On August 14, 2012, an article on Yahoo Finance discussed recent privatization deals by Focus Media (FMCN) and Fushi Copperweld (FSIN). I found the information intriguing and thought-provoking. As a mid-cap company, Focus Media probably has better access to large capital infusion and could therefore strike such a big privatization deal. Nonetheless, the offer price of more than 20 times its trailing EPS is still quite amazing. For Fushi Copperweld, the buyout price is not cheap either at more than 13 times trailing EPS. That's why Fushi's buyout offer was only about 45% over its stock price before the announcement. For a smaller company trading at less than three times trailing EPS, a reasonable buyout can easily be more than 100% of its stock price before the announcement.
Most readers know that I am a strong opponent to using a careless association and the fallacy of generalization to assume that all Chinese small caps are frauds. Naturally, I am also a supporter of beaten-down Chinese small caps with strong business models and management teams that have made efforts to assert their legitimacy. One example is, of course, Longwei Petroleum Holdings Inc. (LPH).
With its strong oligopoly oil business, the videos and photos of the company's operations and third-party site visits, an independent investor group's onsite checkup, and an auditor's independent reconciliation of the company's SAT and SAIC Filings in China Compared to U.S. GAAP Filings, the company looks as real and clean as an average U.S. small- or mid-cap can be. The fact that the market is still not fully recognizing these facts and keeps on placing the stock at about two times its yearly EPS certainly makes a strong case for the company to go private and say goodbye to this discriminative capital market in the U.S.
The CEO, who is a conservative person with traditional Chinese values such as frugality, is not a big fan of putting debt on balance sheet and paying high interests to lenders. That philosophy has delayed the company's last acquisition and slowed its growth rate over the past year or so. However, with the commitment of a huge amount of capital from the China Development Bank and other Chinese banks and financial institutions, such as Abax Global Capital, to help Chinese companies listed overseas to come back home, it is certainly possible that the Longwei CEO decided to offer public investors $4 per share to buyout the float and take the company private by the end of the year if the stock still trades below $3.
In this scenario, the return to American shareholders will be maxed at $4, and the company will probably IPO in China for 10x+ P/E. Chinese investors will then enjoy years of good earnings and dividends. Some investors here in the U.S. might file lawsuits against the CEO saying that he "steals" their shares at a dirt-cheap price.
As we have seen in many other cases, most likely Longwei will win the case because the court will find that it was these same traders/investors, and not the CEO or other executives, who pushed the stock down to the dirt-cheap low level, even when the management team had said repeatedly that the company was strong, its potential for future growth is huge, and its shares were way too cheap from a fundamental valuation standpoint.
Some other companies that I feel are good candidates for privatization basing on valuation multiples (P/E, P/S, and P/B) are Lihua International, Inc. (LIWA), China Yuchai International Limited (CYD), Guanwei Recycling (GPRC), and Trunkbow International Holdings (TBOW). Each of these companies seems to have a reasonably strong business and highly visible and easily verifiable daily operations. I will not be surprised by any buyout offer happening on any of these companies or other Chinese small caps with low valuation levels within the next 12 months.
Among these companies, only Lihua International has shown reconciliations of its SAIC filings and SEC filings. In this regard, Lihua stands out from the other three companies in the list. For other Chinese small-/mid-caps that still want to make an effort to restore the valuations of their stocks in the U.S. capital market before giving an ultimatum (i.e., a leveraged buyout) to the market, I strongly encourage them to do reconciliations of SEC filings and SAT/SAIC filings and invite independent third parties to examine their key assets and business operations.
Disclaimer: my standard disclaimer for my analysis can be viewed here.