RealMoney Silver - Big Brother, Big Growth

Big Brother, Big Growth
By Jonathan Moreland
RealMoney.com Contributor
12/11/2007 11:46 AM EST

You know the market is tough when even a China-based growth stock experiences a selloff.

As its name suggests, China Security & Surveillance (CSR) makes, installs and services security and surveillance systems in China. The Chinese government is a big customer, as are businesses of all sorts in this booming economy. This, coupled with some insider purchases, has made the stock very attractive at this time.

CSR has grown like gangbusters over the past couple of years -- both in revenue and share price. Starting as a penny stock on the Bulletin Boards in mid-2005, CSR recently moved up to the NYSE on Oct. 29 and now fetches over $20. This is quite a comedown from the $33 the stock closed at just six weeks ago, however.

The recent pullback prompted two CSR execs to dig into their pockets and purchase just over $900,000 worth of their shares back on Nov. 23. Though the buys did not represent significant increases in their already large positions in the firm, the cluster qualified the firm for further consideration in my investment process. The company's past and expected growth quickly made it a candidate for me to buy as well.

From 2002 to 2006, revenue at CSR increased steadily from $10.3 million to $107 million. Operating income rose from $2.2 million to $25.3 million, and EPS went from $0.13 to 94 cents. Growth has stayed respectable in 2007. In its latest quarter, revenue increased 51% year over year, to $65.4 million. Adjusted EPS rose 24%, to $0.46, despite a whopping increase in shares outstanding due to another financing earlier this year.

To be sure, the noise created from the company's acquisition strategy and dilutive financings have made for unflattering financial comparisons on a GAAP basis. CSR's growth story relies a good amount on investors agreeing that the firm's adjusted EPS is the metric to hang a P/E on.

But the firm's accounting adjustments are relatively common these days, and the involvement of two large investors -- Barry Kitt's Pinnacle Fund, and Kenneth Griffin's Citadel Fund -- remove concerns of too-creative accounting as far as I'm concerned.

Both outfits are proven savvy China investors and have the resources to detect fraud before they take their large positions. The involvement of these two entities was certainly taken into account in my scoring of CSR's insider profile as a bullish one.

Mandated Growth

Giving depth to CSR's growth opportunities are laws in China that actually mandate surveillance. This is a huge plus for CSR and other security players in China, and it certainly beats the fear factor and insurance breaks that players in the U.S. have to depend on to generate new customers.

Last year, the Chinese government initiated the "Safe City Project." This is a five-year plan to make cities safer by installing surveillance systems in high-volume foot-traffic areas, including areas of businesses and shopping, and transportation centers.

Not intrusive enough for you? China also passed "State Ordinance 458" last year that ordered entertainment venues to be similarly monitored. So the next time you try out your best Barry White in a Beijing karaoke bar or pull a John Travolta in a Shanghai nightclub, smile for the camera.

And those two legislated sources of surveillance demand are over and above that resulting from preparations for the 2008 Olympics, and the monitoring of coal mines and other industrial venues for safety.

Interestingly, the demand for the surveillance equipment itself and its installation has been so robust that CSR has generated most of its revenue from these sources. That is contrary to the business model of players in the mature U.S. market. Here, surveillance firms often give away the equipment as a "razor" to garner the "razor blade" recurring monitoring fees. CSR is just entering the monitoring biz, however, introducing yet another avenue for growth.

As of now, CSR's adjusted EPS (e.g. non-GAAP numbers) are projected to be $1.15 this year, rising to $1.65 in 2008. But those numbers have increased in the past month, and could well rise again as more accretive acquisitions are made, and the firm's new monitoring operations gather steam. With over 40% growth expected, that gives CSR a 13 multiple on 2008's expectations.

If the non-GAAP numbers just don't seem conservative enough for you, though, consider this: Even a new report by Lehman Brothers (LEH) that focuses on the GAAP numbers places a price target of $30 on CSR.