On June 22, when we initiated a position in Ossen Innovation (OSN) at $2.63, we started the process of compiling our information to be able to better explain why we were bullish on the company. Here is a recap of our findings, followed by our in-depth due diligence:
- Independent on-the-ground due diligence by our in-house private investigators indicates that OSN is running a substantial revenue generating operation.
- OSN management takes the position that it will not require capital from equity markets to fund 2011 and 2012 growth. This could help drive P/E expansion.
- The OSN story is a unique scenario that we believe has value when considering positive and negative factors.
- OSN will report financial results on a quarterly basis, even though as a foreign filer it is not required to do so.
- OSN should not be priced to fail.
- We will continue to monitor the OSN story and offer suggestions to management that will ultimately be needed to help restore market confidence in its stock. We highly recommend that management follows these suggestions.
- There is upside to our valuation scenarios if OSN follows our suggestions.
Ossen Innovation is a manufacturer and seller of galvanized pre-stressed steel wires used in the production of bridge cables as well as other pre-stressed steel products used in the construction of bridges and other infrastructure projects. Most of the company’s revenues are currently generated domestically in China.
The company has two manufacturing facilities: One in Maanshan, Anhui province, and the other in Jiujiang, Jiangxi province. The facilities have a combined annual production capacity of 140,000 tons per year.
Our investigator visited Ossen Materials and Ossen Jiujiang on January 29 and February 10, respectively. Here are the photographs he took of both facilities:
Ossen Juijiang Photos
Ossen Materials Photos
At Ossen Materials, our investigator interviewed three employees regarding its operations. He did not have the opportunity to interview any employees at Ossen Jiujiang. Fortunately, a friend of our investigator was a contractor for a project at Ossen Jiujiang and helped our investigator interview a manager there.
Our initial on-the-ground due diligence on OSN was encouraging. Our investigator was able to confirm that the employee headcount, production volumes, and pricing of products are as reported in the company’s SEC filings.
Confirmation of Employee Count
OSN reported in its SEC filing that:
As of June 30, 2010, we had 238 full-time employees. The following table shows the breakdown in numbers and percentages of employees by department:
# of employees
% of total
Research & Development
General Administration, Purchasing, Sales & Marketing
Based on our investigator’s eyewitness accounts and employee interviews during several unannounced visits to OSN’s production facilities, we can confirm that the Ossen Materials employee count is approximately 100 and the Ossen Jiujiang employee count is around 110. In addition, OSN also has several employees in Shanghai. We can therefore comfortably conclude that based on our on-the-ground investigations, OSN has the 238 full time employees reported in its 2010 SEC filing.
Confirmation of Production Facilities, Products and Production Volumes
Ossen Materials has one large production facility of about 15,000 square meters (300m*50m) that houses two production lines. Company sources (including rank and file employees) confirmed that the daily production volume of the two lines is around 150-170 tons. The employees also said that the production lines operate 24/7. There are, however, one or two maintenance days required each month when the lines are shut down. Ossen Materials’ only product is pre-stressed steel products. One employee also said that Ossen Materials has a subsidiary in Jiujiang City, Jiangxi province (Ossen Jiujiang) and Ossen Materials was purchasing a third facility in Zhejiang province. This information is confirmed by OSN’s CFO. The facility belongs to Huijiang as stated in its SEC filings.
If we assume that Ossen Materials produces 160 tons of products 340 days per year, the total annual production volume of Ossen Materials should be around 55,000 tons, which matches the production reported in the company’s SEC filings.
Ossen Jiujiang has seven production areas, including four rooms that are approximately 5,000 square meters and three rooms that are approximately 4,000 square meters. According to the manager of Ossen Jiujiang, Ossen Jiujiang has two production lines that were imported from France and Italy.
Ossen Jiujiang produces two main products: Pre-stressed, uncoated steel products and products coated with rare earth elements that extend the useful lives of the products. The daily production volume of Ossen Jiujiang is around 100 tons per day, including pre-stressed steel products at 60 tons per day and coated products at 40 tons per day. The officer also said the production lines operate 24/7. As is the case with the Ossen Materials facility, the Jiujiang plant shuts down one or two days per month for scheduled maintenance.
If we assume that Ossen Jiujiang produces 100 tons of products 340 days per year, the total production volume of Ossen Jiujiang should around 34,000 tons. This also matches what has been reported in SEC filings. We can therefore confirm that our on-the-ground investigation of OSN’s production facilities and other operating data observed or derived based on information obtained at the two sites visited match what the company has reported in its SEC filings.
Confirmation of Sales Price and Revenues of Ossen Materials and Ossen Jiujiang
Based on corroborating third party sales price information, the pre-stressed products of Ossen Materials were priced at RMB 7,350 per ton as of September 2010. Our research indicates that the price of coated products were RMB 5,500-6,000 per ton as of September of 2010. Our investigator contacted a sales representative at Ossen Materials, who quoted prices similar to those obtained from third parties.
Based on the market pricing information we obtained, we can project revenue capacity for Ossen Materials at around RMB 404.2 million (i.e., 55,000 tons * RMB 7,350 per ton). Using the same approach for Ossen Jiujiang, we project revenues of around RMB 228.8 million (i.e., 34,000*60% (prestressed product)*RMB 7,350/ton+34,000*40% (coated products) *RMB5800/ton).
Based on the aforementioned calculations we can confidently assume OSN can generate around RMB 633.1 million or around $100 million. This is very much in line with OSN’s 2009 reported revenues of $101 million.
A member of the our originally questioned the dramatic decrease of selling costs since 2008. OSN reported dramatic declines in 2009 selling costs in both SEC and PRC filings. The amount of the decline in selling costs differs from what was reported in the SAIC filing. In the SEC filing, selling costs decreased from $4.3 million in 2008 to $.5 million in 2009. In the SAIC documents, total selling costs decreased from $4.4 million in 2008 to $1.2 million in 2009. One of our GeoTeam members challenged the sharp decline in selling costs noting that lower SG&A expense resulted in increased net income making OSN’s 2009 operating results attractive to investors and supportive of the company’s 2010 IPO. Frankly, the question was asked if the numbers were too good to be true.
SEC documents and a research publication disclosed that 32% of OSN’s revenues in 2008 were generated in Europe and the United States. Anti-dumping duties that went into effect in 2009 were levied on OSN and other Chinese importers, making those markets unattractive forcing the company to focus on domestic markets.
When OSN was exporting heavily to the European and US markets in 2008, it incurred high freight and fulfillment costs to get its products to customers. In 2009, when the company pulled back from those markets, its freight costs declined dramatically, which was to be expected. What was surprising about OSN’s 2009 operating results in 2009, however, was how well revenues held up despite the sharp decline in sales in Europe and the US.
Once again, a member of our team asked if the numbers were too good to be true. How did OSN seamlessly pull out of one market and replace all lost revenues the following year in China? Once again the facts support OSN’s story. The Chinese government implemented an incentive plan in 2009 that helped stimulate domestic sales and mitigate the negative impact the anti-dumping duties in Europe and the US had on PRC companies. As a result, OSN’s revenue did not suffer in 2009 as one might have reasonably assumed, given the company’s withdrawal from overseas markets.
Based on our investigator’s onsite investigations of OSN’s operating facilities and our research and observations, we are confident that the production volumes, product pricing, and employee headcounts are accurately reported in OSN’s SEC filings.
More work is needed to substantiate margins, but our analysis of PRC and SEC filings confirms that OSN is indeed a substantial and profitable company, even when considering the wrinkles in the margin picture we highlight in our Circle of Trust analysis.
At OSN’s current prices, we believe that the market is reflecting skepticism concerning the company’s reported operating results and is pricing in the worst case scenario. We view this as an opportunity to pick up OSN’s shares and have added to our current long position at these levels. Overall, we believe that the market will eventually reprice the OSN’s risk premium by assigning more reasonable multiples that do not assume worst case scenarios.
Please see related due diligence material which includes:
- Circle of Trust Analysis, (including conservative valuation scenarios)
- Conference call notes and brief Q&A with OSN’s CFO, Alan Jin, which reinforces no need to tap equity markets throughout 2012.