China Outsources to…Itself

07/02/2009 10:59 am EST

Focus: STOCKS

Robert Hsu

Editor, China Strategy and Asia Edge

Robert Hsu, editor of China Strategy, says a Chinese outsourcing company taps into the vast domestic market, and it has lots of growth opportunities.

China's software outsourcing industry is not that well known. That's because when most people think of outsourcing, they immediately think of India. But what's interesting is that the Chinese have an even greater competitive advantage than its southern neighbor in this industry. There are three reasons why:

1. Lower wages: The average wage for computer programmers in China is lower than India's wages.

2. A larger supply of engineers. The Chinese education system graduates more computer science engineers than any other country in the world, with 600,000 graduates in computer engineering and related areas each year. That's approximately the total for the US and India combined.

3. A large domestic market. Unlike India, China has one of the largest domestic markets for computer software and other IT services in the world. So Chinese IT outsourcing companies can tap into the huge growing demand from domestic companies involved in e-commerce.

Based in Beijing, VanceInfo Technologies (NYSE: VIT) has been around since 1994, making it a pioneer in the Chinese outsourcing industry. Over the years, it has grown to become the largest and most successful IT outsourcing company in China.

With more than 5,000 IT professionals, VanceInfo provides world-class services to corporations in the US, Europe, Japan, and China. Its clientele has increased significantly over the years-[from] 98 in 2005 to 241 in 2008-and now its top customers include Microsoft, IBM, Hewlett-Packard, EMC, and Lenovo. [Sales] from its five largest clients accounted for 54% of the company's total revenues in 2008.

VanceInfo's total revenues soared from $8.2 million in 2004 to $102.7 million in 2008. That's an average annual growth rate of 88%! During the same period, net income jumped from $1.1 million to $16.2 million, and its gross margin was an impressive 38.7% in 2008.

In the first quarter, its net revenues increased 47% from a year ago, [and] net income rose 27% to $3.8 million, or ten cents per share, and operating margin expanded to 14.4% from 12.7% in the same period a year ago.

While seasonality and the economic downturn have slowed VanceInfo's US business, the company saw continued growth momentum from its Chinese and European clients. With enhanced capabilities and strong brand name, the company is expected to continue to win new customers and evolve as an even stronger player.

For the second quarter, VanceInfo expects to post net revenues of $31 million to $32 million and earnings of ten to 11 cents per share. That's a 27% to 31% increase from the same quarter in 2008. For full-year 2009, the company raised its guidance, expecting revenues of at least $128 million and earnings between 46 cents and 48 cents per share.

I want you to buy VIT under $16.50. (It closed around $14.50 Wednesday-Editor.) I'm targeting $21 by the year-end, which would give us a nice 50% gain from today's levels.

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