Agria Corp. Offers 'Bogeyman Trade' Opportunity

Jun. 5.08 | About: Agria Corporation (GRO)

Agria (NYSE:GRO) could be an ideal setup for anyone wanting to try and make a quick and substantial profit on an undervalued company. To explain why, I want to get into the philosophy behind the trade. One of the safest and most profitable ways to make double digit percentage gains in a short period of time is to use what I call 'the Bogeyman Trade.' When a company is sold off in a panic to levels drastically off from what it is traditionally priced at, then you can profit immensely if the catalyst for the selloff is suddenly removed. This also applies if the catalyst never existed except in the imaginations of shorts and easily excitable longs.

I had learned this during the panic of last march. When Bear Stearns (NYSE:BSC) went under suddenly, every broker was priced for Armageddon. Lehman Brothers (LEH) was called the next Bear Stearns. It suddenly became priced as if it could go under at any moment. The fear was already priced in so I decided to buy Lehman ahead of earnings. The next day the stock rallied 45% because earnings basically had to show bankruptcy to be worse then expected. A CNBC commentator, referring to Lehman's earnings report, said that it could just be the "bogeyman under the bed." What he meant was the fear was there, it was priced in, and once you look under the bed you realize there is nothing to be afraid of anymore.

I used this and several similar trades to double the size of my portfolio during the two weeks that followed that march bottom. These included derivatives broker MF Global (MF) was trading at 17 before BSC went under. During the ensuing panic of those few days it went to a low of 3.64. When the panic began to subside it was apparent that Bernanke wasn't going to let anymore brokers go under during the next few months (whether more would go under later could be another story). MF Global went down on rumor and speculation. When things were stabilizing I paid a lot more then the actual low by buying in at 8 but was able to sell it for $12 a little over a week later. I did the same thing with other brokers such as GFIG and FCSX for a quick trade. I didn't know much but I knew what I needed to: MF Global deserved to be priced in the double digits. The panic overselling that had occurred in march that brought it to single digits was an opportunity for a quick and relatively safe profit. The market already did the work for me of telling me what it was fairly priced at before the panic. It was merely waiting for others to calm down.

The downside is that you have to be careful and pick your opportunities because most companies that are sold off deserve it. I believe one of these rare opportunities to profit from 'the Bogeyman Trade' exists in Agria.

In April I saw that Agria was down 50% in one day over the dual announcement that their COO was resigning (the company didn't give him half the multi-million dollar bonus he felt he deserved) and that this would also cause them to have to delay the audit needed to complete their annual financial statements. Combine that with the fact that it's a Chinese company, and PANIC!!!!!

I stepped in and bought the dip thinking here was a growing ag company in China at a P/E of only 6 on an overreaction to a COO resigning. I even referenced previous drops from other companies who've had COO's resign and couldn't find any precedent for such a collapse. In fact, I still can't think of any stock that I would sell at a 50% loss because of an executive resigning, unless it was Steve Jobs of Apple. So it seemed logical to me that, unless Agria's resignee, Frank Xue, was the Steve Jobs of Chinese seeds and sheep breeding, then this was an overreaction.

However, after calling Agria and speaking to their investor relations people, I found out that Zhixin (Frank) Xue was a much bigger deal than I thought. He was more than the COO -- he WAS the company. Chinese companies usually have a complex relationship of subsidiaries for various legal and financial purposes when they trade on US exchanges. Xue was going to resign his position at Agria but keep his position at a sub called Primalights III Agriculture Development Company (also called P3A). The crucial agricultural development work P3A did depended on a highly specialized group of scientists who were extremely loyal to Mr. Xue (who incidentally was P3A's founder).

Agria's investor relations director (who wins points for being the most responsive IR guy I've ever called on) told me that the company had disclosed all of this in their initial IPO filing. I looked it up and, sure enough, he was right. The filing said that if there is a falling out with P3A there's no guarantee they could replace not just Xue but also certain key scientists.

The good news was that his resignation was over pay issues. In my way of thinking, he wouldn't be demanding a big performance bonus unless he had really delivered some big numbers. Agria has a big earnings report coming up, one could speculate that an executive wouldn't be so strident about a performance bonus if they missed the quarter. Xue wasn't resigning because something was wrong with Agria. He felt he was treated unfairly, not that he was on a sinking ship. He just wanted a bigger piece of a company that was growing and producing huge profits.

The panic that occurred from the uncertainty that took place before this was resolved, as well as the lawsuits, scared enough people to sell this at a P/E of less then 10 which is half it's normal P/E range! The fear of the worst case scenario with any lawsuit is already baked into the cake. With only 5 million in debt and over 40 million in cash, GRO is well prepared to handle any lawsuit in my opinion. Agria stock was trading at $8.80 when the dispute opened up over Xue's resignation, and dropped into the $4 range. But now that an agreement with Xue has been reached – announced Monday -- the stock has been on a tear. Personally I believe the stock is headed back to the $8.80 range. It's already back at $7. Now that the catalyst for the selloff is removed we should see a return to the normal price, maybe at a slight discount due to the scare everyone got, or maybe at a slight premium now that they have finally resolved what had been a long-running issue with Xue.

Is Agria now a company free from problems? No. If you want an ag stock without major problems, buy Monsanto (NYSE:MON) at a P/E of 43. But if you want a chance to profit from a dip in a growing Chinese company that practically went clearance sale, and play the catchup back to the high 8 dollar range, then Agria could be a good speculative and China/Agriculture play.

Disclosure: Long