KONG Must Kowtow to Regulators

Kongzhong (KONG - Snapshot Report) is one of the leading providers of wireless value-added services in China. The company’s revenue for the second quarter exceeded the market consensus, while its EPS was in line with market expectations. Revenue has increased sequentially for the past four quarters.

Kongzhong has a good chance to benefit from the potential growth of the wireless Internet services in China because of its leading position and balanced WVAS portfolio. The company’s bull story, however, is clouded by the unexpected policy changes from Chinese telecom operators and regulation changes from Chinese government. The policy changes from China Mobile (CHL - Snapshot Report) have resulted in significant decrease of Kongzhong's profitability for two years and will continue to have adverse impact on Kongzhong’s profitability in the future.

Although we are not very optimistic about its prospects due to the tough WVAS operating environment, the company still has enough cash to look for another source of revenue growth in the future. The low P/B ratio of the stock can provide some support for its stock price. Therefore, we are maintaining our Hold recommendation for the stock.

Based on our estimate for fiscal year 2008 earnings per ADS, the stock is trading at 22.3x, which is below that of the industry mean. Based on our estimate for fiscal year 2009 earnings per ADS, the stock is trading at 15.4x, which is far below that of the industry mean. Using a P/E multiple of 16.3x our fiscal year 2008 earnings per ADS estimate of $0.26 yields a target price of $4.25.

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Read the full analyst report on KONG