A precarious economy, fraud concerns and negative press coverage has scared investors out of U.S.-listed Chinese small caps. Right now many investors have the "fraud" word on their minds and avoid these stocks. Despite the high risk of investing in Chinese small-cap stocks I think there are still plenty of opportunities for keen investors.
Because many Chinese small-cap stocks are currently trading at dirt-cheap levels, some are taken private or acquired by competitors.
Two good recent examples are Tudou Holdings Limited (TUDO) and Tibet Pharmaceuticals, Inc. (TBET). TUDO is going to be bought by its biggest rival Youku (YOKU). TBET is an especially interesting story because despite the buyout offer from its CEO at a price that equals its book value per share, the market still doubts if the CEO is serious and only wants to push the stock close to the buyout price. This looks like a Deja Vu of the HRBN buyout story.
In this article I will present two Chinese companies, which I think are most likely to be taken private or acquired by other companies and will give investors multifold returns soon.
Longwei Petroleum Investment Holding (LPH)
The best buyout candidate I think is Longwei Petroleum Investment Holding Ltd. It is an energy company engaged in storage and distribution of finished petroleum products in China. The company's oil and gas operations consist of transporting, storing and selling finished petroleum products.
Unlike many Chinese small caps, I think this company is completely legitimate and clean. It is one of the most reliable Chinese companies because it has very simple and visible assets and business activities. A lot of photos and videos of the company's two oil storage facilities and activities of its employees and customers' oil transporting trucks are already published for the general public to watch. This exclusive video from Redchip is a good example. In the last news piece, the company announced that it will put new photos and videos periodically on its website to show its last business operations. It also invited all interested investors to visit its facilities.
Last year Rodman and Renshaw's analyst spent several days in the company's two facilities before releasing the buy recommendation and six dollar price target. In addition, so far this year several analysts from institutions have also visited the company's headquarters and spent days there to observe all aspects of its business. The company is honored by Shanxi province government as a "Provincial Honorable and Credible Enterprise." So this suggests that integrity and credibility is high and the company is legitimate. Last, the company is working on showing that its SEC financial report reconciles with its SAT financial report.
All of these things indicate that the company has a real and strong business and represents its financial results honestly.
The stock is currently trading at less than 3 times EPS and less than book value per share. Its EPS will grow a lot in the next several quarters because it is completing the purchase of a new facility in a new area that will almost double its oil storage capacity.
Moreover gasoline consumption in China is still growing very fast this year, and China government is expected to raise gasoline price many times this year. China already raised gasoline prices in February and can raise them again this week.
Longwei is a great buy for three big oil giants PetroChina (PTR), China Petroleum & Chemical (SNP), and CNOOC (CEO) and its major suppliers (oil refiners) that want to get into the wholesale and distribution business. It is also a great buy for other big oil wholesalers in China. Even at six dollars per share, the buyer can get almost 15% ROI a year assuming EPS of 90 cents in the first year after purchase, which may grow 20% - 50% every year. This high ROI is even before considering synergies such as cutting of administrative or transportation costs (if several storage facilities can share trucks or railways). No matter how I look at it, it is a no-brainier.
Another possible development is for one or two institutions to have larger and larger positions in the stock and eventually buy out the entire float of about 30 million shares. More and more specialized mutual funds are getting very heavy in the stock. Revelation Capital Management has already built up a nice stake. Revelation Capital Management is the investment manager for the Revelation Special Situations Fund Ltd, which it launched in March 2005 to invest in equity event-driven and special situations on a global basis. With only 36 stocks in its portfolio, the fund manager has to do a very complete study of a stock and be very confident in it before including it into the portfolio.
American Lorain (ALN)
The next best buyout candidate is American Lorain. The company produces and sells 234 varieties of food products in three main product lines to 26 provinces and administrative regions in China, as well as 42 foreign countries. The company's products include chestnut products, convenience food products including ready-to-eat and ready-to-cook meals and a selection of frozen foods for wholesale. The company is the largest manufacturer of processed chestnut products in China and currently produces about more than 50 high value-added processed chestnut products.
Chestnuts are popular snack foods throughout Asia and the market for them is estimated at a $1 billion in Asia. They are sold in convenience stores, supermarket chains, kiosks and large mass-market retailers.
The market for convenience foods is expanding fast in China. Like Longwei, American Lorain has a very simple business model that is easy to understand and verify. Also like LPH, ALN's margins are believable and comparable with the industry average. The company will start a share repurchase program, and it does business with many European companies, which were already verified. One thing that particularly caught my attention is this. The company doesn't borrow exclusively from Chinese banks. In fact the majority of the debt is from a German bank. Thus, we can say that the company's financial statements were already audited by a German bank. It also shows that the German bank felt very confident on the company's ability to remain profitable and be able to pay loan principal and interests in the future.
Last but not least, institutional investors Jayhawk Capital and Guerrilla Capital Management have very large positions in the stock. It shows that big institutions are confident with the company and bullish on the stock.The stock is currently trading at a P/E of just above 2 and at only about one-third of its book value per shares. The discount to book value is just crazy. At the current price level, another food company can easily offer 6 dollars per share to buyout ALN to take advantage of its strong brand name, profits, and cross-selling opportunities.
Final Note
The game of waiting for a buyout offer can be a long one that requires great patience. At times a potential buyer is not easily visible. However, as China Fire & Security Group (CFSG), Shanda Interactive Entertainment (SNDA), Harbin Electric (HRBN), Tudou, and Tibet Pharmaceuticals have shown us, the biggest payoff belongs to the most determined and patient investors.
Disclosure: I am long LPH, ALN, TBET.
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