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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.

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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

Source: In the Bargain Bin: American Oriental Bioengineering