At first glance, it might not appear that a small Chinese manufacturer of copper wire for various industries would be that crucial to the Chinese small cap sector as a whole. The key is that the Co-CEO has made an offer to take the company private for $11.50, or roughly 20% above current prices.
It could open the door to higher valuations in the sector as a whole, or maybe similar transactions across the sector as management grows increasingly tired of dealing with US investors that think every Chinese company is a scam.
Also key is the sentiment of the small cap Chinese investor where a company involved in the red hot copper sector could trade with a sub 7 P/E even after a buyout offer. In what should be a momentum driven trade, investors still aren't intrigued enough to jump in, possibly allowing the CEO to acquire the company on a very reasonable valuation.
This greatly highlights the valuation and mistrust issues in the sector. Investors say that if these companies offer such a great value, then why aren't institutional investors or insiders taking companies private? Or, why aren't competitors merging? Well, this deal could wake up investors to those possibilities.
James Altucher authored an article (Why China Stocks Trade So Cheap (And Which Stocks Should Fly) with such a theme back in September. For investors to get past the accounting concerns, they need big time Chinese investors to stand behind the numbers. Where is the M&A activity? A company like Lihua International (LIWA) shouldn't be trading at a forward P/E of around 6 when they just forecast up to 35% earnings growth for 2011.
Copper and China should attract momentum investors in droves, but they remain unconvinced for the various reasons mentioned by Altucher. LIWA recently announced a $15M buyback, and combined with the FSIN deal, could significantly increase confidence of investing in this sector. Verification that the valuations are indeed cheap will improve confidence.
Tuesday, FSIN's Special Committee announced the hiring of BofA Merrill Lynch to advise them on the $11.50 offer. Still, investors are leaving 20% on the table, either not convinced the deal will be approved or that the CEO doesn't have the access to the cash.
The sector needs this deal to be approved. Investors need to see that big investors are going to scoop up shares when valuations remain this low. The outcome of this deal will hardly make news in the investment world, but it should intrigue investors looking for the game plan going forward. Time will tell.
We have invested in both Lihua International and Puda Coal (GM:PUDA) with the thinking that investors will finally become comfortable with Chinese small caps. Time will tell.