We’re almost through the first quarter of our CAPS Champion of the World Contest, which means we’ll have our first winner (whoever is leading on August 14). The standings are tight, so it’s still anybody’s game. Some extra points or added accuracy could make the difference. But even if you haven’t entered yet, we still have nine months to go for the grand prize, so sign up here.
If you need an idea to get those extra points, you’ve come to the right place. I’ve got a stock for you to short…one that also happens to be the least impressive company we met with during our recent Motley Fool Global Gains research trip to China. (Incidentally, we have a special report detailing our best ideas from the trip that can be all yours if you sign up to join GG.)
But this is about the company that impressed us least, and that is business hotel operator Home Inns (HMIN).
One definition of a good short is a crummy business run by a management team that abuses its equity that also carries a sky-high valuation. Home Inns possesses each of those traits, which is why I think its stock is destined to fall hard, particularly as some of the optimism currently surrounding Chinese stocks starts to subside. But let’s deal with each one of those charges in detail…
A crummy business
Home Inns owns, operates, and franchises mid-level business hotels in China. The company currently has 522 hotels in 101 Chinese cities, with another 63 in the development pipeline. The company’s pitch to investors is that the Chinese hotel market is starved for strong brands and a standardized experience in the mid-level niche. It points to its rapid expansion and revenue growth of evidence of the fact that the concept is a good one.
I disagree. First, there are tons of branded, mid-level business hotels in China. This is obvious as soon as you step foot in the country, and even in tier 2 and 3 cities. Further, many cities in China have a glut of hotel rooms, which means 5-star hotels today (far superior in quality to HMIN hotels) can often be had for mid-level prices. This reality has manifested itself in HMIN’s financials in that despite 70%+ revenue growth, the company’s operating income has declined year-over-year.
Yet the company continues to expand despite the fact that it hasn’t quite figured out to run its hotels profitably or decided which of its business models (leased-and-operated or franchised-and-managed business) is better to pursue long-term. This expansion includes into a new higher-end concept called the “H” hotel, which apparently has not been successful enough to scale:
Now, one would think we’d see these questions and deteriorating results reflected in the company’s valuation. Oh no. This stock also has…
A sky-high valuation
Here are the relevant multiples:
Meanwhile, you have a cash-consuming business with balance sheet stacked with so much convertible debt (that isn’t anywhere near its strike price) that the company recently had to sell a $50mm private placement to Ctrip.com (CTRP), which was founded by the same group of individuals in order to put itself in a position to meet prospective redemptions.
Shareholders clearly expect some of HMIN’s revenue to eventually fall to the bottom line, but even if we assume HMIN’s gets its margins back to the industry norms of 21% (EBITDA) and 9% (net), we’re still trading at an outrageous valuation relative to peer groups of either other hotel stocks or other fast-growing Chinese companies. That means we’re looking at some mean reversion, particularly since this company has…
A management team that abuses its equity
Here, I’ll let Let’s Stand Up to Scandalous Stock Options, an article I recently wrote for Fool.com, do the talking.
Throw a red thumb on Home Inns. You’ll be glad you did. Agree/disagree? Let me know in the comments. [more]
If you haven't already, now is the time to sign up to follow @TMFGlobalGains on Twitter. Why? Because today we launch a series of Name That Stock contests where you can win fabulous prizes (complete rules follow below). Plus, you'll get all of our witty commentary and links to interesting stuff. [more]
That’s when Park decided to examine more closely the loans that A.I.G. F.P. had insured. He suspected Joe Cassano didn’t understand what he had done, but even so Park was shocked by the magnitude of the misunderstanding: these piles of consumer loans were now 95 percent U.S. subprime mortgages. Park then conducted a little survey, asking the people around A.I.G. F.P. most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost, who had no clue, but then, his job was to sell, not to trade. “None of them knew,” says one trader.
From Michael Lewis's Aug 2009 piece on AIG in Vanity Fair.
Our industry too often confuses alpha and beta. [more]
I'm optimistic about the success of homegrown Chinese brands, but I'm shocked that investors are willing to pay 22x EBITDA to own Li Ning. It's basically a Nike (NKE) rip-off -- everything from the logo to the basketball and workout focus, though its spokesathletes are somewhat more washed up (i.e., Shaq and Baron Davis) -- and it's shoes are the same (expensive) price, but didn't seem to me to be as well-engineered from a performance standpoint:
Something like 361 Degrees seems like a much better bet given that it's a domestic brand that's differentiated itself with specialties in sports specifically popular in Asia such as ping pong and badminton. And it's "only" selling for 13x EBITDA.
Anyhow, just some random musings. [more]
Here's David Byrne (Talking Heads) on the current extravagant U2 tour:
Those stadium shows may possibly be the most extravagant and expensive (production-wise) ever: $40 million to build the stage and, having done the math, we estimate 200 semi trucks crisscrossing Europe for the duration. It could be professional envy speaking here, but it sure looks like, well, overkill, and just a wee bit out of balance given all the starving people in Africa and all.
I gotta be honest...he makes a strong point. Those 200 trucks probably aren't doing a lot to help global warming either. But do as Bono says, not as he does. [more]
This is a fascinating article from China Daily. Basically, the data shows that western China is growing much, much faster than eastern China. Further, lots of the economic troubles people are talking about -- like crappy loans -- are concentrated in the "hot" markers like Shanghai and Guangdong. [more]
Yes, I'm a few days behind on this, but seriously, what? This is just awful: http://online.wsj.com/video/clip-warren-buffett-secret-millionaire-club/31F28D12-5EA4-4515-9CB2-62F9C0CF64CE.html
I'm shocked at how bad this is. Is this for real? This can't be for real...
Joe gets a little tricky to start the week (and for the record, he caught it in his mouth on the first toss). According to Joe the prostate still feels good, but the promised weekend hangover prevention effects were not quote what he hoped.
Pretty big news. Lots of ramifications: http://tinyurl.com/ms4tms
Joe still has no sign of the prostate cancer.
Get our top picks from the China trip in our new Global Gains special report. Just click here to join GG and its yours.
"Let me finish. You should let people like me finish. I'm a chairman. I don't normally talk this far down."
We normally reserve our full notes from company meetings for our Global Gains members, but my recent post on CSKI has attracted a lot of attention from people who are interested in the stock. Further, the post and photograph have been a source of debate on several forums. Thus, in the interest of complete transparency, here are our complete notes from the CSKI meeting as well as all of our photos from the visit. Please note that we are paraphrasing what was said in our discussions, and do not have a transcript to refer to. (Disclosure: We at GG are neither long nor short the shares nor have recommended any action either way.)
CSKI Notes (written by GG co-advisor Nathan Parmelee).
Stanley Hao – CFO
Yangqing Liu – CEO, Chairman
^ - Company believes it has limited exposure to the healthcare reform plan.
^ - This wasn’t the most compelling company we encountered on the trip, but based on what we saw and the valuation the case for being short isn’t necessarily strong either.
We look forward to all of our meetings, but I was looking forward to this meeting for additional reasons. This one had the added enjoyment of seeing how much meat there was to the short argument. The short topic came up almost instantly in our car ride from the hotel to offices where we’d have our meeting and tour. CFO Stanley Hao is clearly spending a lot of time thinking about the attack from Asensio, even if the company isn’t taking the time to directly respond to its critics. Something Tim and I both suggested they not do in favor of running the business and letting the results speak for themselves.
After arriving we went up to Mr. Liu’s meeting room and settled in for some Q&A. Mr. Liu started by saying he had an open door policy and that we were free to talk to anybody we have questions for, which is unusual, but I considered it a positive sign that he was still open to visitors despite the scrutiny the company has received.
What are the plans for the slim patch in future years?
Mr. Liu said sales of the weight loss patch will continue to grow with the business and that export sales are the primary growth driver in the next few years. The focus right now is to get it into the U.S. (Asian grocery stores, etc.) and Russia. So it will continue to be a big contributor, but diagnostic kit sales will grow too. At least the company is targeting their growth. Mr. Liu also added that focusing on how much weight people lose by using the slim patch isn’t exactly fair, because people still buy cold medicine even if it doesn’t get rid of their cold. There is a certain amount of truth to do this, but I’m not sure I agree with the fairness standard he was trying to get at. I think we expect the cold medicine to work too, though it mostly alleviates symptoms.
How has your experience working with the SFDA been so far?
It hasn’t always been easy, but the procedures have become clearer and the process has become better understood internally. Stanley and Mr. Liu felt that having an internal R&D team that is familiar with the process is an advantage for a small company like theirs.
With all the controversy surrounding SHL injections products we were a bit surprised to see you introducing an SHL product now. What is the thinking behind this launch?
Mr. Liu stated that their product has proven effective and that a large company located in the same industrial complex has a similar product that is sold in syrup form (instead of an injection) that is their biggest seller and hasn’t had any problems. CSKI’s product is a suppository and it has proven safe and effective according to Mr. Liu.
What has PWC done to help improve controls?
The work has just started, but PWC has helped to build a process net that will allow CSKI to capture any issues and determine where it can improve its processes. All control points that need improvement will be identified in Q3 and in Q4 they will begin testing the new, improved controls. They felt a bunch of new hires aren’t necessary and that most controls will be achieved through the retraining of some positions.
Would you say you’re more focused on rolling out new products into your existing channels or expanding the distribution of your existing products?
The answer was both, which is always the risk in asking a question this way. But Mr. Liu did elaborate by saying the company is focused on its products, pricing, channels, and promotions and looking to optimize that mix by getting the right products into the right channels and promoting them at the right price. How they focus their efforts depends on how mature or new a product is and which market/demographic they think is the most likely to buy it.
Other than the buzz and extra communication created by the Asensio notes, what has been the most difficult part of communicating with U.S. investors?
In some sense U.S. investors are naïve when it comes to China. They have a hard time understanding that a supplier might be willing to make an arrangement where most of the inventory we need is held on their books until the last minute when we actually need it.
(GG Note: I think investors can understand it, but they’re used to it coming about, because a company has such a strong negotiating position with the supplier and not because of a personal or family relationship with the supplier. Regardless of the specifics though I think investors in general need to understand that there are sometimes personal favors that can be called in. This happens in the U.S. too, but generally we don’t see it happening with publicly traded companies.)
What is your take on the upcoming healthcare regulations?
The regulations will be focused on helping rural areas. CSKI has been focused on expanding into and supporting more rural areas since last year. But overall this should benefit the rural population and will most likely mean more hospitals and pharmacies.
Outside of the Q&A Stanley mentioned that he has been focused on looking for additional board candidates. They have reviewed some and will be reviewing additional candidates, but haven’t made any additions yet.
For the most part I’ve been combining our questions, notes and observations in these notes, but this part is entirely from Tim. We had a misunderstanding on how long the meeting would last and I ended up running back to the hotel to get our bags, while Tim got to take the tour.
- Labs were spartan, but not unlike what we saw at WuXi.
- Product manufacturing areas were closed off due to contamination risk, but there were three long hallways where ointments, weight loss patches, and nutraceutical pills were supposedly being made.
- Did see the packaging and shipping area, which was largely man-powered (low label cost), but did include machines to seal relevant products.
- Campus included 4 buildings, a garage, a dining hall, and a basketball court.
- Dining hall was packed with about 100(?) employees at lunch, which was the number given for how many people worked at this facility. (This was the Harbin Tian DiRen Medical Science and Technology Co. subsidiary that we saw.)
"So now that the stock price has doubled, are you going to reprice your options back up?"
That question silenced Home Inns (Nasdaq: HMIN) investor relations manager Ethan Ruan when we met with him at the company's headquarters in Shanghai, during our recent Motley Fool Global Gains research trip to China. He'd just finished telling us how excited management was that they'd gotten such a good strike price ($7.26 per ADR) on the stock options they canceled, then repriced and re-issued.
Newsflash, Mr. Ruan: Potential investors don't like hearing how excited management is about their latest move to bilk outside shareholders.
HONG KONG -- A new Chinese government-backed investment firm is raising two 4.5 billion yuan ($658.8 million) funds for investments focused on Chinese frontier markets including Xinjiang, Tibet, Heilongjiang and Yunnan, people familiar with the situation said.
This is pretty interesting and given what we saw on our recent trip to China, a promisingly profitably idea. If you got our dispatches, however, then you know that we're already ahead of the rural China investmetn curve at Global Gains. Yes, places like Hohhot are going to be the fastest-growing cities in China these next couple years IMO.
As you can see from this picture, capitalism is already in full force here (the shopkeeper is selling wheel chairs and crutches in his store right out front the city hospital...brilliant!). [more]
Well, here at Global Gains, we're pretty much willing to do anything to suss out the best investment ideas for you (such as eat dried octopus parts). And because our last post on CSKI attract a lot attention from both the longs and shorts (for those who want the full notes from the meeting, they are available to members on our discussion boards: http://boards.fool.com/Message.asp?mid=27828780), we decided to put the company's products to the test. [more]
It's been a while since we did one of these on account of the recent Global Gains research trip to China, but we're back and boy has a lot changed. Personally, I've dropped from the top 25 to 270, so I have some work to do. desertdreams, however, does not. That player continues to ride Fuqi International to a hefty total score. mode7, jddubya, IBDvalueinvestin, and tely1 round out the top 5. [more]
Each time we return from one of these trips, we like to offer up a few travel tips in addition to our stock picks from the trip (that special report will be out later this week). So here’s the stuff that’s not to be missed should you make your way to China in the future:
What a great city. We heard it’s pretty frigid in the winter, but even then they’re supposed to have an incredible ice sculpture festival. In the summer, however, you can take in the shopping on Central Street and then crawl from beer garden to beer garden along the river walk, gazing at the topiary seals, getting beat by old Chinese ladies in ping pong, and watching swimmers dodge large boats in the river.
2. The Muslim Quarter in Xi’an
Great good and fun, competitive shopping. If you go, make sure you know at least this phrase “Tai gui le,” which means “too expensive.”
3. The Five Pagoda Temple
An overlooked tourist spot in Hohhot, but well worth a visit. The Buddhas and surrounding artwork are particularly beautiful.
4. Ba Yin Hao Ri Wa
Again, not too many folks will make it to Hohhot, but if you do, this Mongolian restaurant (translates to Rich Universe) is a must-go. The lamb is outstanding, and the traditional singing and string instruments are incredible (though they are a bit heavy handed with the Baijiu).
5. Chili Octopus
It tastes good and it’s going to make us a fortune.
Always, always worth it to stop in Shanghai
7. Finding a company with a game room
Chinese corporate culture is changing for the better, and it was fabulous to stumble across a company that’s treats its employees well and strives to hold onto them despite the low cost of labor in China.
8. Not getting quarantined
Seriously, these dudes were scary. Make sure you’re healthy and stay healthy if you’re headed to China.
You may have read Asensio.com's short reports on a company called China Sky One Medical (Nasdaq: CSKI) that makes traditional Chinese medicines in Harbin. While the most recent reports have verged on ad hominem (going after the company's IR firm, for example), there were some interesting questions raised early on about inventory and some other things. [more]
We've talked before on this blog about the wastewater treatment opportunities in China. And while some of us are over in China traipsing around, The Snake held down the fort this week with a relevant GG Caps Champion of the World Contest Idea. Here goes... [more]
So we had to drink it.
But yes, even Chinese government Baijiu still tastes like Baijiu...
We at Motley Fool Global Gains visited AOB at their new headquarters in Beijing (pictures below). I'm probably still not qualified to say if $70mm was a fair price or not, but lo and behold when we visited, they were using the facility for what they said they were going to. We walked in on a management level conference for all of the subsidiaries with about 100 attendees, all of whom could stay on site in one of the property's 9 buildings. The courtyard on the campus was also set up to host a teambuilding BBQ later that night (we were invited to stay, but alas had a flight to catch). The Beijing subway is also going to have a stop right near there, several other important companies are in the same EDZ, and the place, though its south of the city, is extremely airport accessible (took us 40 minutes). All in all, it seems like a sound location. [more]
I got a beat down in Ping Ping today. It felt like a true cultural experience.
Some things just should not be sold in airports after you've checked your bags and passed through security. At the top of that category, I submit this giant stuffed monkey from the Beijing airport. That ain't gonna fit in the overhead compartment.
Call me juvenile, but these make me giggle. Of course, it's also the best way to do boots on the ground research in the Chinese fertilizer industry.
Need proof? This guy gets more channels in rural Inner Mongolia than I get in Virgina:
That's why we're still hard at work figuring out the best ways to play this rural boom.
We generally declare Sunday our day off when we travel...which means I've finally gotten to read the papers...which explains the recent burst of blog posts. [more]
China's Ethnic Fault Lines [more]
The people at General Steel (NYSE: GSI) told us their Longmen facility outside Xi'an was running 24/7 to meet all of the demand for rebar in the city and environs. Rather than take their word for it, we went to check it out. [more]
I consider Jonnie (on the left in the photo...as if you needed me to tell you that) to be a Reagan communist. If you know China, you know what I mean. Anyway, he was at full throttle today. Some solid quotes follow below (if you read all of them, you'll basically understand the real China)...
On the Great Wall: "The fact is the Mongolians live a hard life. And that has made them harder then the Han Chinese. So we had to build a wall. No way we could beat them." [more]
Yeah, I know it's not a stock idea, but it makes me laugh.
Hope you're getting the Chinan dispatches...lots of good stuff on the way.
I was a little shocked that Chinese in-flight magazines are now taking pot shots at the founder of our country.
We're having a string of great meetings on this trip, but there was something a little strange about checking into a small hotel (not a Western brand, but a 4-star business hotel) in South China and finding a lascivious ad for 24 hour massages...
And a full kit of novelties...
Nothing quite like seeing these guys point a laser at your forehead to take your temperature and then have the girl sitting next to you get the more thorough thermometer treatment. But quaratine was avoided. Huzzah!
Came across this data whilst doing some background research on AsiaInfo Holdings (ASIA). Pretty interesting:
Fixed-line telephone growth has stalled, but mobile and Internet growth has been huge and given a population of more than 1.3b, still has a long way to go. Expect the mobile companies to do big business in rural areas this year and next as incomes in those areas rise and farms consolidate. I think CHL has the advantage there over CHA and CHU because its network is generally considered the best right now. [more]
No, it's not Godzilla, but before we get to this Thursday's CAPS Champion of the World Contest idea, I just wanted to remind folks that we leave for our research trip to China in just a matter of days! If you haven't signed up yet to receive our free -- yes, free -- dispatches from the road and you're not a Global Gains subscribers, you will not receive them. And trust me, you want to receive them.
So take a moment and click over to this page. Once there just enter your email in the box and click the button to submit. There you're all signed up and primed to get our China notes.
Also, don't forget to follow us on Twitter (a service that, if you haven't tried it, is surprisingly fun).
And now, your idea (from the mind of GG co-advisor Nathan Parmelee)...
Long Kyocera (KYO)Thesis
I’ll be the first to admit that Japanese conglomerates aren’t growth stories and other than their R&D efforts aren’t very dynamic firms. But like any other company they can get far too cheap, which is exactly what I think has happened with mobile phone, office equipment, and solar panel maker Kyocera (KYO). Kyocera has a strong balance sheet flush with cash and investments, has remained profitable in the recession, and is targeting 15% profit growth for 2009. After a lackluster earnings performance in 2008 that’s not the sexiest package in the market, but it deserves to trade at more than a 1.1 multiple to tangible book value, which means it should outperform CAPS S&P bogey from here. [more]
If you ever had media studies, you're going to enjoy these two articles. [more]