My take on Longtop

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First a little background. Longtop did its high profile IPO on Oct. 24, a short month ago at NYSE (think how much market sentiment has changed since then). As the first Chinese software company listed in NYSE, Longtop is in the sweet spot in terms of the customers they serve: the Chinese banks. Chinese banks, both the big 4 and the (smaller) city commercial banks, have lots of money to spend lately, after raising tons of cash through IPO in recent years.

On the serious side, the banks do need to improve the workflow and upgrade their IT system, so that their customers don’t have to wait one hour for over the counter service, or wait half an hour for ATM machine. The banks are also targeting the newly minted middle class for personal banking, credit card and other services. After all, it IS a competitive environment. China opened up RMB services to foreign banks early this year. If people can not get the services at domestic banks, they may go to foreign banks.

Here are two common questions for Longtop.

1) The usage of the IPO proceeds.
According to its F1 prospectus, the company plan to use the net proceeds of this offering as follows:

approximately $25 million to acquire an office building in Xiamen; approximately $10 to $20 million for acquisitions of IT service companies, including approximately $3.4 million in cash and potentially an additional $2.6 million in cash earn-out payment in connection with the acquisition of FEnet. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting Our Results of Operations—Acquisitions and Strategic Alliances.” Other than the FEnet acquisition, we currently do not have any agreements or understandings to make any material acquisitions of, or investments in, any business; approximately $30 million to pay a previously declared dividend. See “Dividend Policy;” and the balance of the proceeds for general corporate purposes.

See the problem here? So the majority of the money will be spent on real estate and dividend (for pre-IPO shareholders).

I know this does not sounds so good, at least to new shareholders. But buying office is not uncommon. I remember about 2 years ago Sohu, the Chinese Internet company, bought the office building it was leasing. I am not saying the company should go buy real estate, save rent and get appeciation from owning it. My point is the return of capital is a complicated matter. In the case of Longtop, raising money may not be the No. 1 reason for coming to NYSE.

Get listed in NYSE means the creditability, which in turn will bring more tangible benifits to the company’s business. Very much like the New Oriental (NYSE: EDU) did for its IPO a year ago. Note the same Venture Captial (Tiger fund) are invested in EDU.

2) Why Longtop issues adjusted report?
This is mostly a name confusion (language problem) for me: if they said GAAP and Non-GAAP, I would not be surprised. But when they said “adjusted”, initially I thought that was due to the change of fiscal year.

Non-GAAP is commonly used by tech companies, mostly to take out stock options. But I think stock options is increasingly a recurring annual expense for many Chinese companies like LFT or MR, so companies just should not simply take that out.

Other factors for the adjustment:
The VSOE or PCS thing. Longtop is does service for its software, to make sure the success of deployment. Here is an explaination of this in prospectus:

“Custom-designed software development. We provide a broad range of custom-designed software development services primarily to large national banks. These projects usually take approximately six months to complete and involve design and implementation of new solutions or significant customization of our software and, in some cases, third party software to meet our clients’ needs. We typically receive a lump sum fee payable according to negotiated payment schedules. Each project’s fee is based on our assessment of the man-hours involved, the size and complexity of the project, competitive pressure, strategic value of the project, cross-selling opportunities and our relationship with the client. The contract value less amounts deferred for the provision of PCS services based on vendor specific evidence of the value, or VSOE, is recognized as revenue over the customization and implementation period using the percentage of completion method based on the efforts expended. We recognize the deferred PCS portion of the contract value on a straight line basis over the PCS term, normally one year.”

Spin off the outsourcing services (longtop international, or LTI), this is not significant and non-recurring.

Last but not least, the Avondale Partners initiated its coverage on LFT today. Copied below, see for more details:
Company Ticker Brokerage Firm Ratings Change Price Target

Longtop Financial LFT Avondale Partners Mkt Outperform $30
Crocs CROX DA Davidson Buy $63

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