The Great Transparency Wall of China, Part II

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 |  Includes: BIDU, CEAI, DEER, HOGS, SNOFF, SOHU, TZOO
by: Robert Weinstein

Following my previous article, The Great Transparency Wall of China: Part I, I continue with part II, discussing the Chinese stocks that I believe are short candidates, as well as other more viable stocks in terms of risk versus reward. With virtually no downside and huge windfall riches to the upside, many Chinese companies will choose to make the quick buck. The increased discount that should be placed on them as a result of headline risk is not fully priced into many Chinese stocks. Of course, we can see that the market is waking up to this real threat to portfolios, but way too slowly.

China Education Alliance Inc. (CEU) is a $38.71 million market cap company. China Education Alliance, Inc. is an educational services company that provides online education and on-site training in the People’s Republic of China. The Company’s principal business is the distribution of educational resources through the internet. Its website, edu-chn.com, is an education network platform, which is based on network video technology and data sources of elementary education resources. The company maintains a database that contains educational resources. Its database includes more than 350,000 exams and courseware for college, secondary, and elementary schools. It also offers video on demand, which includes tutoring on exam papers and test-taking techniques.

CEU has rising revenue year-over-year (yoy) of $46.27 million for 2010 vs. $36.97 million for 2009. CEU’s bottom line has rising earnings year-over-year of $15.26 million for 2010 vs. $15.21 million for 2009, and rising EBIT year-over-year of $16.58 million for 2010 vs. $16.15 million for 2009. Rising revenue along with rising earnings is normally a good sign, but CEU has been faced with investment-crushing allegations of accounting fraud as well as questions about whether this is even a real company at all. The stock price has suffered and is hanging on by a thread. CEU trades on the NYSE and it appears that a delisting could soon be in its future.

In the last month, CEU has moved lower in price, -4.69%, with a one year ago change of -72.27%. Comparing to the S&P500 price change, CEU’s performance is not currently keeping up with the overall market by -3.08% vs. the S&P 500 from a month ago, and the one year difference is -76.8% vs. S&P 500 price change.

The best part about CEU is that you can buy the stock for a large discount to the reported cash on hand while the company has a positive cash flow. Typically when a company trades near or below cash on hand, it is a pharmaceutical or other research and development company with a large cash burn. CEU is one of the few exceptions I have seen in my entire 25+ years of trading experience. A look at Yahoo Finance will uncover a book value per share of approximately $3, of which more than $2 is in cash. With CEU trading at approximately $1.20, an investor could theoretically buy the entire company and quickly pocket approximately $20-$25 million. This of course begs the question, why doesn’t management take the company private, using the cash available to do so? It appears that the answer to this question is one of two possibilities: (a) the numbers being reported are fictitious, or (b) the thought never occurred to management that they could easily pocket $20 million or more and never have to work another day in their life. As the saying goes, you cannot be a little bit pregnant. If the company has gone to the lengths required to fake bank statements and related documents, nothing else can be reasonably trusted to be accurate. I have successfully shorted stocks that trade for less than a dollar before. Absent a materially changing positive financial event, those who are comfortable shorting a stock that is under five dollars may want to look at this one. As a study, the financials cause a recurring thought to run through my head: Why has the price not totally imploded? There are people out there hoping and praying that they can make a lot of money buying what appears to be a very cheap stock. It’s a fool’s game played by market participants who believe that the market is much less efficient than it really is. Even if the stock was discounted by Americans because of the headline risk, the reality should come out as a result of knowing that management itself could buy out the company. Any further examination of this company would at best be an exercise in futility.

Zhongpin Inc. (NASDAQ:HOGS) is a $629.14 million market cap company. Zhongpin Inc. is principally engaged in the meat and food processing and distribution business in the People’s Republic of China (the PRC). As of December 31, 2009, the company’s product line included 358 meat products, including chilled pork, frozen pork and prepared meats, and 34 vegetable and fruit products; these are sold on both a wholesale and retail basis through an exclusive network of showcase stores, network stores, and supermarket counters. Its eight processing plants are located in Henan, Jilin, and Sichuan provinces and in Tianjin in the PRC, where they have an aggregate processing capacity of approximately 1,504.9 metric tons per day or approximately 541,760 metric tons on an annual basis for chilled and frozen pork. Its three prepared pork products facilities are located in Henan province. Its one vegetable and fruit processing plant is located in Henan province. All of its products are sold under the Zhongpin brand name.

Beyond the aforementioned numbers, HOGS has rising revenue year-over-year (yoy) of $946.72 million for 2010 vs. $726.04 million for 2009. HOGS’s bottom line has rising earnings year-over-year of $58.28 million for 2010 vs. $45.59 million for 2009, and rising EBIT year-over-year of $64.29 million for 2010 vs. $52.91 million for 2009. Rising revenue along with rising earnings is a very good sign until news hits the wire and drops the price of the stock over 10%. Interestingly enough, no news actually did hit the wire, and a look at message boards shows investors trying to get answers to why the stock fell out of bed. It is possible that it is simply trading down in sympathy with Sino-Forest which trades over the counter in the U.S. as well as in Canada, until it was halted today by the Canadian regulator. Obviously, HOGS WOULD have been a great short before today. It will likely again be a good short if the stock recovers without news hitting.

Sino-Forest Corporation (SNOFF.PK) is a commercial forest plantation operator in the People Republic of China (PRC). As of December 31, 2009, Sino-Forest had approximately 512,700 hectares of forest plantations located primarily in southern and eastern China. Sino-Forest’s operations are comprised of two core business segments: wood fibre operations and manufacturing and other operations. Wood fibre operations include acquisition, cultivation and sale of standing timber or harvested logs from its purchased, integrated and planted sources, sourcing logs from PRC suppliers and selling them in the domestic PRC market, and sourcing logs, veneer, sawn timber, and other wood-based products globally and selling them in the domestic PRC market. Manufacturing and other operations include production of engineered-wood flooring, sawn timber, finger-joint board and block board, plywood and veneer, and greenery and nursery operations. In February 2009, it acquired Omnicorp Limited.

SNOFF is very likely to be the biggest loser this week. In the last three days alone, it has lost approximately 70% of its value. This is the latest picture-perfect example of why I am writing this article. Muddy Waters released a scathing negative article that insinuated fraud by the company. SNOFF has responded, denying the allegations, but it has done little in terms of soothing the panic sell off occurring even as I write this. It must be stressed that this is not a recent company to go public. While it does trade on the over-the-counter market, it has done so for years, in addition to trading in Canada. After watching wakes of destruction left after Muddy Waters alleged fraud on companies, I believe the odds favor further capital depreciation and losses for investors. It certainly is possible that Muddy Waters is wrong this time, but if I were an investor, I would sell and allocate the proceeds into a different stock that has the appearance of greater potential.

Travelzoo Inc (NASDAQ:TZOO) is a $1.16 billion market cap company. Travelzoo Inc. is a global Internet media company. The company informs over 20 million subscribers worldwide, as well as millions of website users, about the best travel and entertainment deals available from thousands of companies. It publishes these offers by sourcing, researching, test-booking, and selecting offers professionally. It provides airlines, hotels, cruise lines, vacation packagers, and other travel and entertainment companies to millions of consumers. It has two segments: North America and Europe. Effective November 1, 2009, the Travelzoo Web sites in Asia Pacific, the Travelzoo Top 20 e-mail newsletters in Asia Pacific, and the Newsflash e-mail alert service in Asia Pacific were published by Travelzoo (Asia) Limited and Travelzoo Japan K.K., the wholly owned subsidiaries of Azzurro Capital Inc., under a license agreement with the company.

TZOO has falling revenue year-over-year (yoy) of $112.78 million for 2010 vs. $93.97 million for 2009. TZOO’s bottom line has falling earnings year-over-year of $13.16 million for 2010 vs. $5.19 million for 2009, and rising EBIT year-over-year of $23.51 million for 2010 vs. $13.71 million for 2009. Lower revenue along with a drop in earnings is often one of the last signs to get out of the way of a falling stock price. Absent a turn in the top line results in step with the bottom line, it will be difficult to realize an oversized gain.

In the last month, TZOO has moved higher in price, 24.38%, with a one year ago impressive move higher of 32.15%. Comparing to the S&P500 price change, TZOO’s performance is better than the overall market by 5.74% vs. the S&P 500 from a month ago, and the one year difference is 9.5% vs. S&P 500 price change. I believe this is one of the better shorts of the companies listed. TZOO just experienced a blow off top and has dropped about 30% since then.

TZOO reported $-0.85 per share in earnings for the quarter ending 3/31/2011. The next reporting quarter estimated mean earnings are $0.39 per share. Analyst estimates range between $0.36 and $0.42 per share. The current trailing twelve months (ttm) P/E ratio is 0 and the forward P/E ratio is 29.98. TZOO has a price to book ratio (ttm) of 14.83 and a price to sales ratio of 6.04.

The annual growth rate of revenue is 0.2002%. The last fiscal year had accounts receivable to sales percentage of 0.1202% compared to the same period a year earlier of 0.1845%.

With the wild swings and volatility, I will be watching to sell into strength by writing out of the money call options. I will also look for non-front month call options to sell, which will provide somewhat of a volatility shock absorber as well as greater revenue if it crashes.

Baidu, Inc. (NASDAQ:BIDU) is a $48.26 billion market cap company. Baidu, Inc. (Baidu) is a Chinese-language Internet search provider. The company conducts its operations in China principally through Baidu Online Network Technology (Beijing) Co., Ltd., its wholly owned subsidiary in Beijing, China. It also conducts its operations in China through Baidu Netcom Science Technology Co., Ltd., which holds the licenses and approvals necessary to operate the company’s websites and provide online advertising services. The company has launched a Japanese search service at baidu.jp, run by Baidu Japan. Its Japanese search services enable users to find relevant information online, including web pages, images, multimedia files and blogs, through links provided on its websites. Baidu offers a Chinese-language search platform on its website baidu.com. It provides Chinese-language internet search services to enable users to find relevant information online, including web pages, news, images and multimedia files, through links provided on its websites. The Quick Ratio for BIDU is 3.44 (the higher the better).

BIDU has falling revenue year-over-year (yoy) of $1.2 billion for 2010 vs. $651.5 million for 2009. BIDU’s bottom line has rising earnings year-over-year of $534.95 million for 2010 vs. $217.53 million for 2009, and rising EBIT year-over-year of $600.75 million for 2010 vs. $235.09 million for 2009

In the last month, BIDU has moved lower in price -1.21%, with a one year ago impressive move higher of 82.27%. Comparing to the S&P500 price change, BIDU’s performance is better than the overall market by 0.46% vs. the S&P 500 from a month ago, and the one year difference is 52.49% vs. S&P 500 price change.

The current trailing twelve months (ttm) P/E ratio is 76.559 and the forward P/E ratio is 34.05. BIDU has a price to book ratio (ttm) of 2.64 and a price to sales ratio of 2.81. The annual growth rate of revenue is 10.1894%. The last fiscal year had accounts receivable to sales percentage of 0.0375% compared to the same period a year earlier of 0.0363%.

Not only is BIDU expensive with the reported numbers, it has just about everything that a short seller would want. While the company does have some exposure outside of China (including Japan), the primary market is limited to China. As a search engine in China, it must stay in the good graces of the Chinese government. As investors witnessed not long ago with Google, this can be problematic for an international company. Censorship and government monitoring will be a very heavy burden to carry if BIDU tries to venture outside of Asia in a meaningful way. On the other hand, others can be expected to keep making inroads into China. If the Chinese government does relax their regulations, one can expect GOOG to be back sooner rather than later and they have proven to be a very tough competitor. Like some others, I believe the best way to short BIDU is by shorting out of the money call options, and I would prefer to short non-front month to maximize gains from any big drops in the stock price.

Sohu Com Inc (NASDAQ:SOHU) is a $3.12 billion market cap company. Sohu.com Inc. (Sohu) is a Chinese online media, search, gaming community and mobile service group. Sohu operates matrices of Chinese language web properties and online games in China. Its businesses mainly consist of brand advertising business, online game business (conducted through Changyou.com Limited, Changyou), sponsored search business (conducted through Sogou Inc. Sogou), and wireless business, among which brand advertising and online game are its two core businesses. In order to access its games, its game access software must be installed in the computer being used. Game players using personal computers and internet cafe operators can typically download its game access software, interim updates and expansion packs directly from its official game website. The Quick Ratio for SOHU is 3.95 (the higher the better).

Beyond the aforementioned numbers, SOHU has rising revenue year-over-year (yoy) of $612.78 million for 2010 vs. $515.24 million for 2009. SOHU’s bottom line has rising earnings year-over-year of $148.63 million for 2010 vs. $147.83 million for 2009, and rising EBIT year-over-year of $230.53 million for 2010 vs. $204.39 million for 2009.

In the last month, SOHU has moved higher in price 22.79%, with a one year ago impressive move higher of 31.76%. Comparing to the S&P500 price change, SOHU’s performance is better than the overall market by 18.79% vs. the S&P 500 from a month ago, and the one year difference is 24.73% vs. S&P 500 price change.

SOHU reported $1.17 per share in earnings for the quarter ending 3/31/2011. The next reporting quarter estimated mean earnings are $1.05 per share. Analyst estimates range between $1.01 and $1.09 per share. The current trailing twelve months (ttm) P/E ratio is 19.957 and the forward P/E ratio is 14.27. SOHU has a price to book ratio (ttm) of 3.07 and a price to sales ratio of 3.98.

The annual growth rate of revenue is 0.1893%. The last fiscal year had accounts receivable to sales percentage of 0.1022% compared to the same period a year earlier of 0.0905%.

The recent price action describes my opinion for this one also. I would not hold this one either, and if the price shows movement higher, I would be looking to short it. As we have seen in others, there really is no safe harbor or ones that “can totally be trusted”.

Qihoo 360 Technology Co Ltd (NYSE:QIHU) is a $2.99 billion market cap company. Qihoo 360 Technology Co Ltd (Qihoo 360), formerly Qihoo Technology Company Limited, is engaged in the operations of internet services and sales of third party anti-virus software in the People’s Republic of China. It provides internet and mobile security products in China. In January 2011, the company had 328 million monthly active internet security product users, representing a user penetration rate of 83.9% in China. Its internet and mobile security products include 360 Safe Guard and 360 Anti-virus, the internet security products in China with 301 million and 248 million monthly active users in January 2011, and 360 Mobile Safe, the mobile security product in China. The company generates revenues primarily through offering the services, such as online advertising and internet value-added services. Online advertising offers advertising services by providing marketing opportunities on its websites and secure platform products to its advertising customers. The Quick Ratio for QIHU is 4.57 (the higher the better).

Beyond the aforementioned numbers, QIHU has rising revenue year-over-year (yoy) of $57.67 million for 2010 vs. $32.3 million for 2009. QIHU’s bottom line has rising earnings year-over-year of $5.47 million for 2010 vs. $2.12 million for 2009, and rising EBIT year-over-year of $9.02 million for 2010 vs. $4.46 million for 2009.

This is another DOA IPO in which I would not be willing to invest. With a forward PE of over 60, I believe the discount for headline risk has been overshadowed by far too many greedy investors hoping to strike it rich in the Middle Kingdom.

Deer Consumer Products, Inc. (NASDAQ:DEER) is a $235.82 million market cap company. Deer Consumer Products, Inc. (Deer), incorporated on July 18, 2006, is a Chinese designer, manufacturer, and seller of small home and kitchen electric appliances. Deer develops, promotes, manufactures, and sells a range of products, including blenders, juicers, and soy milk makers. Its products are sold both in the China domestic market and to export markets. In the China domestic market, its products target China’s growing middle-class and are sold primarily under the Deer brand name, as well as under one store brand for a retailer’s private label programs. In the export market, it manufactures its products for overseas consumer products companies who sell them under brand names, including Black & Decker and Betty Crocker Kitchens, as well as store brands for retailer’s private label programs. The company operates 13 tooling houses, 136 injection-molding machines, 18 production lines, and possesses an annual production capacity of 14 million units. The Quick Ratio for DEER is 2.1 (the higher the better).

DEER has falling revenue year-over-year (yoy) of $175.85 million for 2010 vs. $81.34 million for 2009. DEER’s bottom line has rising earnings year-over-year of $30.35 million for 2010 vs. $12.37 million for 2009, and rising EBIT year-over-year of $36.85 million for 2010 vs. $14.23 million for 2009

DEER reported $0.17 per share in earnings for the quarter ending 3/31/2011. The next reporting quarter estimated mean earnings are $0.2 per share. Analyst estimates a range of $0.18 to $0.22 per share. The current trailing twelve months (ttm) P/E ratio is 7.042 and the forward P/E ratio is 5.23. DEER has a price to book ratio (ttm) of 2.63 and a price to sales ratio of 2.15.

The annual growth rate of revenue is 1.1618%. The last fiscal year had accounts receivable to sales percentage of 0.3165% compared to the same period a year earlier of 0.2434%.

In mid–March, DEER came into play and the price of the stock has not made it back since. In the beginning of May, it looked as if it might make a full recovery, but has since fallen back to the lows put in. I would not rate DEER a short at this time, but one to keep a watch on to see if it does move higher again or just keeps going down and making new lows.

Fiscal Quarter Ending Month-YR

Estimate

Actual

Difference

Difference %

Mar-11

0.16

0.17

0.01

8.49%

Dec-10

0.3

0.32

0.02

5.79%

Sep-10

0.21

0.28

0.07

33.33%

Jun-10

0.12

0.18

0.06

50%

Mar-10

0.09

0.12

0.03

38.41%

Click to enlarge

I have been saying in my chat room that one could short every single Chinese stock and likely finish very positive at the end of two or three years. With over 6000 stocks trading in the US markets, there really is no reason to subject your portfolio to what may appear to be an extreme outlier that just happens to be occurring about once a week.

Hopefully, the landscape will change soon, and the risk will be much lower for investors. With my experiences in China, I would love to be able to use my information to be buying companies instead of being highly fearful of what may happen.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I may short naked calls in stocks listed in part I or II at any time