I've talk a little bit on this blog about the niches in China we at Global Gains are looking for the best returns, but 3 China Profit Plays lays it out most succinctly in one place. [more]
The WSJ writes that the spreads look pretty good, and I agree. EDD is a good vehicle, IMO, if that's something you're interested in doing. This is particularly true if you think commodities are going to rebound and buouy tax revenues in places like Brazil, Peru, and some of the other oil-producing states. [more]
This time in China.
That article makes a couple of relevant bearish points:
1. Chinese stimulus lending has not gone to building the real economy, but has rather been invested in the stock market or in stockpiling commodities (which has spurred price increases that some have taken for a global economic recovery).
2. China can't seem to stop their banks from lending even though they've told them to stop. So either they actually haven't told them, or the banks have lost control.
3. China is more committed to putting up an impressive GDP growth rate than it is to helping the economy transition away from low-cost export manufacturing.
These are all real problems, but do note that the article is quoting the two China bears (Mr. Pettis and Mr. Xie) that have been quoted in all of these types of articles. But there is truth in what they're saying, though I do continue to believe China will be a long-term economic success story. [more]
I still get to keep $2.5mm...
C'mon. No way she didn't know.
Up 50% in the last 15 min of the trading day. Anybody know what happened? Glad we were on the right side of that move. [more]
You know the geography of China and you know the history of China, so you're ready to know what you should start thinking about investing in. That's what this next series of posts aims to help you figure out.
As always, these posts are just a primer for the full coverage you'll get if you sign up to receive all of the notes we send back from our upcoming trip to China. To get those free notes, simply enter your email address on this page.
Our first theme is the SSE...
If you've never heard the term SSE, that's ok, we invented. It stands for state-sponsored entrepreneur and is a play on SOE, or state-owned enterprise, which are the dominant economic units in China today.
SSEs are a theme we hit on during last year's trip to China and include private companies like General Steel (GSI) that get beneficial financing from state-run banks and that are favored acquirers of small state-owned companies as the government seeks to make its economy more efficient.
But SSEs can also be the publicly-traded state-owned companies such as China Blue Chemical, that benefit from the same trends.
The key is that these are smaller companies that are very entrepreneurially run, but do glean some benefit from good relationships with the government that give them a temporary competitive advantage in China's fast-growing economy. Look out for SSEs in any China research that you do; we think they're a key long-term play.
We have a few potential SSEs on our meeting dance card for the upcoming trip. Remember, if you're interested in getting those notes from the field, simply click here and enter your email address on the page. [more]
We'll be sending tweets back from China. This is a first-time experiment for us, so no promises on the value of our <140 characters.
Anybody have thoughts on how to be a good Tweeter? Put 'em in the comments.
Thus far in our Global Gains CAPS Champion of the World Contest we’ve you advised to go long some stocks and short some other stocks -- and our results have been quite good. This week, however, I’m recommending you go long and short two stocks together at the same time. That’s because it’s arbitrage, and while a 50% accuracy score may drag on your rating, you have the potential to rack up some big points.
But before I get to the idea, allow me to plug our Global Gains 2009 research trip to China. This is an annual event for our service and each year we've gone, we've discovered a stock that went on to more than double for us (CFSG in 2007 and CGA in 2008). Given that the broader market has done over that same period of time, we're quite proud of that fact.
As always, we'll be sending dispatches back from the road on what we find free to anyone who signs up. If you'd like to sign up to receive those dispatches, simply enter your email address in the box on this page.
And if you know people who are looking to learn more about investing in China, please send them the link and encourage them to sign up as well. The content should provide to be both interesting and valuable. And if you're into Twitter, you can also find us there, where we'll be providing real-time tweets from China. Should be interesting.
And now, this week’s contest idea…
Long Sohu.com (SOHU) and Short Changyou.com (CYOU)
Thesis: Sohu.com and Changyou.com are two significant Internet plays in China. Sohu.com is a popular news and communication portal that owns a hive of websites relating to various interests. Changyou.com is a large online gaming company that specializes in massively multiplayer online role playing games (MMORPGs, for short). And while it’s very difficult given Internet growth rates in China to calculate the value of either of these companies individually, it’s easier to figure out what their value should be relative to one another. That’s because SOHU recently spun-off CYOU and continues to own 70% of the company’s shares. Today, there’s a discrepancy in that valuation (either CYOU is overvalued or SOHU is undervalued) and you can make money by arbitraging it out.
Valuation; Following its IPO, CYOU shares have been on a tear. The company is now worth $1.95 billion dollars and trades for 9x revenue and 14x EBITDA. While that looks really expensive, these Chinese gaming stocks are notorious fast growers with lots of potential customers. So let’s assume CYOU is fairly valued. If that’s true, then SOHU’s stake in the company is worth $1.37b dollars. Yet SOHU’s stand alone market cap is just $2.47b. So if we net out the value of the CYOU investment, then you can buy SOHU’s entire business for $1.1b. But SOHU also has $178mm in net cash on its balance sheet. If we take that out, then SOHU’s operations are selling for just $922 mm.
So what do you get for $922mm? Roughly $250mm in annual sales, $152mm in annual gross profit, $50mm in annual EBIT, and $44mm in annual earnings. Do the math and net of CYOU, SOHU is selling for 3.6x sales and 20x earnings. That doesn’t scream cheap, but this is a business that grew its top line 20% year-over-year and its operating line more than 40% year-over-year. Further, the average Asian emerging markets Internet services peer today sells for 8.4x sales and 31x earnings.
Takeaway: If we assume CYOU is fairly valued and the sector is rising, then SOHU stock stands to appreciate much more than CYOU stock, and you’ll earn more points on the SOHU long than you will on the CYOU short.
If, however, you believe that CYOU is dramatically overvalued and SOHU fairly valued, then reverse everything I wrote above and you’ll earn more points on the CYOU short if the sector is falling than you’ll lose on the SOHU long.
Either way, the value of the two companies should converge over time and by going long SOHU and shorting CYOU you will earn a nice dose of points on that convergence.
State-owned Sinopec (SNP) is buying E&P company Addax for more than $7 billion. The company has extensive operations in -- you'll never guess -- Africa as well as in Iraq. China continues to lock up that continent's natural resources for use, presumably, in China and nowhere else. [more]
How do I know? I just got this alert from the City of Alexandria (VA):
Recently there has been a spate of fairly brazen thefts of copper gutters and downspouts from homes in old town, some in broad daylight, by persons who appear to be working as contractors. We know of such thefts from houses on the 400 block of South Union and at least one such theft in the 500 block of Duke St. If you have copper gutter/downspouts, or know that your neighbor(s) do, please be aware of the problem and let your neighbors know. If the neighbors see anything suspicious (for example) they are unaware you are having construction work and see a 'contractor' at your house, they should call the police forthwith.
Of course, there's legal way to profit from this trend. Buy Peru...forthwith. [more]
Yesterday, as we try to get everybody excited about the upcoming Global Gains research trip to China, I provided a brief introduction on China’s geography and how that affects the country’s economy and our investment ideas. If you’re interested in that post, you can find it here.
Today, I’m going to focus on a very brief overview of China’s history and how that’s affected the country’s modern economic development. But before I get to that, I’d just like to remind anyone who is interested that you can sign up to receive all of our real-time dispatches from China in July for free simply by clicking on this link and providing your email address on the page. Please also forward the link to anyone you know who might interested in learning more about or investing in China.
We make these dispatches free to everyone on Fool.com because I feel pretty strongly that more Americans should be educated about China (it is a rising power, after all) and because intelligent American investors in carefully-chosen Chinese stocks should do pretty well over the next 10 years. In fact, during each of our last two trips to China we’ve uncovered a previously small and unknown company that has more than double since we wrote about it. Given what the market has done over that same period of time, we’re pretty proud of that fact.
But onto today’s brief overview of China’s history.
When I say “brief,” I mean brief
I’m not sure how well this slide will show up on the blog, but I apologize in advance for any strain it puts on the eyes. Bear with me though. You can’t use 48 point font when you’re trying to fit thousands of years of Chinese history on one slide:
This is the first in a series of posts to get you up to speed on China in advance of our Global Gains research trip to the country in early July. As always, we’ll be emailing back real-time dispatches from the field on what we find for free to anyone who signs up to receive them.
If you’d like to sign up to join us on this year’s trip, simply click here and provide your email address on this page. Now onto the post…
Geography and China
One of the most important things to understand about a country before you invest in it is its geography. For example, you want to know where it’s located, what natural resources it has, how those things affect the economy, and how the geography affects the politics of a country. These four things are particularly important when it comes to China.
As you can see, China is an enormous country. And though it’s roughly the same size as the United States in terms of landmass, it has more than 4x the population (1.3 billion v. 300 million). Further, most of China’s population is concentrated in the east around Beijing, Shanghai, and Guangzhou. That’s because these areas have seen more economic development than the rest of China, generally have friendlier climates, and have access to water and to the coasts.
This geography currently affects government policy in that the government is pushing a go-west initiative to even out development in China and raise rural incomes. It’s doing this because it wants to diversify the economy (the country can’t keep growing on low-wage manufacturing jobs in southeastern China), strengthen the agricultural sector to become food independent, and spread the “Chinese miracle” so that impoverished peasants don’t start organizing to revolt. This western development is an important investment theme in China and one that will produce a lot of winners.
Another way Chinese geography affects politics and investment is in the Taiwan question. While I won’t go into the history here, Taiwan is a disputed province. Many Chinese would like it to be part of the PRC, while many Taiwanese would like to remain independent. If Taiwan were ever to return to the PRC, it would likely be as an SAR (like Hong Kong or Macau). Thus, the PRC continues to encourage development in HK and Macau in the hopes of proving to Taiwan that being an SAR wouldn’t be such a bad deal.
The 10,000,000 foot view
Now, take a look at this map:
This one really shows why China has and continues to make such a massive investment in infrastructure. If it is to expand west, it needs many more roads and rails to make sure that part of the country can ship goods out to the east. Because unlike the US, China has just one coast (it also makes you wonder if China at some point is going to try to blast through the Himalayas to get more direct access to the fast-growing Indian market).
You can also easily see in that photo why most of the Chinese population lives in the east. As you can see, northern and western China is extremely dry. In fact, that part of the country is running out of water. This has caused China to pursue a massive north-south pipeline project, which has been another major infrastructure investment.
That last point also brings up the question of resources. Yes, China needs water, but it also needs oil, metals, and food. You can clearly see that China does not have much arable land relative to the size of its country and that much of that arable land (in the south and east) has already been developed for cities and manufacturing. One imagines that if China had to do it over again farther north where it could be both near the desert and near the coast and save that prime farmland in southeastern China for productive farms.
That’s just a primer on the geography of China, but it should give you an idea of how China’s geography will affect its development over the next 10 years. Indeed, knowing that, you may now share our view at Global Gains that some of the best opportunities in China are in western China and in the infrastructure space.
Again, if you’d like to join us as we explore that thesis on the ground in China in July, simply click here and enter your email address. Then we’ll be able to send you all of our free real-time dispatches from the road. [more]
We're midway through the first quarter of our Global Gains CAPS Champion of the World contest, which means we're far along enough to start making some observations, but not so far along that it's not worth your time to enter. So what are you waiting for? Enter here now. [more]
Yes, it's going to be big. I love this space (Brazilian consumer credit), but boy is it expensive to play. Redecard -- a dream stock that's been on my watch list since its 2007 IPO -- continues to trade for 10x sales and 15x EBITDA. Pricey. [more]
Apple (AAPL) CEO Steve Jobs apparently had a liver transplant in Tennessee two months ago, though the WSJ is speculating that perhaps it's not as innocent as it sounds:
Getting a liver transplant to treat a metastasized neuroendocrine tumor is controversial because livers are scarce and the surgery's efficacy as a cure hasn't been proved, Dr. Hawkins added. He said that patients whose tumors have metastasized can live for as many as 10 years without any treatment so it is hard to determine how successful a transplant has been in curing the disease. [more]
Ben Stookesberry is my hero.
Let me provide some context. I enjoy whitewater kayaking. I have a boat, and I can do simple tricks in the Potomac, including boofing 3 to 6 foot drops. It's fun as heck. But what the guys are doing in that article (including an incredible video of Ben Stookesberry dropping a 65-foot falls with a headcam) is unbelievable.
What does this have to do with investing? I call your attention to this passage: [more]
In fact, it's the best little investment opportunity I know. A key excerpt:
You may not know that Peru -- not Brazil, not India, and not China -- was the fastest-growing economy in the world, in 2007 and 2008, with 9% GDP growth. It’s expected to remain the fastest-growing economy in all of Latin America this year as well, with an official forecast of 3.5% GDP growth.
Second, you may not know that Peru is a major exporter of valuable commodities such as copper, gold, silver, zinc, and phosphate, which should see prices rebound this year as consumption growth resumes in the major emerging markets.
Third, you may not know that Peru recently signed a free trade agreement with China that will further accelerate its economic development.
And fourth, you may not know that Peru is on the verge of completing the IIRSA highway that will link Peru’s Pacific coast with the Atlantic coast (and population centers) of Brazil. This will turn Peru into a crossroads for trade between Brazil and China -- two of the world’s biggest emerging trading partners.
Learn more here: http://www.fool.com/investing/international/2009/06/18/the-best-little-investment-opportunity-i-know.aspx [more]
Oh, Thursday. The day you get another Global Gains team-vetted stock recommendation for use in our CAPS Champion of the World contest, or, if you're really bold, real life.
This one comes from the mind of our crack analyst Nate "The Snake Weisshaar" and is a smart way to play the world's growing demand for food. But before I reveal too much, I'll turn it over to The Snake....
Buy Israel Chemicals (ISCHF.PK)
Thesis: The problem with agreeing with a well-publicized long-term trend is that it becomes difficult to make money off investments that are aligned with that trend. Take agriculture for example. I think most of us can agree that land is limited and people need to eat and as incomes rise, diets become more land intensive (it takes more grain to feed cows to make beef than it does to feed a human on said grain). Under this umbrella, it makes sense that companies dealing with farmland or agricultural technology will have a decent run going forward. [more]
Let's assume you're training to run fast in a foot race. What type of training are you going to do? Are you going to run sprints up hills? Are you going to start with a 3-mile jog and gradually increase your distance each day? Are you going run with a partner? Are you going to do some combination of everything?
The answer to that question obviously depends on what type of foot race you're trying to win. If it's a 100 meter sprint, you're going to focus on build up an explosive burst. If it's a marathon, you're doing to do a lot of distance training. Either way, the training regimen you design to achieve your goal is based explicitly on what you goal is. If you didn't have a goal, you wouldn't be able to design an effective training regimen.
So it goes, too, in investing.
Here's what I mean by that
I mentioned in a recent post that I'd caught some flak from a hanful of Global Gains members for issuing two valuation-based sell recommendations. But I did so because my analysis told me the risk/reward trade-off for those two stocks was not attractive, particularly as compared to a few other stocks on our scorecard.
Similarly, I received some questions via email about a comment I made in the "Is Buy and Hold Dead?" roundtable that many of you signed up to receive from Fool.com. The gist of that comment was that I would back up the truck on TIPS that offered a before inflation rate of return of 5% to 6%. You wanted to know if I meant that and if I'd really be happy with that.
My favorite part of my job is finding obscure Chinese micro cap winners. I love doing the research, the background checks, and the valuations. Most of all, however, I love when we catch one that rockets up. And while I'd love to earn 35% annually, I recognize the fact that there are a finite number of stocks that can offer that type of return and that I can't expect to bat 1.000 and find every single one of them.
So I ask myself: What is my goal? What am I training for?
Obviously, if I'm taking risk in stocks, I'd like to beat the market. That means something greater than 6% annually in real terms. But if you can get 6% annually in real terms with no risk, why would you pass that up? We have to assume bull markets will revert to their mean, and if you can get a long-term index fund return with no risk, I think that's a smart move.
Now, risk-free returns today are miniscule, so you need to do other things. And when it comes to emerging markets stocks, I tend to demand between 14% and 16% annual returns to make it worthwhile to hold them. That's because there's so much that can go wrong. Once my expected return drops below that, I'll seek out a similar return from a security with better business quality. Here's the key, though, if you can't find that, don't move the goal posts. Opportunities always come back.
And that's the lesson
The reason why you might be able to get 6% TIPS in a raging bull market, is because everyone is chasing 20%+ annual returns in equities. But if your goal is 6%, you can ignore the chasing and get the risk-free security. If you don't have a goal, you're liable to keep chasing the highest possible return, which will expose you to maximum risk.
Now, if your goal is higher than 6% real returns, you probably have to augment your portfolio since I wouldn't expect TIPS to get any higher than that. But you can do the math much easier to determine your proper risk-adjusted portfolio allocation plans as long as you know what the goal is on the other side of the equal sign. (Note that the farther your goal is away from zero, the greater volatility you have to accept in down years.)
So, do you know what your goal in investing is? Or are you chasing the highest possible return? [more]
The recent (last few days) downturn in the stock market hit emerging markets particularly hard and that's caused some upheaval atop the standings of our Global Gains CAPS Champion of the World Contest. [more]
It's official: Our Global Gains team will be heading back for another research trip to China in July. We have the visas, the flights, and even some of the meetings already booked.
While I don't have all of the details yet, one focus of this year's trip will be rural China, with stops in Shaanxi province, Inner Mongolia, and Heilongjiang provinces. That's because we believe the opportunities here are significant given the government's recent commitment to raise rural incomes. Further, if you've read Yasheng Huang's book Capitalism with Chinese Characteristics, then you know that the rural entrepreneur in China is the most entrepreneurial Chinese entrepreneur of all (I hope you stayed with me there).
As always, our real-time reports from the field will be free to anyone who signs up, though you'll have to join Global Gains in order to get full, vetted write-ups on our best ideas at the end of the trip. More information forthcoming on how to get those free dispatches, and I hope you'll join us in China. [more]
We've caught a little bit of flak as well as earned some praise over at Global Gains recently because we recently sold two stocks -- both emerging markets small caps -- that we thought had gotten ahead of themselves in terms of valuation. At the same time, however, we noted that we'd be willing to buy these stocks back at the right price because they remained strong companies with bright futures.
Some people liked the move and were happy to make good money in this volatile market, while others accused us of having a trading mentality and thought we were sacrificing long-term returns. As I answered those questions, I realized my thoughts might be useful as part of the "Is Buy and Hold Dead?" debate going on on Fool.com. So, I figured I'd post something here.
First, it's important to realize that not all securities are equal. Treasuries, for example, are risk free, while a volatile stock like Arcelor Mittal (MT) -- 1-year beta greater than 2 -- carries quite a bit more risk. So, if it got to the point where your expected return from Arcelor Mittal was 3% and you could get the same return from a risk-free treasury, you'd be not daft to sell your stock and replace it was a risk-free asset.
Similarly, when it comes to emerging markets small caps, I personally would accept anything less than a 10% expected future annual return. That's because -- between dividends and capital gains -- you should be able to approach that number with a stalwart like Philip Morris International (PM), which while certainly not risk-free, has one of the world's top 5 brands, a strong balance sheet, and oodles of cash-generating capabilities.
So why not make the trade?
Reasons not to make the trade
First, making a trade costs money. There's the transaction cost, and if you're selling a winner, the taxes. But don't let the tax tail wag the intelligent investor dog. While you should aim to minimize taxes, taxes should not be making asset allocation decisions for you. Similarly, trading costs have come down so far so fast at this point, that's not an inhibitor either.
The other reason might be that you're worried you're giving up significant -- though small probability -- upside. That's fine and a real concern since one big winner can have enormous power in terms of helping your portfolio achieve outsized gains. But if you're going to be that type of investor, you need to be willing to stomach significant volatility. And while that's fun on the upside, it can be crippling on the downside.
This doesn't mean you can't do it. Just be prepared. If you're good at valuation, though, or have someone you trust who is good at valuation, infrequent managed selling from overvalued assets to undervalued assets is one of the most powerful tools you have to improve returns and reduce volatility. But it involves being able to make a forecast and have confidence in a valuation.
Yes, those are specialized skills and they may not be correct 100% of the time, but in a volatile trading environment of any type, volatility can work to your advantage if you let it. [more]
Our crack Global Gains analyst Nate "The Snake" Weisshaar ran the numbers again this week on where you can find the world's cheapest stocks, and we've seen some changes in the numbers given the market's recent run-up. Take a look:
A new name jumps out at me...India. Your thoughts? [more]
It’s Thursday morning and that means it’s time for our next idea in the CAPS Champion of the World Contest. But before I get to that, I'd be remiss if I didn't point out that we have a brand new issue of Motley Fool Global Gains releasing at noon today. It includes two new picks (picks that this year are beating the market by 25 percentage points on average), a wildcard resource play, and an update on our global asset allocation strategy.
If you're a member of GG, make sure you take a look. If you're not a member, you can join free for 30 days by clicking right here.
And now -- courtesy of GG co-advisor Nathan Parmelee -- Champion of the World Contest Idea #5:
Short China BAK Battery (Nasdaq: CBAK)
There has been a lot of crying in the business press about the animal spirits being wrung out of the market by the collapse of the credit market. Sure some of the speculative nature has subsided, but I offer up China BAK Battery as proof that speculative spirits are still alive and well in pockets of the market. With its history of losing money, cash consumption, and a very weak balance sheet the only reason China BAK is up 300-some-odd percent from its lows are the huge expectations investors have for the company.
But I think there’s a very good chance that China BAK will need to tap what’s left of its credit line or issue additional shares to survive...making it a great short for our CAPS contest. [more]
I don't know how many of you have been reading about the "Green Dam," the new firewall software China would like preinstalled on all computers sold in the Middle Kingdom. Well, China Journal today has the 5 categories it bans:
1. adult/ pornography
2. extreme adult/pornography
3. violent games
5. illegal activities/drugs (including gambling)
First, I'm glad someone is finally culling extreme pornography out of the wrongfully castigated pornography segment. Second, since homosexuality is illegal in China, they must have wanted to be pretty explicit about giving it its own category rather than just include it under "illegal activities." Third, if you take these 5 things out of the Internet, what the heck is left? [more]
GigaMedia (GIGM) is a 5-star CAPS stock. It has 2,139 outperform ratings against just 34 underperform ratings. But since Bill Mann recommended the stock in Global Gains in our January 2007 issue, it's down 40%. That's bad, but not that bad when you measure it against an MSCI EAFE global index that's down 34%.
But as I've said in the past on this blog, when it comes to measuring returns, you should do it against more than just the market. You need a peer group that will help you decide if your stock is actually a good company, or if it's just benefited or been hurt by sector forces.
When you stack GIGM up against a peer group, it looks pretty bad. Consider this selection of Asian online gaming and other Internet properties:
Company, Return since December 2006
So not only has GIGM been a poor performer, but it's missed out on a rising tide that lifted a lot of boats to pretty high levels. Seeing that should drive home the point that something is not right with this company...and that's why it's so important to cross-benchmark your returns on your portfolio and on individual companies to the market as well as peers and peer groupos.
As for GIGM
Now, I agree that the stock is cheap given its balance sheet, ongoing operations, and opportunity in the Asian gaming market, but this is one I'd sell as soon as I thought I could get fair value because I don't see the type of business quality that would justify any sort of above average multiply or create years of compounded returns on capital.
So why the overwhelmingly positive sentiment here on CAPS? I don't know. [more]
This blog post a month back from bradford86 seems to have attracted a lot of attention -- at least as measured by emails I received about it asking me about the stocks and discussion of it on our Global Gains discussion boards. Further, the stocks featured in it have done remarkably well over a month-long time period making it appear that now is the time to buy Chinese penny stocks.
It isn't. And if you do want to dabble in the Chinese microcap sector, be prepared to do a boatload of due diligence. At Global Gains where we've earned some solid returns from China Green Agriculture (CGA), China Marine Food (CMFO), and China Fire & Security (CFSG), that's meant thoroughly scrubbing the filings, traveling to China to see the companies and meet management, talking with hedge funds who are both long and short the stocks, and doing substantial analysis of the competitive landscape.
I don't believe any of the stocks mentioned in that blog post were subjected to the same level of analysis. Take Orient Paper (OPAI), for example. Here's what bradford 86 had to say about it:
Oriental Paper (OPAI), as mentioned earlier under China Finance, is growing 30% a year by manufacturing and distributing paper and paper products in China. Cramer recently indicated that things are looking good in the world of Corrugated Paper. This makes Oriental Paper is look even better.
He further notes that because of the stock's valuation, it has appreciation potential of nearly 1,000% -- a 10 bagger.
Now, I'd be remiss if I didn't point out that the stock is up 140% since that blog post. That said, I'd steer very clear of this stock unless you have good answers for the following questions (all information gleaned from public SEC filings):
1. How do they keep such low inventory levels? Most paper companies seem to keep 8% to 12% of annual sales in inventory. These guys are at 2% and yet are growing at 30%-plus annually?
2. Why did they have a 25-year-old CFO who appears to have started working for the company when she was 23? Really, that's a legit C-level office for a public company? (To be fair, they just hired a new guy last month, but I would bet this company has some significant internal controls weaknesses.)
3. The customer list seems to be pretty volatile, yet the company has no advertising expenses and extremely low SG&A. Then they say in the 10-K that they rely on their CEO for his "personl and business contacts." Given that paper is essentially a commodity and this company seems to small to have any cost advantages (though they claim their proximity to the Beijing /Tianjin population center is an advantage), this may be a company that makes money by fulfilling non-competitive orders given by buddies that run SOEs. (I believe most book/newspaper/printing business in China would be sate run.) That's dangerous in that business could disappear pretty fast if the relationship sours or people move jobs.So, who are the customers, why do they do business with OPAI, and does the company have any sustainable competitive advantage?
4. In May 2008, the Company issued 5,000,000 shares of common stock to three consultants for services rendered during the year ending December 31, 2008, valued at $500,000.
So, that's value per share of $0.10, or an implied market cap for the whole company of $4.5mm. At the time the company had $53mm in trailing sales and $5.9mm in net income. So, really, you gave away shares and diluted your shareholders 12% at a P/S of .008x and a P/E of 0.7x? Either the financials are false or these guys care not a lick for their shareholders or they are horribly bad business people who don't understand what equity is. Which is it and how does that make you feel as a part-owner of this business? (Incidentally, they had between $1.3 and $2.4mm in cash at the time.)
5. Related Party Transactions
The Chief Executive Officer of Orient Paper loaned money (over a period of time) to the Company for working capital purposes, which amounted to $6,148,710 as of March 31, 2009. During the three months ended March 31, 2009, and 2008, Orient Paper did not make a payment towards this loan. On July 24, 2008, the Chief Executive Officer of the Company agreed to change the term of the loan from payable on demand to a period of three years, maturing on July 23, 2011 and with no stated interest.
On August 1, 2008, a member of the Board of Directors of HBOP loaned money to the Company for working capital purposes which amounted to $879,000 and $880,200 as of March 31, 2009, and December 31, 2008, respectively. The amount owed bears interest at 7.56% per annum and is due on July 31, 2011.
On August 5, 2008, a member of the Board of Directors of Orient Paper loaned money to the Company for working capital purposes which amounted to $1,098,750 and $1,100,250 as of March 31, 2009, and December 31, 2008, respectively. The amount owed bears interest at 7.56% per annum and is due on August 4, 2011.
It's a generally a troubled company that's resorting to loans from multiple insiders to fund working capital, yet the numbers on the financials would seem to indicate a quite healthy company. So what are prospective lenders seeing that we're not?
Beware the tout. And if you are interested in learning more about investing for the long-term in China in solid companies with a sound asset allocation game plan, we can help you with that at Global Gains. Click here for more information.
As someone who's done and continues to do a lot of long distance flying over oceans, I've been fascinated/horrified by the complex investigation into what happened to the Air France flight seemingly crashed amid a storm off the coast of Brazil. [more]
Two slides for you today. First, why China will succeed...
It’s Thursday. It’s the morning. This is the CAPS Champion of the World Contest official idea #4. If you’re not signed up to play, do that here. *waiting…waiting*
Signed up? Good. Let’s dive into the pick…
Short Cogo Group
Following a 200% rise since November, Cogo Group (Nasdaq: COGO) has gone from woefully undervalued to woefully overvalued thanks to optimism surrounding the rollout of 3G in China and what that means for handset makers. But while Cogo should benefit a little bit, 9.5x EBITDA is far too much to pay in this environment for a middle-man commoditized parts supplier. That premium looks even more absurd given that 3G uptake in China at China Mobile, China Unicom, and China Telecom has by all accounts been much slower than anticipated with consumers citing the high cost of changing handsets (according to survey data from Hong Kong’s Yuanta Securities) as one reason why they’re holding off on making the switch.
Cogo Group is a China-based company that designs and sells module solutions using established technology (think cameras, Bluetooth accessories, LCD displays, wireless stations, switches) for new electronic products such as cell phones and laptops and for telecom infrastructure primarily in the Chinese market. Cogo is a key parts supplier to Chinese handset manufacturers such as Huawei, ZTE, and Lenovo who are happy to outsource the manufacture of commoditized parts to Cogo so they can focus on designing and manufacturing high-technology and unique value-adds. Cogo’s position in this niche is thanks to company founder/CEO Jeffrey Kang who has the relationships with the Chinese companies that allow Cogo to win business. While this is an ingenious, asset-light business model that helps OEMs speed time to market, it’s also the classic middle-man who will be the first along the value chain to see profit margins squeezed if consumers (as they are today) are feeling pressure on their wallets and pocketbooks.
At more than $7 per share, Cogo trades for more than 27x earnings and has an EV/EBITDA ratio of more than 9x. Those multiples are high given the mediocre quality of the business here and have not yet incorporated findings that the rollout of 3G handsets in China has been much slower than expected. Further, while the company’s $108mm in net cash ($2.75 per share) gives shareholders a sense of security, the fact is that this cash will likely never be paid out to shareholders. Rather, it will hoarded until it can be used to make an acquisition at will, I suspect, be at somewhat inflated prices.
But even if we net the $2.75 out of the share price, a $4.25 value per share on the business implies (at a 14% discount rate) 16% annual revenue growth over the next 10 years at 5% EBIT margins. That seems excessive to me, and I don’t expect the company to achieve those expectations. Bulls will argue that we should expect much higher profit margins, but I can’t see that given increasing competition, the rising costs of manufacturing in China, and the company’s middle-man status.
All told, I put fair value here (including cash) at $4.50 to $5.00 per share. That means at least 30% downside from here. Put a red thumb on this one and watch the points roll in.
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From the WSJ...
Federal Reserve Chairman Ben Bernanke Wednesday urged lawmakers to commit to reducing the nearly $2 trillion budget deficit, warning that the government can't borrow "indefinitely" to meet the growing demand on its resources. Lawmakers minds were blown and fell into stunned silence save for Barney Frank who could be heard stammering "But...but...that's the only play in our playbook." The country seemed to be headed for its darkest hour until Daphne Newberg, a recently arrived intern from California, offered to let Congress borrow her father's credit card and all in attendance agreed this was a reasonable and bipartisan solution.
So, I made some of that up. But can you tell where the real article ends and the satire begins?
If you've read Francis Fukuyama's Falling Behind, then you know that the problem that's dogged Latin America for centuries has been political instability and inconsistent respect for property rights. That latter reputation is the reason why, as Joshua Goodman reports on Bloomberg today, Brazil's "nation’s currency plummeted 60 percent, and its borrowing costs tripled to 24 percent" with the 2002 election of former Marxist Luiz Inacio Lula da Silva.
Fast forward 7 years, and Lula has been an enormous success. Brazil's market is up, investors are excited, the country has taken a position of economic leadership in Latin America, and Lula has turned out to be a centrist who has forged good relationships with the developed countries such as the US as well as with other emerging nations such as China and Turkey. And these countries are very happy to forge friendly relations with Brazil given that it is an enormous potential market for their exports as well as a country that is rich in natural resources. in fact, World Politics Review today called Lula the "diplomatic leader" of Latin America.
Of course, as happens in democracies, Brazil is now preparing to replace Lula with two candidates who have the same potential to freak out investors as Lula did in 2002. And though both seem to claim that they will continue Lula's policies, elections are always a bit of a wildcard. If you're an investor in Brazil or a potential investor in Brazil, take some time to check out these links to understand the two candidates and what their leadership could mean for Brazil. After all, Latin America has long been a continent of false starts. Though we're pretty optimistic at Global Gains about the Brazilian market going forward, that doesn't mean there won't be volatility. [more]
We're in uncharted territory this week, folks, as desertdreams has displaced IBDvalueinvestin in first place. The secret to desertdreams’ success? Accuracy…and bullish bets on China. [more]
Look out, folks, China just bought Hummer. A full conquest of the world's oil reserves cannot be far behind.
It's almost a foregone conclusion these days that CDs are going the way of the dodo. MP3s are the rage, Apple's iTunes has enormous network effects, Amazon.com and MySpace offer convenience, etc. [more]
This blog tends to stick to international investing, but the death of GM (as we know it) is too big. The story has been covered in-depth elsewhere, but I'll just ask this: How do we expect a poorly run company to suddenly be run better now that it's highly politicized and largely owned by the government? The state of Virginia can't even run a decent liquor store. [more]