American Oriental Bioengineering Stirs Up Controversy

American Oriental Bioengineering (AOB) announced Wednesday that it would reduce the size of its pending secondary offering, after Barron’s recently wrote a negative story about the company (see story, subscription required).

AOB, which makes and distributes traditional Chinese medications in China, is listed on the NYSE. In the forefront of its offerings, AOB has a compound that fights bed wetting, which is available in prescription soft-gel capsule and OTC patch formulations.

Last weekend, Barron’s published the article, which was very critical of AOB and which alleged the company was suspect on a number of different counts, starting with its appearance on U.S. stock exchanges through a reverse merger. That took place in 2002. From there, AOB migrated to the AMEX and then on to the NYSE.

Barron’s said the company has a history of misleading claims about its products. The paper said that AOB sometimes hints, for example, that its soy peptide products can inhibit the growth of cancer tumors. More damagingly, Barron’s reports the label of the UrinStopper Patch claims the product contains “radioactive photons” that “warm the acupoints.” But an independent lab analysis of the patch did not show any radioactive materials, according to the paper.

The article goes on to comment on a number of different liaisons that AOB has had with shadowy figures, including the CEO of a penny-stock touting firm called CEOcast. The CEO of CEOcast spent some time in jail for his shenanigans. In addition, the article pointed out that the company’s pronouncements were not always trustworthy. At one point, the company said it would go after the American market, while at other times, it said it wants to exploit its position in China.

A shareholder, one who has traveled to China to check out the company, its wares, and its presence in the Chinese market, responded to the Barron’s critique (see article, subscription required), putting many of the accusations in context and pointing out that many of them were seemed built on guilt through innuendo.

After all, the company did test its soy peptide product in mice with cancer, and it did show some efficacy, as independent trials proved. But the rebuttal did not address the question of the claimed radioactive photons and the efficacy of the bed-wetting drug.

Nevertheless, given its well-established clout with the skeptics, Barron’s and its caveat-filled article had an immediate negative effect on the price of AOB, which dropped from $9.31 on Friday, June 22, to $8.39 at the close on Monday, June 25.

New Terms for the Secondary

Two days later, on Wednesday, June 27, AOB amended its prospectus for the secondary offering, reducing the number of shares being sold from 13 million to 8.5 million. In the restructured offering, the long-time CEO of AOB, Tony Liu, is selling just 500,000 of his own shares (included in the number above), which was down from 2 million shares in previous filings.

Previously, AOB was set to receive some $140 million into its coffers from the secondary (not including any of Liu’s proceeds). Now, it expects to net just under $64 million, a combination of fewer shares being sold and a lower price – AOB based its reduced expectation on a share price of $8.60.

Financial Condition of AOB

Even with its lowered financial horizons, AOB will have $157 million after the offering. It has traditionally increased its revenues by acquiring its products from other makers, and, in fact, last week, AOB announced a tentative agreement to pay up to $30 million for a rival purveyor of traditional Chinese medicines, privately held Changchun Xinan Pharmaceutical Group Company Limited (see story).

The shares of AOB had a very good season during the fall of 2006, when they ran up from a range of around $5 each to a high of $14.19. That climb followed the realization that revenues for 2006 were going to double – which they did, moving from $55 million in 2005 to $110 million in 2006. Profits came in last year at $29 million or 46 cents per diluted share, for a margin of 26%.

In the first quarter of 2007, revenues rose another 35% to $25.7 million. Net income was up 31% at $6.4 million. Reflecting the growth-through-acquisition theme, most of the increase in the year-over-year comparisons came from the Jinji Yi Mu Cau product, which treats pre-menstrual pain.

At present, American Oriental Bioengineering has a stock price of $8.76. That represents a decline of 38% from its high. Its market capitalization is $568 million, or about 5 times revenues. The price-earnings ratio is 18, even though the company is growing at better than 30%.

These are very healthy numbers. Compared to other Chinese biopharmaceutical companies, including the ones involved in traditional Chinese medicine, American Oriental Bioengineering is cheap. Moreover, it has the financial muscle to consolidate at least part of the widely fragmented traditional Chinese medicine market.

AOB 1-yr chart:

Disclosure: none.

Comments

[RichardJFan:]

If the company is so financially strong, and if the stock is so cheap, why is management doing a secondary offering at all?

That is very suspicious.

2007 Jun 28 11:29 AM

[marksage:]

I don't have any specific insight about this company, but the bit about "radioactive photons" is easily understandable by anyone who has ever read the English text on a bottle of Chinese patent medicine - Chinese medical concepts generally don't translate well into English and they usually make no sense whatsoever. The joke is on whoever takes such pronouncements literally. However, I can attest from experience that Chinese medicine works, regardless of the fact that the explanations given make no sense from a western perspective.

As for the secondary offering, the stock had a great run and since the offering has been reduced (not increased) since the fall in price, it doesn't smack of desparation or chicanery.

2007 Jun 28 07:48 PM

[hpski:]

The intricacies Chinese herbal medicine is outside my knowledge base, however US based companies of similar profile usually don't get this much attention. It' been my observation that pharma type companies look at secondary offerings as a way to either continue drug development and/or to acquire a later stage med, or a company in possession of such. It appears that AOB is gearing up for one or more acquisitions. From a marketing perspective, the U.S. population in general has been spending more $$ on alternative medicine than ever before - if AOB uses the proceeds to enter the US market, its valuation may be bid up considerably. I am presently not a buyer of this stock, given the Barron's article, merged with the current controversy surrounding quality control of Chinese imports.

2007 Jun 29 10:39 AM