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Look At Market Fluctuations As Your Friend Rather Than Your Enemy; Profit From Folly Rather Than Participate In It: Warren Buffet, The Oracle of Omaha
I Always Made the Most Money When I Bought At The Point of Maximum Pessimism: Sir John Templeton, the Father of Mutual Funds
The China Small Cap sector has been a mess this year. The problem can be traced back over the last 5 years, as there has been a awful lot of capital chasing some fantastic growth companies.
It's a different culture over there. Put yourself in the place of a Chinese Entrepreneur. Hard working, clever, frugal- perhaps runs a second generation family business. All of a sudden these Americans show up offering you all kinds of capital and the prestige of being a US public company. What do you do? You take the money, and then run things the way you always have, ignoring American standards of reporting and full disclosure.
Over the past 10 years approximately 600 Chinese companies have found their way to the US Public markets. Of that 600, about 200 trade with senior listings on the NYSE, NASDAQ, or AMEX.
Opportunistic short sellers became the proverbial whistle blowers on a number of the China based companies who were simply reporting numbers that just seemed too go to be true. It turned out, in some cases, they probably were.
At last count, there are about 23 companies that have been accused of fraudulent practices. The majority of the accusations have so far proven baseless, but 3 or 4 stand out, and have cast a giant black cloud over the entire sector. Investors have lost about $3 billion in this sector in Q1 of '11.
The common thread in the instances of fraud- the companies came public via the "Reverse Merger" short cut. For the investment community, this means there wasn't enough due diligence done and the front end, and the management teams were not coached well enough to understand their obligations of reporting by US standards.
The larger cap China stocks that came public through traditional IPOs continue to trade at high multiples. Institutional fund managers are comfortable with these stocks, and they tend to trade at PE's akin to standard growth valuations- 40 to 100 times earnings is the norm. Baidu (NYSE: BIDU) is trading at 95 times trailing earnings.
In the 23 years I've been following the small cap world I've never seen a divergence chasm anywhere near this large. This valuation divergence is a vacuum, and nature abhors a vacuum. A vacuum. is a space that will eventually get filled.
The haves and the havenots in the China space will meet in the middle at some point in time. There is a fortune to be made when this sector recovers.
I'm still cautious on the reverse merger stocks. However, in the meantime, suppose I could find you a company that came public through a traditional IPO with the full due diligence and corporate governance package, but has been trading as if it's a reverse merger?
Read on McDuff.........
Tibet Pharma (TBET) might be the best company with the worst timing in IPO history. That's why growth and value investors need to look at this one today. The Initial Public Offering, priced at $5.50 per share, opened for trading on January 25th.
Within days rumors and accusations related to one of the two big China blow ups- Rino International (RINO) hit the China sector. All the stocks sold off rather violently, and TBET became the baby that was thrown out with the bath water.
Investors in the IPO thought they were getting the steal of a lifetime. After all, the company fully expected to deliver $1 per share in earnings for 2010. At 5.5x trailing earnings, with other China stocks trading at 40 or 50 times trailing, the investors were drooling.
I've often said stocks take the stairs up and the elevator down. The poor investors never saw a big price surge as funds were selling everything China, and TBET got caught in the storm.
Here's why TBET is the one to own today- the market is now pricing all the China reverse mergers as if they were all publishing fraudulent numbers. The China based companies that came public through traditional IPOs are all trading at the usual high multiples of growth companies.
TBET is the one stock that is an IPO, but trading as if it were a reverse merger. When investors catch on to this value- wow- there's a ton of upside. In the meantime, any investor who wanted out has gotten out, so in my view this stock is really ready to turn around candidate.
We all recognize the term Shangri-La- it's the fictional place described in the 1933 novel Lost Horizon by James Hilton. In the book, Shangri-La is a mystical, harmonious place. Heaven on earth if you will. An Orient paradise.
Shangri-La is an actual place, and TBET is headquartered there.
The company is a pharmaceutical developer and manufacturer. The company focuses its products in the area of human respiratory, digestive, urinary, and reproductive treatments.
TBET has a competitive advantage based on geography. Many of their ingredients are rare and only grow in this region in the south of China. The 190 full time employees in its 52,000 sq ft manufacturing facility find themselves very close to the raw materials they need to manufacture.
Skipping straight to the important stuff, here's the audited numbers:
The first analyst report was issued on the company after the market closed today. This particular analyst forecast a price of $11 on the stock over the next 12 month.
That's a (pause for effect!!!!!) 170% return from today's oversold levels.
I started out by calling this a value idea, and it's a value idea.
Technically, there's nothing about this chart you can point that screams the stock is going up tomorrow, but it very well might.
This idea is for the folks who want to own $1 plus in Earnings and a 30% to 50% growth rate for $4 per share on the assumption it could trade to $11 in the next 12 months.
In my view, this stock is absurdly oversold, and a bounce into the $5 range could happen with just a few strong volume days.
Your competitive advantage here is the simple understanding of the Warren Buffett quote at the top- Buffett believes market fluctuations are your friend- not your enemy. This market fluctuation is your friend because it has made the stock so cheap.
As compared to other China based companies, this one has not lost as much value. The $5.50 IPO generated $14.4 million in cash for the company to use for expansion purposes.
Therefore, the drop from $5.50 to $4 was only 27%- not as bad as many of its brethren.
It's one reason I believe TBET is a good candidate to come back. However, the real competitive advantage- IPO As RTO- this company came public at $5.50 per share in January, and it couldn't have been worse timing.
A worst case scenario has been priced into these stocks, but this one has been treated very unfairly. A bargain for a value and growth investor. $11 is likely when this sector gets hot, but a move back to $5 or $6 could happen as a few blue light special shoppers snatch this one up.