Fushi Copperweld (FSIN) continues to trade at multi-year lows due to continued short selling on the premise of concerns related to the credibility of US listed Chinese companies, in general, and Abax Global Capital (Abax), Fushi Copperweld management's buyout partner. Abax is currently under confidentiality and standstill agreements and is in the process of performing due diligence related to the previously announced proposal to take the company private at $11.50 (representing an almost 100% premium to Wednesday's closing share price).
The most recent selling activity began on Thursday (6/16) after Citron Research (an outspoken short seller) released a report on Harbin Electric (HRBN) aimed at undermining the credibility of China Development Bank (CDB) and Abax, which provided no evidence regarding CDB or Abax and whose claim was subsequently refuted by a press release made by HRBN management.
Here's a little background info on Abax: The Morgan Stanley backed firm currently manages over $900mm of hedge and private equity funds and is working with the China Development Bank in raising a new China focused private equity fund with up to 4bn yuan (over $600mm) in commitments to pursue the acquisition of US listed Chinese companies. The new fund had already received government approval and, as of May 18, 2011, was working through the registration process and aims to be operational by mid-July (see here). Abax has invested and worked with Fushi Copperweld in the past, making FSIN a highly likely buyout target for this new fund given the current dialogue.
At current levels, FSIN presents a very compelling investment opportunity inclusive of the unlikely possibility of the company having committed any fraud. Bottom line is that FSIN is very different compared to many other US listed Chinese companies, given its 500+ customers in over 30 countries, US and UK presence (it has operations in Fayetteville, Tennessee and in Telford, England) and big 4 auditor (KPMG), but has nevertheless been indiscriminately (and illogically) targeted given the company's Chinese operations and reverse merger origins over 5 years ago.
Essentially, FSIN shares represent an incredibly cheap non-expiring option on both Fushi Copperweld's operations (which have been publicly listed and SEC reporting for over 5 years) as well as the company's 3/31 cash balance of $134mm (~$3.50 a share) and accounts receivable/inventory of $82mm (~$2.14 a share) which have been signed off on by KPMG. The current cash value is likely higher given the increasing cash provided from operations which reached $15mm in Q1 '11 (almost $0.40 a share). FSIN currently has only $6mm of debt ($0.16/share) on its balance sheet.
Based on just these current asset balances (as of March 31) and just $0.16/share in debt, FSIN would likely be worth at least $5.00 in liquidation. This $5.00 number attributes no value to the property, plant and equipment reported on 3/31 which totaled $122mm or an additional $3.19 per share. As previously mentioned, a portion of both the current and fixed assets are located in the US/UK (Tennessee/England) given the assets and cash flows associated with these operations. This should give even the most fraud concerned investor some comfort given the recoverability of US domiciled assets is far superior to that of PRC assets (see FSIN website and March 31, 2011 10-Q filing).
It's a Deal, It's a Steal, It's the Sale of the Century
The above details are meant to illustrate some reasons why the take-private proposal is extremely attractive for the insiders and Abax. Without even looking at the current valuation based on earnings and cash flow (which are outrageous and will be discussed shortly), the business appears to be worth at least the $8.67 attributable to just the current assets and PP&E, less outstanding debt as of March 31, 2011 that were reported in the KPMG prepared 10-Q filed on 5/10/11. This $8.67 figure currently represents roughly 50% upside from current prices.
This is a margin of safety with which I can, and many others should be able to, get comfortable with. Now on to valuation: In 2010, FSIN achieved ~$68mm of EBITDA and ~$59mm of free cashflow. Based on a current equity market cap of ~$220mm and ~$130mm of net cash, this equates to an EV/'10A EBITDA multiple of roughly 1.3x. Consensus '11E EBITDA currently stands at $74mm which would equate to a 1.2x EV/'11E EBITDA multiple (estimates are based on the input of the four Wall Street research firms currently covering FSIN, of which three have buy ratings and one has a hold). For a company with essentially no debt, this is outrageously cheap.
At prevailing prices (once adjusted for net cash), FSIN has a cashflow yield of almost 70%, meaning that at current levels, Fushi Copperweld generates the cash equivalent to a buyer’s initial investment in less than a year and a half. Even if the deal at the $11.50 buyout price is 100% financed with equity and no debt financing is utilized (highly unlikely given FSIN currently has next to no debt), the cash flow yield is still almost 20%.
When looking at a few of FSIN's domestic comps for relative valuation, we see that Encore Wire Corp. (WIRE) currently trades at 6.2x '11E EBITDA and Coleman Cable (CCIX) currently trades at 6.0x '11E EBITDA. Based on these multiples, it would appear that FSIN has substantial upside
Looking at price to earnings and cashflow multiples generates similar results. FSIN trades at just 4.9x '11E earnings and less than 1.9x '11E earnings after adjusting for the ~$3.50/share in cash
Conclusion: Too Good Not to Have aTaste
FSIN last provided an update on the going private process on 5/27/11 indicating the following:
The Special Committee has negotiated and executed confidentiality and standstill agreements with each of Mr. Fu and Abax. The Special Committee and its independent financial and legal advisors are currently facilitating the due diligence investigation of the Company by Mr. Fu and Abax so that they can be in a position to submit a firm, fully financed offer to the Special Committee. The Special Committee, with the assistance of its advisors, is also considering other strategic alternatives to Mr. Fu’s proposal, including any other acquisition proposal that may be submitted to the Company or to the Special Committee or remaining an independent public company.
- No fraud has been found at FSIN.
- An $11.50 MBO proposal remains on the table and is currently being evaluated by the Independent Directors while the buyers are performing due diligence under the negotiated and executed confidentiality and standstill agreements.
- Current valuation is outrageous on every conceivable measure (at less than 2x EBITDA, cashflow and earnings).
- FSIN has engaged established financial, legal advisors and auditors in the form of BofA Merrill Lynch, Gibson, Dunn & Crutcher LLP and KPMG.
- FSIN is a multinational corporation with over 500 customers in 30+ countries, with operations in the US, UK and PRC and an operating history that spans 5+ years. FSIN also has a credit facility provided by Regions Bank - a sizeable and respected American bank with very little appetite for off-the-fairway lending. Meaning that they are likely very comfortable with their collateral.
- As of March 31, 2011, FSIN reported ~$3.50/share in cash as confirmed by KPMG (likely will be higher as of 6/30), accounts receivable and inventory totaling ~$2.14/share as well as PP&E of ~$3.19/share.
- The longer the shares trade at such discounts, the greater the likelihood for success of a buyout by insiders and Abax or any other strategic/financial buyer for that matter. Management is well aware of this fact and will not speak up regarding progress until a definitive agreement is reached (as is in their long term financial interest).
- Short interest in the US listed Chinese sector is at all time highs due to the indiscriminate shorting of Chinese companies (which FSIN is inappropriately included in given their global operations and customer base). Over 20% of shares outstanding and 30% of float for FSIN was sold short as of June 15; the remaining shorts will cover at some point, and it should be quite a run when that occurs.
Max downside is 100% if the company magically disappears (assigning some reasonable probability range here is sensible). For those of us that don't believe in magic, let’s focus on some potential measures of upside:
- Almost 100% upside associated with the $11.50 buyout offer.
- Roughly 50% upside just to get back to the March 31 tangible book value (which will likely be higher at 6/30 due to cash generation).
- Potentially over 100% upside based on peer valuations.
One has to appreciate that even at $11.50, the insiders and Abax view this deal as incredibly cheap and expect to generate wildly attractive returns in short order by relisting Fushi Copperweld on the Hong Kong stock exchange.
The negative sentiment and perceived risk of fraud in this sector has gotten out of control and has left the good apples at the same ridiculously cheap valuations as the bad.
With upcoming second quarter earnings, the likely announcement of a definitive agreement, numerous other potential positive catalysts on the horizon and still no indication that FSIN has committed anything fraudulent over the last 5 years of reporting as a public company - logic seems to say to place your bets with management, Abax, KPMG and the institutional investors that continued to hold over 50% of FSIN's shares outstanding as of the end of the first quarter.
Note that the markets are, in reality, often very inefficient and it is always prudent to base your decisions on underlying company specific and situational information and not general sentiment and trends.
While the short China trade has been a very profitable one for the past 6 months (I’ve quite enjoyed it), it has become overly crowded with continually diminishing merit given that almost every company in the sector is priced for fraud/bankruptcy. Time to find the survivors and make a killing on the opposite side of the trade.
Disclosure: I am long FSIN.