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BSPM Deflates As Hot Money Rushes Out

I turned on CNBC on Good Friday, prepared to have a normal work day. Much to my surprise, the market was closed, and I found myself with the day off. Just shows you how aware I am. CNBC was running a documentary on Enron entitled "The Smartest Guys In the Room". The documentary chronicled the demise of Enron, and how the financial statements were engineered to make the company appear profitable when it was indeed hemorrhaging money.

How does the apply to Biostar Pharma (OTC BB: BSPM) in light of the post 2009 audited earnings release and subsequent pullback in what had been, to now, a rather hot China stock? Glad you asked- it's a legacy problem the investment community is saddled with thanks to our quite often misguided bird brains in Congress.

We had what I like to call Enronitis happened in the early part of the last decade. As it turned out, a whole series of high flying tech stocks from the '90's were using the accounting standards to exaggerate their financial health. 

Rather than simply look to better enforce the perfectly adequate laws we already had on the books, Congress came up with some rather barbaric cures for Enronitis, and much like aggressive chemotherapy, the cure can be worse than the disease.

We now have Sarbanes Oxley as law in the US, and the depths of absurdity related to this regulation cannot be fathomed. I won't go into details, but suffice it to say this blight on the US securities industry causes more wasted resources than you can imagine, especially to smaller companies. I has in effect allowed the audit firms to become extortionists and eliminated competition for accounting services.

Coupled with the Sarbox mess, we have FASB- Federal Accounting Standards Board, that comes up with GAAP (generally accepted accounting prinicples). The problem- these GAAP standards create a presentation that simply does not reflect the financial performance of companies. Believe you me, today's financial statements look nothing like your the financial presentation of you Grandfather's IBM . They are simply a mess.

For astute investors with a little longer investment time horizon, these absurd standards are heaven sent if you want to accumulate stocks at favorable levels. Such is the situation with Biostar- BSPM- who knocked the cover off the ball in Q4. If you like this company, the knee jerk reaction by the hot money that doesn't know how to look past the headline number is heaven sent, and provides a favorable entry level I didn't think we'd see.

I'll dig into the numbers and explain why this is as good a "glass half full" situation as you are likely to come across. Let's get into it.

Through the first 9 months of '09 BSPM reported $32.6 million in revs and $.38 in EPS- in short, a great company. Then, in Q4 BSPM reported $17.1 million in revs, and a loss of 0.04 in EPS- how is it possible this highly profitable and rapidly growing company reported a loss in Q4? The market responded by taking about 12.5% off the stock in three trading days.

The answer requires you to dig into the audited 10k, and have some understanding for the draconian nature of the FASB regs for GAAP accounting. 

In '09, BSP engaged in a financing of preferred shares- a Series B Preferred. It has a feature that allows the preferred to convert into common stock.  Despite not having paid one dime in cash to the holders, BSPM was forced to take a "one time dividend" charge of $2.7 million in Q4- simply because the roughly 3 million preferred shares converted into about 1.5 million shares of common stock at $2.06 per share.

Therefore, simply because the Preferred shares could convert to common, the company was forced to book a $2.7 million expense without paying one time. If they had simply issued the shares at $2.06, there would have been no $2.7 million charge. Make up your own mind- does this presentation truly reflect the financial health of the company? I don't think so.

Couple this with another $1 million non cash charge from employee compensation stock options, and you have about $3.7 million in expenses the company never paid- at least from my point of view.

So, if you take the $3.7 million in funny money charges, and add it back to the $1 million "GAAP" loss, you end up with a company that generated $.11 in EPS in Q4, and $.49 in EPS for the year.- Some are using the number $.47 as an accurate EPS for the company's performance- in any case- worth way more than the mid to high $3 range where the stock currently resides.

So, now that we've clarified the stuff that makes the financial performance look bad, let's look at the really good stuff. Gross profits.

In 2008, BSPM achieved $33.9 million in revenues, and $14 million in gross profits. In 2009, BSPM delivered $53.3 million in revenues (up 57%), and $39 million in gross profits (178% increase).

This is really something. Year over year, gross margins improved from 41.3% to 73%- this company is selling products at nearly double last year's margin- margin expansion is a metric Wall Street is always looking for. 

Technically, the stock is now a screaming buy in my view. The stock was $2 back in October, and considering the company is really delivering close to $.50 in EPS, it is absurdly undervalued in my view. You simply don't find stocks with 50% plus growth rates and accelerating margin growth trading so cheap.

I still like this stock in the range of $7 later this year. A NASDAQ listing is likely in the cards once the stock clears $4 as well. I'm just guessing, but I can't imaging any reason the stock couldn't trade on NASDAQ.

Biostar Pharma (OTC BB: BSPM) is really making money hand over fist. You can thank the bozos in Congress and the FASB regs for the lack of earnings growth. The charge associated with the Preferred was one time according to the company's audited 10k filing, so it won't hit again in subsequent filings.

The stock sold off for 3 days as the hot money reacted incorrectly to the headline number. It has now stabilized and appears to want to start to drift up. Without these non cash charges, BSPM could report embarrassment of earnings next year.

Full disclosure- I now own 10,000 shares at about $3.75, and intend to start accumulating again tomorrow. Don't forget to check at www.pinksheets.com for an accurate quote if your trading this stock.

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