China Biotech Smallcaps: Are They for Real?

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Includes: BSPM, CBPO, CHME, CYXN, LTUS, WX
by: Danny Furman

I'm a rookie when it comes to investing. I believe that enjoying stock analysis and committing myself to it makes me better informed than some more experienced investors, but I accept that in some cases my peripheral vision is lacking. One of those cases seems to be smallcap biotech companies in China.

Historical research has me convinced that markets are inefficient (see Seeking Alpha Author Glen Bradford's Blog for a good read on inefficient market theory and China) and, with enough exposure, stocks should achieve valuations consistent with earnings and growth for their industry. Exposure may or may not be their biggest issue, but many profitable Chinese biotech businesses trade for little more than their 2008 earnings.

After Asian markets soared Monday, I expected investors to spend that night on a DD marathon looking for value in those countries. If they did, they really don't like biotech.

Biostar Pharma (NASDAQ:BSPM) improved sales by about 70% year-over-year for 2008, booking $33M in revenue and $6.7M in net income. The Company recently launched a website (zggbyy.com) with products and services for hepititis patients. The stock, BSPM, is traded about once a week, usually an obnoxiously small quantity (as is my stake, without more volume even I am quite skeptical). On Tuesday the share price, on one transaction, sunk 75% to 30 cents, making the P/E ratio approximately 1.

Is this company a scheme? I doubt it, but this is an area in which my inexperience has taken over. Conventional wisdom says not to even look at these types of companies, which are primarily traded on the pink sheets. "This is Accounting Fraud Central."

Is it, though? Have falsified press releases always looked like this (I'm curious)?:

This increase in revenue and net income reflects an increase in sales of all five of Biostar's State Food and Drug Administration ("SFDA") approved drugs, most notably the Xin Aoxing Oleanolic Acid Capsule, the only SFDA- approved, over-the-counter (OTC) treatment for hepatitis B. The increase in sales is also attributed to the continued implementation of the Company's "Blue Sea" project, which markets products directly to consumers in rural China through retail pharmacies at higher retail prices. Domestic PRC customers account for 100% of Biostar's sales.

China has significantly increased scrutiny of publicly traded companies with new listing requirements and increased overall regulation. What also keeps me so intrigued is how little competition many Chinese medicine makers have. The Chinese government seems to actually care what its citizens ingest as medicine, and benchmarks are set for quality instead of minimum safety standards (unlike here, in China you can't sell speed on tv and call it weight loss medicine). China Biologic Products (NASDAQ:CBPO) seems well positioned, as through a recent acquisition, it is the only distributor to several population segments of highly demanded albumin and immunoglobin blood products. They even secured a $5.3M deal to distribute in India.

My last question is: Will there be an industry that benefits from increased trade with Taiwan more than Chinese medicine? My thoughts are that Taiwanese electronics will outshine ones produced in The Mainland, but Chinese food and medicine will gain market share in Taiwan.

Some more heavily (emphasis on more, not heavily) traded stocks in this sector include WX, GNPH.OB, OTC:CYXN, OTCPK:LTUS, OTCPK:CHME. All have been relatively stagnant lately, unlike their geographically neighboring stocks. Also in common between them is a great balance sheet and strong growth.

Disclosure: Author once held long positions in LTUS and CHME and currently holds CYXN, WX, CBPO and BSPM.