CellStar Corp. has abandoned plans to proceed with an initial public offering of its operations in the People’s Republic of China, citing continued negative impacts on its business as a result of changes in China’s economic environment and structural changes in the handset industry there.
CellStar first discussed problems in China and said it was assessing strategies to remodel its business plan there after releasing depressed second-quarter financial results in July. At that time, the company promised it would announce plans regarding the IPO and its struggling Singapore and Philippines operations before releasing third-quarter results, due in mid-October.
“The changes continued to negatively impact our financial results in the third quarter and unfortunately we see no significant signs of improvement as we enter the fourth quarter,” said Robert Kaiser, CellStar’s chief executive officer, in a conference call last week.
Citing a “known shift” in the economy and handset sector in China, CellStar has decided to not proceed with the IPO, and will record a $2 million charge to cancel it.
CellStar also said it will exit its unprofitable businesses in Singapore and the Philippines, which were not included in the proposed IPO, a move that will result in a $4 million loss in the third quarter. The company said it will continue to pursue opportunities for its Taiwan operations.
CellStar, which also operates in the United States and Latin America, entered the Asia-Pacific region in 1993 when it launched operations in Hong Kong. Singapore, the Philippines and Taiwan followed in 1995, and the People’s Republic of China in 1997. The Asia-Pacific region represents 50 percent of CellStar’s total revenues and of that, China represents 80 percent.
The IPO originally was proposed in March 2003 and first delayed because of the negative effect Severe Acute Respiratory Sickness had on China’s economy. The target time frame for the IPO then moved to summer 2004, but uncertain economic conditions in the Hong Kong market caused it to be delayed again until at least this fall.
The conditions in China and the charges taken with the IPO cancellation and exits will have “a significant negative impact on our results in the third quarter,” said Kaiser, adding that continuing changes in the industry and economy in China will continue to impact revenues and profits for the “next several quarters.”
The company warned that its third-quarter revenues are now estimated at $76 million, down 52 percent from the second-quarter 2004, and its operating losses are expected to be between $7 million and $8 million, not counting the $2 million and $4 million exit charges.
Multiple issues are affecting CellStar’s handset business in China, and according to the company, it is not alone, as overall handset sales in China dropped 23 percent in the second quarter from one year ago.
The country counts 40 million excess handsets in its channels, CellStar said, which has caused major manufacturers there to cut prices and offer promotions in an attempt to reduce the build up. “Significant pick up [in the handset business] is not expected until inventory levels return more toward normal levels,” said Kaiser.
Among other problems in the region: the Chinese government implemented tighter credit controls in an effort to cool the rapidly growing economy; handset manufacturer Nokia Corp. cut its prices to boost its market share, which according to CellStar triggered a chain reaction among Nokia’s competitors; high penetration in major cities is slowing the demand for cell phones; and carrier subsidies are becoming common.
CellStar will be forced to wait for the excess inventory to “work its way out of the system,” Kaiser said. “There’s just not a flow at the moment,” he said.
Meanwhile, the company said it continues to believe there is growth opportunity in China and plans to restructure its business model to better operate there.
Specifically, CellStar plans to pursue joint ventures with its local distributor partners to operate retail locations in China, made possible by China’s recent entry into the World Trade Organization. The hope is the shift will allow CellStar to continue to participate in the wholesale market and increase its presence in the retail market, which it said typically has higher margins.
CellStar plans to enter one or two joint ventures in each of its four China regions by the end of 2005, said Terry Parker, CellStar’s executive chairman. “[We are] committed to this new strategy and plan to move as quickly as possible,” said Parker.
CellStar also hopes establishing a presence in the retail sector will help it move into more rural areas of China, so the company can serve increasing demand there rather than only focus on the country’s highly penetrated major cities.
The changes will take some financial backing, and while the company said exact numbers are unknown, it is confident that the funds that will be required are already available via existing lines of credit and existing cash flow in China.
Following the company’s latest warnings last week, its stock was trading at $4.10 per share, 20 cents below its previous 52-week low, and the stock was downgraded from strong buy to neutral by Southwest Securities.
