A Preemptive Strike Against The Coming Lihua Hit Piece

Apr.10.12 | About: Lihua International (LIWA)

Fellow investors in Chinese copper wire manufacturer Lihua International (LIWA) must have been feeling a bit nonplussed last week as the stock dropped 11% on Wednesday and then plunged another 17% on Thursday on no new news whatsoever. Perhaps an impatient institutional holder felt the pressure of being in an unfashionable, underperforming Chinese small cap as the bull market was passing them by and decided to clumsily dump the stock at any price.

However, based on the recent rash of short attacks on this much maligned sector in general, and on LIWA in particular, I would venture to guess that the shorts are taking one more run at LIWA by aggressively selling short to both drive down the stock and position themselves before they release another hit piece. I don't necessarily begrudge short sellers, in fact I echo the sentiment that they are often the de-facto enforcement division of the perpetually overworked and understaffed SEC, and have indeed brought some frauds in other Chinese companies to light. However, I think most of the rotten low hanging fruit has been harvested and now some unscrupulous outfits are trying to make a quick buck off legitimate companies like LIWA. Therefore, rather than waiting for the inevitable, I've decided to go on the offensive and outline the same old innuendo I believe the shorts will focus on and why it's misleading or just plain wrong.

To start, they will cry that LIWA's net property, plant, and equipment (PP&E) of $18M is too low for a company approaching a billion dollars in revenue. However, they'll conveniently ignore the $19M in land use rights that are the only way Chinese companies can utilize the "property" part of PP&E. Also, they'll dismiss the additional $15M of construction in progress, saying that this wouldn't have contributed to current revenue, even while comparing to a much higher future revenue number that requires additional CapEx spending of $45M to bring two new smelters online.

Next, like judo experts, the shorts will use LIWA's own strength against it, claiming their financial metrics are too good to be true, but of course the P/E and other ratios will seem absurdly low since the company has been beaten down even while delivering excellent earnings. They might even bring up old gross margin numbers that seem too high when in fact as they've become a more mature business they've fallen almost exactly in line with U.S. competitor Encore Wire (WIRE).

Finally, they will say that LIWA's cash, which has been verified by an independent audit, must not exist because if it did then they would be using it to buy back stock, even though they have been buying back stock to the tune of over $2M just last year despite difficulties converting yuan to dollars to do so. This might not seem like much, but for a company that is also aggressively expanding at the same time it represents a greater percentage of cash than used in the much publicized buyback at Berkshire Hathaway (NYSE:BRK.B) and is more than WIRE has ever bought back.

If short sellers are able to uncover anything else that is suspicious and factual, then I will be happy to consider their thesis and engage in an intelligent discourse rather than this unfortunate finger pointing. However, I doubt shorts will make much of an honest effort to embrace the facts and understand the company better, since they might find that where there's smoke, there's only wire, with the only fire coming from the company's new smelters that will continue to churn out profits.

Disclosure: I am long LIWA.