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

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 (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

Comments

[marseillais]

And do not forget that EPS for 09 will be known in less than 2months. Quarterly results two weeks ago were encouraging and management seems on track to meet ambitious targets, even more so now with the support of HOL sponsors (more working capital for increasing production capacities).

The warrants, currently at $1.55, have just a non sense pricing: any basic model would give you a value at 2.15$, and even more so considering that the underlying (HOL) is deeply undervalued. The warrants can go to 6$ max due to callability at a certain stokc price. I don't think they can go that high, but to 3$, that is possible if the stock quickly closes the gap with intrinsic value.


This is still a fast growing company in a strong market, that you basically acquire for nothing via the US market.

The stock is weak post deal due to massive dilution, as the sponsors of the SPAC had numerous options and warrants that are exercised, so massive equity is issued these days.

2009 Nov 23 12:00 PM

[JohnnyK]

Does anybody know why both the stock and the warrant are not performing well? Additionally, why is there a difference between the warrant's price+coverstion cost and the stock's price?

Thanks

2009 Dec 11 05:29 PM

[marseillais]

post-deal, nothing has been announced by the management. in other words, it is no longer a SPAC, it is now an operating company, but who is going to check back all the documents filed in oct and nov about that company to realize that it is a good business with 6x PE ? No one, hence no real volume post deals. the spac arbs are out, but there is still no shareholders basis for this company, except the managers/insiders. Now they have to communicate about earnings, assets, etc..., the usual numbers that will be announced early 2010.
as for the warrant, that gap existed prior the deal because of the uncertainty of the vote. As to why it still exists now, I have no clue other than just undervaluation, like the stock, and lack of volume, which is taking the stock to the pink sheets apparently.

2009 Dec 14 12:28 PM

[mars01]

How do you think the recent delisting notice will affect trading in the short-term?

Long-term, I agree with the original thesis and see this as a very cheap way to gain exposure to China...

2009 Dec 15 10:06 AM

[mars01]

How do you think the recent delisting notice will affect trading in the short-term?

Long-term, I agree with the original thesis and see this as a very cheap way to gain exposure to China...


On Dec 14 12:28 PM marseillais wrote:

> post-deal, nothing has been announced by the management. in other
> words, it is no longer a SPAC, it is now an operating company, but
> who is going to check back all the documents filed in oct and nov
> about that company to realize that it is a good business with 6x
> PE ? No one, hence no real volume post deals. the spac arbs are out,
> but there is still no shareholders basis for this company, except
> the managers/insiders. Now they have to communicate about earnings,
> assets, etc..., the usual numbers that will be announced early 2010.
>
> as for the warrant, that gap existed prior the deal because of the
> uncertainty of the vote. As to why it still exists now, I have no
> clue other than just undervaluation, like the stock, and lack of
> volume, which is taking the stock to the pink sheets apparently.

2009 Dec 15 11:24 AM

[marseillais]

there is already no volume and total lack of interest for the stock on the Amex post deal...meaning that after the hedge funds arbitraging SPACs, no one replaced them (except the management, we are still waiting the 20F explaining the capital structure post deal, and I am sure they have way more than the original 20% (which is why they have not been in a rush for the stock to pop up).
So if they go on the pink sheets: for sure over the next weeks, it will remain very weak. But many investors are scouring the pink sheets for cheap companies (see Sonkin and the Hummingbird Fund), so HOL might actually find at last the interest it deserves easier on that exchange.
At the end of the day, these are earnings/balance sheet announcements that will decide the stock price, and this company remember is brand new, like an IPO.

2009 Dec 15 11:30 AM

[RogerDanger]

Some SPACs have run into problems as most of their hold for yield hedge fund shareholders were bought out using pre-merger agreements (so the deal could proceed), leaving the post-deal SPAC firm with few assets or a pile of debt - look at Triplecrown Acquistion as an example.

2009 Dec 16 01:09 PM