To OTC Journal Members: 
 

Looking For Upside Earnings Surprises? Think Xinhua Sports and Media (NASDAQ: XSEL)

We're in the heart of earnings seasons for large caps, and as I predicted the biggest surprises are to the upside. I'm also looking for some upside surprises in our small cap world- look for better than expected numbers out of NF Energy-NFEC (they doubled their estimate last quarter), China Ed- CEU- already up 12% on my first eay- Force Protection (FRPT), and Universal Travel (UTA- up 94% from my call).

Has anyone noticed the break out in CalAmp (CAMP)? You're now up 53% on that one since my August call at $2.18. It's finally broken out through $3. They announced earnings last week- there was no surprise in the August quarter, but a big surprise in their forecast. I continue to believe this one is destined for $5.

I'm looking at another new idea for the weekend. It's a stock that's been on a tear of late, and might be a bit extended. I'll probably publish on it this weekend with a bit of technical caution. It's in China, and it's making big money.

I'm anticipating the possibility of a big surprise to the upside out of Xinhua Sports and Media (NASDAQ: XSEL), one of the few China ideas I'm covering that hasn't made a major move- yet.

I believe XSEL has a credibility barrier to break, and a couple more quarters like Q2 should turn some skeptical institutions into believers. Unlike my other China ideas that are pure growth, XSEL is a fallen angel and I believe a turn around situation that has trememdous upside for the next several years.

Consider the following- US born, but 25 year veteran of China Fredy Bush has completely refocused this company. It was originally a $400 million IPO back in '07- a $12 stock at the time.

The company raised the money, and tried to become all things media in China- it was too much. Between radio, print, magazines, and TV, the company was simply not focused and numbers turned in the wrong direction.

Now, here's the part where you need a little foresight. Imagine a complete refocus of the company. Sell off your non core assets and focus on replicating one of the greatest broadcasting successes in the history of US based television- ESPN.

ESPN delivered its first broadcast of a sporting event in 1979. It was the World Series of Baseball- NOT!!- It was the World Series of softball, pitting the Milwaukee Schlitzes against the Kentucky Bourbons. I'm guessing there were some adult beverages served at the event. I don't know who won. 

Fast forward 30 years- ESPN is estimated to generate $7 billion in revenues this year, and one of the most profitable subsidiaries in the Disney Empire (NYSE: DIS).

So, here's where a little imagination and foresight is required. TV broadcasting is not exactly the same in China as it is in the US. The government has a bit more control before the broadcast- in the US, the FCC looks at content after the fact if its problematic.

Sports is non controversial, and Xinhua Sports and Media bears the same name as the 70 year official news agency of the Chinese government- Xinhua.

XSEL is migrating nearly all its programming from lifestyle to sports, and their audience is 6.5 times the size of the audience ESPN had when it started in 1979. On a per capita basis, XSEL's audience is even bigger- over 90% of Chinese citizens have access to TV.

Soccer and basketball are huge. XSEL is rapidly adding content in those areas. 

Here's what I find intriguing- the numbers. Q2 was really a breakout quarter for the company, but the market is not buying into a reasonable valuation yet.

In Q1 '09, XSEL generated about $25 million in revs. In Q2, XSEL's top line jumped to about $39 million. Here's where you need a little imagination. XSEL did not report EPS (earnings per share), unlike most of the other China situations I cover. 

XSEL is significantly burdened by its many divestitures and write downs. This is the draconian nature of GAAP accounting, and believe me, it is infinately more complicated than it was when your Grandfather put his AT&T stock certificate in the safe deposit box.

If you take out all the non cash stuff that the accountants charge off, XSEL really had positive cash flow off its operations of about $5 million in Q2. If the company were able to report $20 million in profits in one year, it would equate to EPS of $.26 per share.

XSEL is one of the few China situations I'm covering that hasn't made a big move yet. I launched my coverage at $1.70 in August, and the stock is still trading around that level. 

Q3 numbers will be coming out sometime in the next few weeks. The market has not bought into this company's turn around and potential profitabiliy quite yet. 

The chart is setting up nicely. As you can see, XSEL traded up on a nice incline from May to August. Then it broke out on big volume in front of Q2 numbers. Since mid August it has been griding sideways, absorbing this year's gains and letting new money accumulate at higher prices.

Top line growth just from Q1 to Q2 was 56% this year. What will Q3 bring? I don't think the company needs to deliver another 56% quarter over quarter. That was just nuts.

However, if they can just replicate the Q2 performance, I believe the market is going to start buying into the growth and profit potential, and this stock could begin its next leg up. 

I'm publishing this update today because the stock is quiet and no one is paying attention. Q3 numbers will be out in a few weeks, and if they can replicate or exceed Q2, the market is going to start taking a hard look at the mere $127 million market valuation of this company. 

If they can replicate about $40 million in revs, you're looking at accumulating a cash flow positive company, delivering annual revenues of $160 million, at less than 1 time sales and about $.26 per share in positive cash flow.

Longer term- they have no real competition to become the ESPN of China. There's some local sports programming on Government owned networks, and a little sports programming from another content provider.

Delivering sports programming on dedicated sports channels to a very sports hungry audience made up of the largest consumer class in the history of the world should become a lucrative endeavor in the long run. Short term, I'm betting on the Q3 numbers. Long term- there's simply no telling how high this could go.

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