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June 11, 2009 – Comments (2) | RELATED TICKERS: CBAK , SNE , BRK-A

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)

Thesis
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.

Company description
China BAK is a battery manufacturer based in Shenzhen. Its batteries are used it laptops, netbooks, mp3 players, phones, and other electronic devices.  Given what seems like constant demand for the newest electronic devices (full disclosure: I love my kindle) and China’s low-cost manufacturing you might think it’s not such a bad business to be in. Unfortunately for China BAK, batteries are commodities and that means it faces competition from bigger companies like Sony (SNE) and lower cost competitors such as Berkshire Hathaway (BRK-A) investment BYD Company (BYDDY.PK).

Valuation
China BAK is expensive in comparison to BYD too. BYD is currently riding high on its investment and endorsement from Berkshire Hathaway, but it’s only a 3-star stock in CAPS (to China BAK’s 4) and trades at a slightly lower EV/EBITDA multiple of 23 compared to China BAK’s 24. Unlike BYD, China BAK has never generated free cash flow, doesn’t have a good record of operating profits, and hasn't gotten a stamp of approval for the world's smartest investment team.

The biggest problem though is the combination of negative cash flow and a small cash balance. Over the last two years China BAK has overcome its lack of cash flow by taking on more debt and issuing shares. With just $25 million in cash left and a cash burn rate well in excess of that for each of the last three years it’s likely that China BAK will be issuing equity or tapping the remaining $75 million in its credit line in short order.

Either one of those events would trigger a downward reassessment by the market, so put a red thumb on this one and wait for the points to roll in.

Have a better idea? Let us know in the comments below.