Commentary

Should You Outsource Your Capital To SinoCom?

Tech Market WatchBy Perry Wu
SinoCom Software Group is a Beijing-based company involved in the fast-growing outsourcing part of the software market. While India has gotten much publicity of late for its prowess in handling technology outsourcing, SinoCom has concentrated on taking advantage of the low-cost, high-tech brainpower available on the mainland.

Founded only in 1995 as a wholly-owned foreign enterprise in China, the company currently boasts a branch office in Chengdu and ten different representative offices scattered throughout China. Deloitte and Touche recognized the company in 2002 by placing it on its list of the 500 fastest growing tech companies in Asia.

A few weeks ago, SinoCom did its IPO and is now listed on the Hong Kong Stock Exchange.

The company was originally formed by a combination of Japanese entrepreneurs and a Chinese, Mr. Wang, who had worked in the Japanese IT industry. When Mr. Wang returned to China in 1995 he struck up a deal with the Japanese entrepreneurs to set up an outsourcing operation in China while the Japanese concentrated on getting Japanese IT customers. As a result of these Japanese roots, the company's business currently flows mainly from the needs of its Japanese customers. It has now built a blue-chip base of customers and currently has contracts with four Japanese IT companies: NEC, NEC Soft, DIR, and NRI.

In 2002, SinoCom diversified beyond its Japanese base by taking on Sun Microsystems as a client. SinoCom now has a major contract to handle Sun's technical support services in China. If a Sun customer in China purchases a major piece of hardware, it may be SinoCom that will assist in the installation and maintenance of the system. While this contract currently represents only 7% of the company's sales, this is the type of business that SinoCom can hope to acquire more of as it establishes a stronger franchise in China.

Essentially there are two ways that SinoCom can handle an outsourcing engagement with a client. The first way is where SinoCom will fully dedicate a set of its PRC employees to only work for a particular client on developing software. SinoCom then charges a monthly service fee to the client for the use of the labor of SinoCom's employees. The other way is on a project basis, whereby SinoCom charges service fees for the software development project for a client and decides itself what labor to allocate to the project.

In theory, the economics of SinoCom's business should be quite favorable. The company is basically just selling labor so it requires little in the way of fixed costs. In the event of an economic downturn, SinoCom should survive by simply laying off its employees–which is becoming easier for a private employer to do in China.

Indeed, SinoCom's financials do paint a picture of just this sort of good economics. As of February 29, 2004 (before the IPO) the company had zero debt on its balance sheet and held HK$93 million of cash. Even more impressive, the company boasts 30% profit margins (based on net profits of HK$33 million and sales of HK$114 million), proving the viability of its business model.

Further reducing its overhead, the company's offices around the mainland are leased rather than owned. So the company's two basic costs–labor and rent–are highly variable while the company appears to have virtually no fixed costs. As a business therefore, SinoCom's financial risk is rather low.

So SinoCom appears to be a good way for an investor to capitalize on the outsourcing trend in China. As a young publicly-traded company, it remains to be seen whether SinoCom can translate its good economics into sustainable shareholder value, but an investor might still take a serious look at outsourcing his capital to SinoCom.

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.

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