China Holdings Acquisition Corp: The Stock Can Move Up 50%

|
 |  Includes: HOL, TMI, TTY
by: UtuAlpha

China Holdings Acquisition Corp (HOL) is a Special Purpose Acquisition Company (SPAC) that is purchasing a Chinese ceramic tile manufacturer known as JinJiang Hengda Ceramics Co ("Hengda"). On 11/20/09, this deal was approved by shareholders, and typically these deals close within a day or two of a successful shareholder vote. Like most SPACs, the stock has zero Wall Street coverage, which helps explain its significant discount to intrinsic value. At $9.75, the stock trades at a P/E (2009E) of 6.5X ($1.50 in EPS). Comparable stocks in the Chinese building materials industry trade in the 15-30X range, and with Hengda's targeted 15-20% EPS growth rate, this range seems more reasonable. To be conservative, I'm using a 10X multiple to get a price target of $15.00, for 54% upside.

For those with a higher risk appetite, the warrants (ticker HOL.WS on the NYSE Amex) at $1.50 trade at a 33% discount to parity (strike price is $7.50, and with the underlying stock at $9.75, parity is $2.25). The warrants expire on 11/16/12, and assuming an implied volatility of 30%, intrinsic value for the warrants is currently $3.30, for 120% upside. At a target price of $15.00 for the underlying stock, the warrants would be worth about $8.00, but given that the warrants are callable by the company when the stock hits $13.50, upside on the warrants is limited to $6.00 for 300% upside. Note that the warrants will not be exercisable until after the stock is registered.

Hengda, founded in 1993, has a nearly 4% market share in the $5 billion ceramic tile industry in China. The company generates about 95% of its revenues from the domestic Chinese market, and its products are available in over 2,000 styles, colors and size combinations, and are used for exterior siding and for interior flooring and design in residential and commercial buildings. Hengda's products are known for their high quality and innovation. New products, such as the ultra-thin tile, have approximately 50% higher gross margins than the industry average.

Hengda's manufacturing facility is located in JinJiang city, Fujian province, with an aggregate annual production capacity of 28 million square meters. Hengda is in the process of building a second production facility, which will increase capacity by 42 million square meters by 2012. The company has maintained long-term relationships with its customers, with 9 of its top 10 clients having purchased its products over the past 10 years.

The ceramic tiles industry in China has grown at a 20% rate (by revenue) over the past 3 years and is expected to grow 10-15% per year over the next 5 years. The industry is fragmented, with the top 10 manufacturers accounting for just 20% of total revenues, the remaining 80% is spread among hundreds of small mom and pop factories. Clearly this is a great platform for both organic growth and market share gains.

To get a sense for timing, 2 Chinese SPACs that have recently completed their acquisitions: footwear maker Exceed Co (NASDAQ:EDS), and advertising company China MediaExpress Holdings (TMI) were up 54% and 48%, respectively, within 6 trading days of their shareholder votes. Due to limited floats, the upside volatility can be significant in the short term.

Disclosure: Author is long HOL stock and warrants