In the Bargain Bin: American Oriental Bioengineering

Business Description

From its website: American Oriental Bioengineering (AOB) is a leading, fully integrated, pharmaceutical company located in China dedicated to improving health through the development, manufacture and commercialization of a broad range of pharmaceutical and healthcare products. A majority of their current products are offered and derived from Chinese based traditional medicines and are manufactured using plant based materials.

• Company Website
• SEC Filings

click to enlarge images

Is it a Great Business?

1. Is it understandable? AOB makes money by manufacturing and selling its medicines throughout China. I may not be able to fully know every single product the company is selling, but based on historical revenue, its products are selling well.
2. Is management competent and honest? So far, this appears to be the case. There has been consistent growth in revenue and earnings; operating costs are well controlled. The earnings on assets are high. The balance sheet is not over leveraged at all. AOB reported cash on hand of $70,636,510 at the end of 2008 and total long term liabilities of $132,158,197. Management has been awarded stock options, but in a fair manner. Also, the current CEO, Tony Liu, is the principal founder of the company.
3. Does AOB have favorable long term prospects? Nearly all of AOB's sales in are China. Based on my reading of economic data and trends, the prospect of the Chinese people wanting to increase their standards of living remains very strong. I also had the fortune of traveling around and living in China recently. Based on my general observations, I can say that they are highly ambitious and want very much to improve their quality of life. In places like Shanghai, Beijing, Xiamen and many other developing cities, the standards of living are already very high. Higher income of the Chinese should allow for more and more customers of AOB's products. The prospects look terrific for AOB going forward.

Is It a Great Price?

With 78.25 million shares outstanding and a share price of 3.98, the entire company cost about $311 million. I ask myself this question: If I had $311 million, would I want to buy this company or simply leave my $311 million in the bank? To answer this question, I use the 5 year CD rate to see what my earnings would be over the next 5 years versus what I think AOB may be able to earn over the next 5 years and compare the difference.

I also try to figure out what the potential future value might be for AOB in 5 years time. In this case, I make my earnings estimate based on it being an ongoing business in 2013 and put AOB up for sale at a Price to Earnings multiple of 10. I choose a P/E of 10 because AOB should still be able to grow earnings at a rate of 10%, making the PEG 1.0. Based on my calculations, AOB may be able to earn $108 million in net profit in the year 2013. This means that the company may be worth $1.08 billion or $13.80 per share, assuming 78.25 million shares are still outstanding in 2013.

But the key question is: If 13.80 in the value in 5 years, what is the present value and rate of return should I demand? I'm not expert on Chinese politics or the pharmaceutical business there; I'll want a higher rate of return on my investment to offset my perceived additional risk. Personally, I'd want at least 10% per year. In that case, AOB's fair present value today would be $8.57 per share. (see worksheet below)

Because AOB is currently being offered by some of the shareholders for $3.98 per share as of March 24th, 2009, it is selling at a deep discount to what I believe to be a fair present value. At this price, AOB does seem to be selling at a great price, assuming my estimates don't fall short. I also like that AOB would earn substantially more in profit than my $311 million would earn in interest on a 5 year CD.

See below my worksheet calculations.

Disclosure: I own shares of AOB for myself and for clients

Comments

[Grayray:]

Nice article, well thought out and explained in articulate manner. I am a holder of AOB and definitely think that this is one good company. I know some of the stockholders get upset with CEO's moves, but all in all I think it's a winner.

Mar 29 01:06 PM

[Ånden som ...:]

"CEO's" move? Please explain, I don't know this company very well, but I'm considering it.


On Mar 29 01:06 PM Grayray wrote:

> Nice article, well thought out and explained in articulate manner.
> I am a holder of AOB and definitely think that this is one good company.
> I know some of the stockholders get upset with CEO's moves, but all
> in all I think it's a winner.
>

Mar 29 02:44 PM

[Jason Tillberg:]

This is a move that took the stock down from over 7.00 in January to as low as 3.30 earlier this month: app.quotemedia.com/quo...

If you are serious to giving this company thought, read that news article and read what Tony says. Here is sample: 'Our recent property purchase in the BDA is a long-term investment in AOBO which builds out our multi-functional headquarters and centralizes our management in Beijing, while deepening our presence in a very important development region focused on attracting leading pharmaceutical companies. Additionally, at a time when our significant cash position yields negative real returns, this fixed asset allocation does not constrain our financial flexibility, but rather, we believe, positions us to secure government support in various forms, such as R&D grants related to the PRC's stimulus plan as well as potential low-interest bank loans.'

Just 4 days later, the PRC granted AOBO High Tech Status, just as Tony suggested.

app.quotemedia.com/quo...

My opinion was the the purchase of the building was a fine deal given that the cash on hand was earning negative real rates of return and what's wrong with buying a building outright in cash that should help with growth ahead.




On Mar 29 02:44 PM Ånden som Går wrote:

> "CEO's" move? Please explain, I don't know this company very well,
> but I'm considering it.

Mar 29 03:26 PM

[soltra:]

Most Chinese people have some knowledge of traditional Chinese medicine and firmly believe in its potency. So I see great future for this company because their products are or will be popular in China and around the world.

Mar 29 05:57 PM

[Alan Young:]

I liked AOB as a niche player last year. They got a lot of cash and started acquiring numerous small companies with it. I wanted a medicine-seller bringing value to shareholders, not an empire-builder trying to expand the balance sheet exponentially, so I dropped out--along with many other investors. That's why the stock has been unpopular.

Chinese medicine is hard enough to understand; Chinese small-business acquisition and real estate deals make it too complicated.
I wish them well, but this stock is not for me.

Mar 30 02:17 AM

[balabanovj:]

Jason's not an idiot, but he clearly hasn't followed AOB very well or done adequate dd. AOB feeds investors the bare minimum of added EPS to keep them hanging on and not a penny more. The rest they give away as stock in their acquisitions. If the company were more patient and content to grow more organically, I would buy them. There are just much better choice out there that will give far, far, far better returns over Jason's 5 yr time horizon; eg, CSKI, and CPHI.OB

J. Balaban

Apr 11 01:13 PM

[drbob66:]

Anybody else been watching the chart of AOB lately? I'm no expert at technical analysis, but it looks to me as if it's trying to break through an 11-month downtrend line. I bought some at $4.28 yesterday, and I may try to snag the other half tomorrow if the price action is good. The volume needs to pick up, at the very least. My guess is that $4.14 will be the make-or-break price for a continuation of the move higher in this stock. I suppose their Q1 earnings report on May 7 will dictate whether this stock is really a "bargain" at these prices.

Apr 28 07:58 PM

[Jeffrey Wal...:]

Hi Jason,
Thanks for the article. How much do you know re: the SHL situation in China and impact to AOB (beyond what mgmt relayed on last call)? Any details you can share re: the dynamics and ongoing risk are appreciated.
Thanks,
Jeff

From 4Q call:
"Third, we expect some impact from the recent recall of SHL injectables. While AOBO’s products was not recalled, SHL contributed roughly 15% of our total revenue in 2008, as sales volume will likely decline year-over-year as the recall impact industry-wide demand."

May 01 08:11 PM

[Jason Tillberg:]

Hi Jeffery,

Nothing more than from what was said on conferance call as well. The earnings estimates were brought down for that reason however and that was considered in the analysis.

Next earnings report should shed more light on that product for sure.

Jason


On May 01 08:11 PM Jeffrey Walkenhorst wrote:

> Hi Jason,
> Thanks for the article. How much do you know re: the SHL situation
> in China and impact to AOB (beyond what mgmt relayed on last call)?
> Any details you can share re: the dynamics and ongoing risk are appreciated.
>
> Thanks,
> Jeff
>
> From 4Q call:
> "Third, we expect some impact from the recent recall of SHL injectables.
> While AOBO’s products was not recalled, SHL contributed roughly 15%
> of our total revenue in 2008, as sales volume will likely decline
> year-over-year as the recall impact industry-wide demand."

May 07 08:26 PM

[Jimmy / pus...:]

Jason, Many thanks for your prescient analysis. May I inquire as to where you found or did you develop the template for determing the net present value of the stock? Thanks! Jimmy

Jun 17 08:19 AM