Editors' Note: This article discusses micro-cap stocks. Please be aware of the risks associated with these stocks.
The compelling attraction of investing in a country that sports a booming population and spectacular growth rates has been clouded by constant fear of fraud and investment scams. Many public Chinese companies have been uncovered as complete scams, with company buildings and plants either being abandoned, or not producing anything at all. The most recent company subject to fraud allegations was NQ Mobile (NQ), after this MuddyWaters report was released last month. NQ Mobile's market value was cut in half and has yet to recover.
American investors have already lost billions of dollars to these fraudulent companies, and the prevalence of fraud in Chinese stocks has skyrocketed ever since American investors diverted their money into Chinese companies during the 2009 financial crisis. The Chinese government has repeatedly refused to work with SEC officials to curb the excessive amount of scams, which means it's up to the individual investor to do their own due diligence and uncover potential gems that are indeed fraudulent free. Although I did not step on a plane and directly visit the operations of the companies mentioned below, I strongly believe that they represent solid Chinese companies that are not involved in any fraudulent activities and have true exposure to the explosive growth of the Chinese market.
Gain Exposure to the Chinese Housing Market
IFM Investments (CTC) was founded in 2000 and provides real estate services throughout China; the company is headquartered in Beijing and employs approximately 13,000 people. IFM operates four different segments, including company-owned brokerage services, franchise services, mortgage management services, and primary & commercial services. The company has exclusive rights to use and franchise the popular estate brand, Century 21.
The company reported revenue of $119 million in 2012, and had approximately $26 million in cash as of September 30, 2013. The company's cash per share stands at $1.73, and their book value per share is $3.46. With shares currently trading at $2.00, and a market cap of only $30 million, the company seems undervalued. The company is in a turnaround mode, after cutting their losses from more than $50 million in 2011, to $8.5 million in 2012. The company posted a profit of $1.2 million for the first quarter of 2013, but posted a loss totaling $7.9 million for Q2 and Q3 of 2013. The company expects to recognize $1.6 million in revenue related to completed projects for Q4 of 2013, and an additional $7.5 million for Q1 of 2014.
The company recently hired Steve Ye as CFO. Ye is focused on introducing cost cutting measures, streamlining operations of the business, and increasing their investor relations efforts. PwC is the company's auditor, and many of the company's directors and management have held senior level roles in publicly listed US companies. A solid balance sheet, strong management, and coverage of the entire Chinese housing market make shares extremely attractive at current prices.
Gain Exposure to the Chinese Advertising Market
Tiger Media (IDI) is a micro cap advertising company headquartered in Shanghai that was once the subject of fraud when it operated under the name of SearchMedia Holdings. Then, the company had a different core business, and different management running the company. Since changing their name, business, and management, Tiger Media is on a clear path to profitability and it's only a matter of time before their growing LCD advertising network covers all tier I and II cities.
(A) The company has shed nearly 10% since my article was released in mid September.
(B) In the middle of October, shares rallied, following the strong price action by VisionMedia and other Chinese media stocks. Tiger's shares broke through $2.00 intraday on October 17th.
(C) The company released less than stellar quarterly results, announced that their CFO had resigned, and canceled their quarterly conference call.
(D) Tiger Media lowered the exercise price of their existing warrants to $1.25, from $2.50. The warrants expire at the end of December.
According to CEO Peter Tan, the departure of Steve Ye simply seems to be a career move, and nothing else (revenues of $100+ million at CTC, compared to beginning phases of new business at Tiger Media). Tiger Media's balance sheet makes it the most risky investment out of the three mentioned in this article (only $2.6 million in cash).
In their recent earnings release, CEO Peter Tan stated that their LCD network continues to receive positive responses from a diversified customer base, and that they have entered into an agreement with the Shanghai Film Group to market up to 100 new movie titles on their LCD network. COO Stephen Zhu commented that their LCD business continues to expand, and that they have commenced testing of their Wi-Fi and 3G capable LCD screens with China Unicom (CHU), and are planning to fully deploy the technology by the end of 2013. The interactive O2O (online to offline) presents a significant source of new revenues for Tiger Media, and should begin to materialize in 2014.
The growth story of Tiger Media is still intact, and the future prospects of the company seem stronger than ever now that they plan to fully deploy their O2O technology by the end of 2013. The company is expected to resume their quarterly conference call next quarter, and this should provide a clearer image of the company's utilization rates and their planned expansion into tier I and II cities.
Phillip Frost's position in Tiger Media has not changed since he last purchased approximately 300,000 shares at an average price of $0.81 on July 10th of this year. Frost owns approximately 32% of Tiger Media. Prospective investors should watch to see if shares close below key support of $1.24. If shares break this level, watch support levels of $1.00, and view this as a buying opportunity.
Gain Exposure to the Chinese Pharmaceutical Market
Tianyin Pharmaceutical (TPI) is a profitable small cap company that develops and markets modernized traditional Chinese medicines and other pharmaceutical products. The company has a portfolio of medicines, and their potential blockbuster product, named Gingko Mihuan, is expected to record upwards of $26 million in sales for 2013. The company has 10 drugs selected for the Essential Drug List (EDL) in China.
Since highlighting the company in mid October, the company has released quarterly results, and replaced its auditor. The company's original auditor had failed to renew its license with the SEC, and Tianyin was forced to terminate their relationship with the auditors. Since then, the company has hired Paritz & Company as its auditors. No financial wrongdoing has been found in previous financial reports, and management does not expect to find any.
Many readers questioned the legitimacy of Tianyin in the comment section of my last article. One reader questioned the likelihood that Tianyin actually had 10 drugs that were truly on China's EDL, but these were found and verified. Management has delayed a share repurchase program, and they recently stated that they would commence share repurchases in the beginning of 2014. The company has explained that they want to finish their current CAPEX projects before purchasing more shares, but they have plenty of cash on hand to do both at the same time. This has raised eyebrows for some, but I believe the company is simply trying to control spending and is being cautious. There are plenty of business factors that can affect the allocation given to a share repurchase. As an investor, I'd become suspicious if the company did not go through with their repurchase plan by the first half of 2014, after they complete all of their construction and relocation projects. The company has also been talking about creating a capsule form of their most popular drug to create a new stream of revenue for more than a year, but this has yet to materialize.
Tianyin Pharmaceuticals has $1.02 in cash per share, and a book value above $3.00 per share. The company's growth has been flat in many areas, and revenues recently declined by 8% on a quarterly basis. This is because of pricing pressures from China's new healthcare policies; therefore the company is extremely conservative with their guidance moving forward. Although the company is experiencing pressure from their API business, and new healthcare policies, the company's main drug continues to gain traction in many provinces throughout China, and sales should increase as the drug is added to more EDLs in other provinces. Tianyin has ample room to grow their business. The company has state of the art production facilities that meet the standards of the EU and US, and they are actively exploring options to sell their product in these markets. A capsule form of their most popular drug can also create a significant revenue stream if it's ever created. Investors should keep an eye on management's share repurchase program, and their geographical expansion plans (slated for end of 2014/beg of 2015).
Technically speaking, shares of Tianyin seem to be on the verge of breaking out above a $1.00 after falling from its intraday high of $1.44. Shares are currently trading below the company's cash per share, which make under a $1.00 an attractive entry point for the speculative investor. There is strong support at $0.89.
All risks associated with micro cap stocks apply to the above three companies. There are many headaches and risks associated with Chinese stocks. The stunning feeling of investing your hard earned capital into a fraudulent company has turned thousands of investors away from publicly listed Chinese companies. Many Chinese companies that have strong business prospects, a diverse board of directors, and executive management that has worked and studied in America are trading far below their book value, and sometimes below their cash value per share. Investors who do their own due diligence can identify fraudulent free, undervalued Chinese companies, and I believe the above three companies represent that.