General Steel Holdings: Acquiring Its Way to Industry Monopolization

With Monday's market swoon, I saw an opportunity to add to our holdings of General Steel Holdings (AMEX: GSI). Essentially a portfolio of steel companies, GSI holds controlling interest in Shaanxi Longmen Steel, Tianjian Daqiuzhuang Metal Sheet Co., and Baotou Steel, as well as serves as an acquisition vehicle for in-process and future steel-related acquisitions.

GSI's unique business plan revolves around acquiring government owned steel companies operating in niche segments of the steel industry – or companies enjoying near monopolies in certain geographic areas – and increasing their profitability and efficiency with "the infusion of applied western management practices, advanced production technologies, and capital resources." The cowboy factor is that GSI intends to acquire its assets by "leveraging [its] relationship with certain key people and local governments."

With this in mind, does GSI function solely as a speculative play? In as much as there are companies in China worth investing in for the long term, I don't believe that GSI represents solely a speculative play as much as it represents a speculative growth play. I feel that with the old adage true in a marketizing China – that the mountains are high and the emperor is far away, so it's certainly possible that a company with exploitable connections can make good on this promise – as it has so far with Longmen and Baotou. Additionally, Chinese officials have not been mute of their intentions to allow infrastructure entities - including those in the aluminum, steel, and petrochemicals industries - a far more significant portion of the global pie - be it by active government support, or by passive allowance.

Considering Kevin Brennan's earlier case of GSI's near-term, and already completed, acquisitions, I feel that a company experiencing both niche market and general market growth – with a trend toward monopolistic action in the face of an acquiescent government – is a worthwhile equity in which to invest. Further, with third quarter revenues expected to be between $300M-340M, representing an increase of between 539%-624% over Q3/2006, net income to increase by roughly 4000% over Q3/2006, and full integration (for the Q3/2006) of the Longmen and Baotou Joint Ventures, GSI is on track to meet its revenue and net income guidance for 2007 of $751M and $16.4M, respectively. Finally, with a forward (2008) P/E of ~5.6, ROE of 16.80% and ROTC of 10.91%, we are long GSI, and purchasing additional shares whenever it serves our cost basis.

Disclosure: Author is long GSI. Information for this article found on General Steel Holdings' website. Additional figures were culled from Kevin Brennan's Seeking Alpha article published on October 10, 2007.