China Biotech Smallcaps: Are They for Real?

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 (BSPM.OB) 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 (CBPO.OB) 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, CYXN.OB, LTUS.OB, CHME.OB. 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.

Comments

[Roy Manning:]

CBPO is a great investment. I'm looking for $5 a share by years end. They had great earnings in 3rd and 4th quarter. They just made 2 acquisitions making them the only Plasma company in 3 provinces of China. Their sales to India are really picking up. Their acquisitions should start adding to revenues this quarter. The company is predicting 20 million in profits in 2009.

May 06 08:54 AM

[Monkey Man:]

There usually are good reasons for why many of the names you mentioned trade the way they do...

May 06 08:54 AM

[Danny Furman:]

Roy, I agree that CBPO is the class of this group. It's valued more highly than the others but has very little competition.

May 06 09:35 AM

[balabanovj:]

CBPO will likely hit the $8-10 range by years end- eps will be at least 0.90 in FY '09. They're solidly run and are ramping up exports, which give them much higher margins. You could even see $12. LTUS's prospects are more questionable, simply due to their cash position, so it's difficult to preduct price movement. $2 would be the max at the moment I would imagine, until they can pad their balance sheet a bit. Nevertheless, they're very profitable and are making great progress. Another company to really keep an eye on is CPHI. They too are growing very strongly, but have a very large accts receivable balance. I just received an email form Diana in IR though, who explained the standard credit cycle with govt hospitals, which at the moment are their primary customers. The following is a quote from her email, "Following the prudent accounting principles, we accrue the allowance for doubtable receivables. The percentage of a trade receivable that is deemed doubtful is as follows: 100% after 720 days; 50 % after 360 days; and 7.5% up to 360 days. During the 15 years of operating history, the company has never had any uncollected receivables." This makes me feel quite comfortable with their accts receivable balance, since I know they will get paid. CPHI has one of the most impressive product portfolios and pipeline I've seen and provides visibility for continued strong growth for at least the next 5 years. At current levels they're a steal. They also have plans to re-list at some point, either on NASDAQ or AMEX. This is probably one company you can feel comfortable buying and holding. Discloser: Long on all of the above.

James Balaban

May 07 08:32 AM

[joejax:]

Biostar is an American company that owns the Chinese pharmaceuticals co. It went public in the U.S. after going through an exhausting registration process with the SEC. I'm an investor in the co., who went over to see the pharmaceutical facilities and meet with the CEO and other top execs three years ago. Only then did I invest. At the time of our meeting, the CEO laid out an ambitious marketing plan to increase revenue and geographic customer reach in China (it does not export), particularly its drug approved by the Chinese government for over-the-counter sale to cure Hepatits B, which is said to afflict some 10% of Chinese. My recollection is that the co. was then bringing in some $5 million in annual revenue. As was pointed out by Mr. Furman, the co. brought in $33 million in revenue in the last fiscal year. Earnings have grown handsomely as well. The co.'s financial statements are rigorously examined by its Chinese-American CFO (with doctorate in accounting from a U.S. educational institution), whom I have met on several occasions. To answer Mr. Furman's question: Biostar is definitely for real.
Joseph Amiel

May 15 03:58 PM

[Danny Furman:]

Great info, thank you Mr. Amiel! I liked the 10K and website enough to buy a few shares, glad to hear from someone with more thorough knowledge. Having the only state approved OTC hepatitis B meds sounds like growth in 2009 to me. It amazes me that western investors are so skeptical about China, however each series of earnings reports for the coming years should slowly change that.
Thanks again Mr. Amiel and all the best.


On May 15 03:58 PM joejax wrote:

> Biostar is an American company that owns the Chinese pharmaceuticals
> co. It went public in the U.S. after going through an exhausting
> registration process with the SEC. I'm an investor in the co., who
> went over to see the pharmaceutical facilities and meet with the
> CEO and other top execs three years ago. Only then did I invest.
> At the time of our meeting, the CEO laid out an ambitious marketing
> plan to increase revenue and geographic customer reach in China (it
> does not export), particularly its drug approved by the Chinese government
> for over-the-counter sale to cure Hepatits B, which is said to afflict
> some 10% of Chinese. My recollection is that the co. was then bringing
> in some $5 million in annual revenue. As was pointed out by Mr.
> Furman, the co. brought in $33 million in revenue in the last fiscal
> year. Earnings have grown handsomely as well. The co.'s financial
> statements are rigorously examined by its Chinese-American CFO (with
> doctorate in accounting from a U.S. educational institution), whom
> I have met on several occasions. To answer Mr. Furman's question:
> Biostar is definitely for real.
> Joseph Amiel

May 15 09:20 PM