel rooms and over 3,000 premium hotels and resorts across the world. C as well as integrate those facilities' existing 5,500 display terminals in conference rooms, ballrooms and lobbies into CNIT's cloud-based network via CNIT's proprietary Taoping USB device. 2
Investment Positives Comparatively Strong Revenue Growth Trend China Information Technology reported strong Q2 results on Aug 21, 2017, with revenue of $5.7 million vs. $3 million in Q2 of FY2016, representing 94% YOY growth. The Net Income was $ 35,000 vs. GAAP Net Loss of $7 million of FY2016. CNIT reaffirmed its FY 17 guidance across the board, the CEO projected that, as a result of these trends, CNIT would achieve or exceed its projection of 2017 revenue of $17 to $19 million - about 90 percent of which will be derived from equipment sales - and earn adjusted net income of $3.2 to $3.6 million. CNIT s Near-Term Operation Outlook is Bright CNIT's improved bottom line performance compared to the first half of last year also resulted from cuts of about $2.2 million in administrative expenses, which, in turn, resulted from both a decrease in compensation and benefits related to a reduction of TIT employee headcount and a decrease in bad debt provision and depreciation. R&D expenses for the first half of 2017 increased about $0.3 million compared to the first half of 2016, primarily due to the increase in amortization of software for the CBT segment. Selling expenses for the first half of 2017 dropped about $63,000 to $0.6 million from the first half of 2016, due mostly to a reduction of the sales force for the Company's TIT business. Exhibit 1: CNIT 2016 Q2 Income Statement Waterfall Exhibit 2: CNIT 2017 Q2 Income Statement Waterfall Exhibit 3: CNIT 2017 Terminals Sales from May to September Exhibit 4: CNIT Revenue Generated by CBT and TIT Sector From 2013 to 2017 3
In the last 4 months, CNIT has signed 12 regional contracts for the sale of 50,500 terminals to be installed in total, expected to generate $16.1 million sales and service revenue. CNIT also partnered with AMTT Digital Service Group, China's largest hotel internet service operator serving 1 million hotel rooms and over 3,000 premium hotels and resorts across the world. The first step of the partnership calls for AMMT to install approximately 30,000 CNIT cloud-based elevator ad terminals at AMTT's current and potential customer hotels as well as integrate those facilities' existing 5,500 display terminals in conference rooms, ballrooms and lobbies into CNIT's cloud-based network via CNIT's proprietary Taoping USB device. Exhibit 5: CNIT Revenue Mix by Segment, Historical and Projected Exhibit 6: CNIT Annual EBITDA and EBITDA Margin, Historical and Projected The Business Transformation from Public Sector to Private Sector is Paying Off In early 2013, CNIT made a strategic decision to transform its business from servicing the public sector (Traditional Information Technology segment) to focusing on the private sector (Cloud Based Technology segment). Leveraging our experience and expertise in handling large-scale IT projects for the public sector, CNIT started investing in research and development (R&D) to develop software products for the private sector. In 2014, continuing our business transition from the public sector to the private sector, CNIT identified and provided cloud-based ecosystem solutions to four core markets including new media, healthcare, education, and residential community management. CNIT predominately sold their cloud-based solutions to the Chinese new media industry. In 2016, CNIT generated only $8.7 million of revenue in our cloud-based technology (CBT) segment for customers in the education, new media and elevator IoT sectors. Based on the revenue in Q2 2017, we estimate that the revenue of FY2017 should be around $18 million. The CBT segment will contribute $16.9 million and TIT will contribute $1.1 million. For the revenue in the future year of 2018, 2019, 2020 and 2021, we estimate CBT segment revenue to be up 50% every year and TIT revenue to be down 10% every year. The CBT revenue growth is largely driven by the sale of Cloud Based Terminals. Our assumptions for modeling the company s expenses and margins are: 1) Cost of Goods Sold (COGS): Remains stable at 57.5% of revenue (based on a historical average over the past 3 years). 2) Selling, General, and Administrative (SG&A) Expense: SG&A expense will stabilize around $2.5 million in 2017, and we predict a 5% increase in the future year because of the high efficiency of operation of CNIT in Q2. 3) Research & Development (R&D) Expense: Based on the continuing expense on R&D, we predict a 10% growth yearly. 4
Valuation Summary Our PT is based on our Valuation Models, which is a DCF Model and a Comparable Companies Model. For Comparable Companies Model, we value CNIT by using an LTM Price/Earnings multiple ranges from 31x to 50x and an EV/EBITDA multiple range from 29x to 38.7x. The median of LTM EV/EBITDA is 31.8x and the median of LTM P/E is 46.7x, which are both in-line with comparable public companies. For Discounted Cash Flow Model, we calculate the Company s WACC at 10.9%, derived from a 6.7% pretax cost of debt, 2.93% normalized risk-free-rate, and a beta of 1.44. Exhibit 7: Range of Implied Price From Valuation Current Share Price: At $1.23, CNIT appears substantially undervalued relative to its peer companies as well as to the implied intrinsic value from our discounted cash flow (DCF) analysis. As shown above, we believe a share price closer to $3.02 would be more in-line with the median EBITDA multiples from the comps and the DCF output. 5
Comparable Public Companies Analysis To value CNIT, we use a set of comparable public companies with a focus on P/E multiples and EV/EBITDA multiples. Exhibit 8: Comparable Companies - Specialty Cloud Service IoT Companies That Sell Service, with Market Value Between $8 Million and $3 Billion Company Current Stock Market DEBT Enterprise Share P/E E.V. / EBITDA Price Capitalization Outstanding Value Outstanding 16A LTM 17E 16A LTM 17E ($) ($:M) ($:M) ($:M) x x x x x x SLOB $ 76.70 $ 3,231.00 $ 335.64 $ 3,566.64 42.55 50.2x 45.5x 38.0x 35.2x 31.6x 25.6x NCIT $ 20.00 $ 272.00 $ 31.20 $ 303.20 9.1 54.3x 48.0x 43.0x 32.0x 29.0x 22.0x SLP $ 15.65 $ 269.00 $ 22.90 $ 291.90 17.3 57.0x 50.0x 42.0x 36.7x 31.9x 26.7x TSRI $ 4.32 $ 8.50 $ 1.23 $ 9.73 2.0 37.5x 31.8x 25.0x 36.9x 48.7x 28.3x Median 52.3x 46.7x 40.0x 36.0x 31.8x 26.2x High 57.0x 50.0x 41.0x 36.9x 48.7x 28.3x Low 37.5x 31.8x 25.0x 32.0x 29.0x 22.0x CNIT $ 1.08 $ 43.00 $ 6.79 $ 49.79 40.23 Discounted Cash Flow (DCF) Analysis To project Free Cash Flow and complete the Discounted Cash Flow analysis, we relied on our financial projections: Exhibit 9: CNIT Projected P&L Consolidated Income Statements Actual Projected (in US$ thousands) 2016A 2017E 2018E 2019E 2020E 2021E Revenue: Segment: CBT 7,135.5 16,920.0 25,380.0 38,070.0 57,105.0 85,657.5 TIT 3,058.1 1,080.0 1,620.0 2,430.0 3,645.0 5,467.5 Total Revenue 10,193.6 18,000.0 27,000.0 40,500.0 60,750.0 91,125.0 Y/Y revenue growth (%) 76.6% 50.0% 50.0% 50.0% 50.0% Cost of goods sold 7,607.2 10,358.4 15,537.6 23,306.5 34,959.7 52,439.5 COGS as a % of revenue 74.6% 57.5% 57.5% 57.5% 57.5% 57.5% Gross profit 2,586.4 7,641.6 11,462.4 17,193.5 25,790.3 38,685.5 Gross profit margin (%) 25.4% 42.5% 42.5% 42.5% 42.5% 42.5% EBITDA -8264.14 2,915.2 6,366.9 11,704.8 19,882.1 32,329.9 EBITDA margin (%) -81.1% 16.2% 23.6% 28.9% 32.7% 35.5% Deprecaiton 920.7 966.7 1,015.1 1,065.8 1,119.1 1,175.1 Amortization 406.7 406.7 406.7 406.7 406.7 406.7 EBIT -9591.561 1,541.8 4,945.1 10,232.2 18,356.3 30,748.1 EBIT margin (%) -94.1% 8.6% 18.3% 25.3% 30.2% 33.7% Net Income (Adjusted) -9864.22 2,372.5 5,775.8 11,062.9 19,187.0 32,008.4 6
Exhibit 10: CNIT Projected Unlevered Cash Flow Discounted Cash Flow Analysis (in US$ thousands) Actuals Projected Unlevered Free Cash Flow 2016A 2017E 2018E 2019E 2020E 2021E EBIT 1541.8 4945.1 10232.2 18356.3 30748.1 Depreciation & Amortization 1373.5 1421.8 1472.5 1525.8 1581.8 Changes in Working Capital 7049.8 3991.3 6041.3 9119.7 13741.0 Capital Expenditures -5400.0-8100.0-12150.0-18225.0-27337.5 Taxes 1045.5 1045.5 1045.5 1045.5 1045.5 Total Unlevered Free Cash Flow 5,610.5 3,303.8 6,641.5 11,822.3 19,778.8 Net Present Value Calulation Period 1.0 2.0 3.0 4.0 5.0 Discounted Cash Flow 10.91% 5,058.7 2,685.9 4,868.3 7,813.6 11,786.5 Total Net Present Value 32,212.9 Assumption: Terminal Value: Long-Term Free Cash Flow Growth Rate of 1%, or, alternatively, a Terminal EBITDA Multiple of 6.0x in a conservative way. With these assumptions and the Free Cash Flow projections above, the DCF produced the following output: Exhibit 11: Sensitivity - Terminal FCF Growth Rate vs. Discount Rate and Implied Share Price from DCF Analysis Terminal FCF Growth Rate: -2% -1.50% -1% -0.50% 0% 0.50% 1% 1.50% 2% 9.0% 3.53 3.68 3.84 4.03 4.23 4.46 4.71 5.00 5.34 9.5% 3.33 3.46 3.61 3.77 3.95 4.15 4.38 4.63 4.91 10.0% 3.15 3.27 3.40 3.55 3.71 3.88 4.08 4.30 4.55 Discounted Rate 10.5% 2.98 3.09 3.21 3.34 3.48 3.64 3.81 4.01 4.22 (WACC): 11.0% 2.83 2.93 3.03 3.15 3.28 3.42 3.57 3.74 3.93 11.5% 2.68 2.78 2.87 2.98 3.09 3.22 3.36 3.51 3.68 12.0% 2.55 2.64 2.73 2.82 2.93 3.04 3.16 3.30 3.45 12.5% 2.43 2.51 2.59 2.68 2.77 2.87 2.99 3.11 3.24 13.0% 2.32 2.39 2.46 2.54 2.63 2.72 2.82 2.93 3.05 Exhibit 12: Sensitivity - Terminal EBITDA Multiple vs. Discount Rate and Implied Share Price from DCF Analysis Terminal EBITDA Multiples 4.0x 5.0x 6.0x 7.0x 8.0x 9.0x 10.0x 11.0x 12.0x 9.0% 2.77 3.29 3.81 4.34 4.86 5.38 5.90 6.43 6.95 9.5% 2.71 3.22 3.73 4.24 4.75 5.26 5.77 6.28 6.79 10.0% 2.65 3.15 3.65 4.15 4.64 5.14 5.64 6.14 6.64 Discounted Rate 10.5% 2.59 3.08 3.57 4.05 4.54 5.03 5.52 6.01 6.49 (WACC): 11.0% 2.53 3.01 3.49 3.97 4.44 4.92 5.40 5.87 6.35 11.5% 2.48 2.95 3.41 3.88 4.34 4.81 5.28 5.74 6.21 12.0% 2.43 2.88 3.34 3.79 4.25 4.71 5.16 5.62 6.07 12.5% 2.37 2.82 3.27 3.71 4.16 4.60 5.05 5.49 5.94 13.0% 2.32 2.76 3.19 3.63 4.07 4.50 4.94 5.38 5.81 7
Monte Carlo Simulation to Forecast Stock Price We apply Monte Carlo Simulation to forecast CNIT stock price for 1 year starting from Sep 25, 2017. Based on the mean and variance of CNIT daily return from Apr 20, 2017, to Sep 25, 2017, we use Exponential Brownian Emotion formula to simulate CNIT stock price of 100 possible outcomes in 1 year. Formula: Exhibit 13: Monte Carlo Simulation on CNIT stock price Exhibit 14: Frequency Bins of CNIT Forecasted Stock price We stack the illustrated outcomes into bins and get the Frequency histogram of CNIT forecasted stock price in 1 year starting from Sep 25, 2017. Based on the outcome, price range from $1.9 to $2.4 has the highest frequency, which is 20% of the total. The second highest frequency range is from $3.0 to $3.6, which is 15% of the total. In sum, price range from $1.9 to $3.6 has a frequency of 35%, price lower than $1.9 has a frequency of 23% and price larger than $3.6 is 29%. 8
Investment Thesis CNIT has strong revenue streams sustained by growing digital advertising market in China. Based on the near-term rapid growth sales, it is expected that CNIT could continually sign more contracts with advertising companies, distributing more Cloud Based Terminals around metropolitans, shopping malls and residence buildings in different provinces in China. AMTT, China largest digital service to hotels and resorts, partnered CNIT to advance to new business horizon. The first step of the partnership calls for AMMT to install approximately 30,000 CNIT cloud-based elevator advertising terminals at AMTT's current and potential customer hotels as well as integrate those facilities' existing 5,500 display terminals in conference rooms, ballrooms and lobbies into CNIT's cloud-based network via CNIT's proprietary Taoping USB device. Proprietary Cloud-App-Terminal technology enables end-to-end digital ad delivery and IoT platform services. Within the last 4 months, the stock price has increased 82% from $0.67 to $1.22 per share, but still near low end of historical valuation. Experienced and committed management. Investment Risk The following represent the greatest risks to our investment thesis: It is possible that CNIT cannot keep its high growth of the sales of CBT terminals. While the initial results have been positive, there is no telling how successful the additional campaigns in other regions will be, or if there s a ceiling on the total number of units that might be on CBT terminals eventually. Further weakening of foreign currencies relative to the US$. The ability of management to execute on new acquisitions. The ability to grow organically and keep the product pipeline robust. Potential regulatory delays, rejections, or failures of pipeline products. The economic sensitivity of any self-pay products or weakening consumer demand. Domestic or international pricing pressures for marketed products. Failure to execute on new product launches. 9