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, Barel Karsan (392 clicks)
Long only, deep value, contrarian
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New Dragon Asia Corp (NWD) looks like a straight-up steal. While the company hasn't made money in four quarters, the losses are dwarfed by the company's liquid assets; the company has a net current asset value $27 million, but trades for just $9 million at its current price of 12 cents per share. While you never know what will happen when a stock trades at a such a low level (it could easily increase by 50% or be cut in half just like that), there are enough warning signs behind the numbers to scare the average value investor away.

First of all, the potential for dilution is large. An astute reader pointed out that the outstanding stock warrants are far out of the money, so they are indeed practically worthless. Unfortunately, significant potential for dilution still exists in the form of convertible preferred stock. The pref share dividends can be paid in common stock (similar to a situation we saw for Quest Capital (QCC), and the pref share principle must be redeemed in the next few months. The company's shares outstanding have increased by almost 25% in the last 9 months in the conversion and payment of dividends for these pref shares!

Unfortunately, the company's problems are not only in its finance department. NWD mills and distributes flour and related products, including "instant noodles" (packet noodles and cup noodles for preparation at home) through its Long Feng brand. Considering the industry it's in, one would not expect a recession to have such a huge effect on revenues. This is not a company selling heavy-duty, expensive-to-finance equipment that can't be justified in the current environment. Sure, its customers may reduce inventories, so some sales compression can be expected, but the drop in sales the company continues to experience is extreme: instant noodles and flour revenue dropped 75% and 63% respectively in the most recent quarter.

The company's only explanation is the "slowdown in the economy worldwide". What one would expect to be a stable business is not so, suggesting the company is being battered by competition or is out of favour with its customers, and management does not appear forthcoming with the details.

Finally, the company recently announced that its independent certified accountant has resigned. The reasons for this are not clear, but experienced investors will tread carefully when such an event has taken place.

A share purchase of NWD may indeed prove fruitful. If the asset numbers are correct, the company does appear to trade at a discount. However, considering the unexplained operational problems this company clearly faces, along with the threat of continued massive dilution, a purchase of shares at these low levels amounts to speculation as opposed to value investing.

Disclosure: None

Source: New Dragon Asia Is Cheap, But Is It Worth the Risk?