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    Stock Alert – Litigation with Evolution Capital still weighs down CDC Corporation

    The shares of CDC Corporation (NASDAQ: CHINA) increased 11% to $3.10 in the afterhours session on March 4, gaining nearly 2% to trade at $2.84 this morning, moving on insignificant trading volume. There was no news to support this appreciation, which we regard to the volatility of small-cap stocks. The company closed the March 4 regular session at $2.79 on 147,400 shares traded.

    CHINA shares lost more than 65% over the last year, pressured down by the lawsuit with Evolution Capital.  The company filed a lawsuit against Evolution in 2010 alleging breach of non-disclosure agreements, breach of the note purchase agreement relating to the company’s 3.75% Senior Exchangeable Convertible Notes due 2011, etc., seeking a recovery in excess of $295.0 million. This matter is still in the early stages of discovery; however, it seriously distracts management from pursuing the regular business opportunities.

    Evolution has also asserted claims against CHINA, seeking to recover  in excess of $60 million owed to Evolution under the same 3.75% Senior Exchangeable Convertible Notes, which Evolution put back to CHINA on November 13, 2009. To date, the Court granted Evolution’s motion for a preliminary injunction against CHINA and ordered CHINA to pay Evolution a $50,000 sanction. The imposed injunction is also precluding the company from distributing dividends.

    While CHINA believes Evolution has taken substantial steps to harm the company and its prospects, it offered to compromise, proposing Evolution a structured payment of $41.2 million for its Notes, or par value, payable in 2011 and 2012. However, Evolution rejected this offer mentioning that currently its claims exceed $64 million including interest and costs.

    As of September 30, 2010, CHINA had a cash and investments balance of $104.0 million, which would be enough to meet any potential obligations it may have under the current litigation.

    CHINA, headquartered in Hong Kong, has operating segments in enterprise software applications and services; IT consulting services, outsourced application development and IT staffing; online games; and the Internet portal China.com. CHINA owns approximately 85% of CDC Software (NASDAQ: CDCS).

    For Q3 2010, CHINA reported revenue of $78.3 million and Adjusted EBITDA of $7.0 million, compared to revenue of $76.6 million and Adjusted EBITDA of $9.0 million for Q3 2009. The growth was driven mainly by robust operations at enterprise software assets (CDC Software) that expanded 9.1% to $53.0 million, offset by a 17% decline to $15.8 million in global services revenue (CDC Global Services). The media services revenue (gaming and china.com assets) were up 6.8% to $9.4 million during Q3 2010 compared to Q3 2009.

    The company reported a loss of $6.1 million or, $0.18 per share, in Q3 2010, compared to a loss of 7.9 million, or $0.23 per share in Q2 2010 and a net income of $5.6 million, or $0.15 per share in Q3 2009. Analysts, polled by Thompson Reuters, expect CHINA to gain $0.06 a share on revenue of $84.9 million in Q4 2010.

    The recent quarter confirms that the company is making its way back to recovery by improving its topline revenue, building higher margin software as a service offering, and positioning to capture the growth in the cloud computing segment. Moreover, CHINA announce plans to relocate its corporate headquarters from Shanghai to the upcoming state-of-the-art Sanshan Science and Technology Park in Foshan as part of its long-term plans to expand its operations in one of China’s most prosperous and rapidly growing cities. The company has recently opened a government-funded cloud computing center there.

    Going forward, the company would rely on solid organic growth, as the global IT spending is recovering, accelerating cross-sell activity and expanding in emerging markets, as well as through strategic investments and acquisitions. China’s government plans to provide more financing, research and tax support for software and semiconductor industries could further boost the company’s potential. Moreover, the eventual resolution of current litigation could likely position the company to rebound from current lower valuation.

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