A Value/Growth Story With A Possible Take Private Ending

| About: China Carbon (CHGI)

Over the past year accounting scandals have tainted many good Chinese companies with the stench of the bad. Mouth-watering intrinsic values of some of these good, honest and above-board companies have incited a buying frenzy by inside management and private equity players who know what the values are, and know what the outlook going forward is.

Central to this thesis is that the massive state-owned China Development Bank is providing more than $1 billion in financing to help Chinese companies leave the U.S. stock market. To date, by my count, 33 Chinese-domiciled, USA-listed companies have gone private over the last 18-months. It is notable that The Bloomberg Chinese Reverse Mergers Index of 82 companies lost 52% of its market value from June 2011 through July 16, 2012. Rich value metrics and a solid growth arc resonate. (See below)* Hence the opportunity in China Carbon Graphite Group, Inc. (OTCPK:CHGI).

It is my belief that quite soon the management of China Carbon Graphite Inc. (OTCPK:CHGI) will avail itself of China Development Bank funding and take the company private at about $1.25 / $1.50 or more for the 14.8 million shares that are not under management control.

Key in the "takeout" timeline, and certainly validating the company's operational success, is that last week CHGI rolled-over a big chunk of debt ($14.8 million) at about the same low interest rate for another two years. CHGI has about $45 million in debt at interest rates of about 5%.

CHGI is one of China's leading wholesale suppliers of fine grain and high purity graphite, and the top overall producer of the nation's carbon and graphite products. Positive demand trends and an increasing number of applications for graphite use through technology innovation in such areas as battery, solar, semiconductor, aerospace and nuclear power applications have CHGI's annual growth rate of revenue and earnings-per-share on a solid, high double-digit trajectory.

China has restricted its graphite supply and has included it in its list of strategic materials (along with rare earths, vanadium, titanium, etc). The European Union and the USA have also listed graphite as a critical material, even though 80% of it is mined in China. Market research has estimated that the global demand for graphite is expected to increase by as much as 50% in the last half the current decade-and let's again mention that CHGI is China's top overall producer.

Honing in on the exceptional value metrics that will fire a take-private deal

  • Price to Sales 0.27
  • Price to Book 0.25
  • Trailing PE of 3.98
  • Book Value of $2.10 a share with a 49 cent stock price
  • 2012 @EBITDA of $8.78 million…and a market cap of $11.75 million
  • 2012 Revenues of $55 million with a market cap of $11.75 million
  • $0.14 EPS going forward 12 months…with a 49 cent stock price
  • Enterprise value of $62.4 million vs. public value of $11.75 million

The projected growth / net income revenue arcs also look extraordinary

  • Estimate of 2013 Net income is $4 million (at least)
  • Q2 net income was $870,000
  • Net Income in 2011 was $2.97 million
  • Net income in 2010 was $1.38 million
  • Net income (loss) in 2009 was $1.47 million
  • Q2 revenues were $11.88 million
  • Revenue in 2011 was $49,847 million
  • Revenue in 2010 was $30,994 million
  • Revenue in 2009 was $15,370 million

CHGI is now the prime supplier of nuclear grade electrode graphite to China's 14 operational nuclear plants. Isostatic carbon graphite is used as a moderator or reflector within nuclear reactors to slow down neutrons and make them more efficient in producing fission in the fuel. Notable is that China has another 25 nuclear plants under construction, and 50 more are being planned.

Sales of nuclear graphite are $175,180,000 per year now, and that number triples in size as the 25 new nuclear plants come online.

Each year one nuclear plant uses 500 tons of nuclear grade electrode graphite. Margins for the nuclear grade are 50% vs. margins of 12% for low grade graphite.

Because 2012 is CHGI's first full year of production of high-quality isostatic graphite, sales for next year look to be 15-20% higher as they have just finished doubling production of their higher quality product; 2013 will run at full 60,000 tons capacity producing the higher quality and much higher margin product as all higher margins fall to the bottom line.

The opportunity for China Carbon Graphite

CHGI is but one of a number of premier China stocks available at once-in-a-lifetime prices in an economy that is still growing at about 7%. The profit proposition for owing the China Carbon Graphite shares resonates as share price is just off its multi-year lows and the company's growth arc going forward looks to be set in stone while the value metrics are more that appealing.

With a current price-to-sales of only 0.27 and a share price of 49 cents a reasonable take-private takeout at say a price-to-sales of 0.75 (still cheap) would equate to a price-per-share for (OTCPK:CHGI) of over $1.50. And when you project even a slight increase in revenue / income the profit proposition of owing the shares improves dramatically for both management and investors

Management is queuing up a take-private deal IMHO and I'm expecting a lot more upside.

Since 2007, China's Ministry of Science & Technology has granted China Carbon Graphite Inc. the "National Hi-Tech Enterprise" status, a distinction awarded to hi-tech companies at the forefront of their fields and industries.

Eight Very Recent Deals

  1. 8/14/2012 - In a $3.1 billion buyout deal an investment consortium of U.S. and Chinese private equity funds made an offer of $27 for each ADR of Focus Media (NASDAQ:FMCN) - just prior the stock was $18. A total of 19 Chinese companies delisted from American exchanges during the first half of 2012. At least 16 more companies are in the process of attempting to delist.
  2. 9/12/2012 - 3SBio (NASDAQ:SSRX) is set to acquire all of the outstanding shares of 3SBio Inc. not currently owned by Dr. Lou and his affiliates in a going private transaction for $15 per American Depositary Share ("ADS", each ADS representing 7 ordinary shares of the Company) in cash, subject to certain conditions
  3. 9/27/2012 - Medtronic (NYSE:MDT) and China Kanghui Holdings (NYSE:KH) announced that they have entered into a merger whereby Medtronic will acquire Kanghui. The agreement calls for Medtronic to pay approximately $816 million in cash or $30.75 per ADS. Both stocks hit 52-week highs on the news.
  4. 9/27/2012 - Nuokang Bio-Pharma (NASDAQ:NKBP) accepted a go-private offer of $5.80 for each ADS. The shares hit a low of $2.25 earlier this year at the depths of the 'sell China' crisis.
  5. 10/12/2012 - Ninetowns (NASDAQ:NINE) - In a "going-private" transaction Consortium Members are offering a price per share in the range of US$1.80 to US$2.00 in cash for all of the outstanding ordinary shares not already owned by management.
  6. 10/15/2012 - Yongye International (NASDAQ:YONG) - Management announced on October 15, that the company's CEO proposed a "going private" for $6.60 share. Despite the 38% premium to the closing price, the company's book value per share is $7.64.
  7. 10/15/2012 - China Shengda Packaging Group (NASDAQ:CPGI) received an offer from Chairman Nengbin Fang to take the company private in a cash deal at $1.40 per share, valuing it at roughly $54.3million. Mr. Fang and his family own about 54% of the outstanding shares.
  8. 10/15/2012 - American Lorain Corporation (ALN) NYSE received an offer from Chairman and CEO Si Chen to take the China-based processed snack foods, convenience foods, and frozen foods company private in a deal to acquire all of the outstanding ordinary shares of the Company not currently owned by Mr. Chen at a proposed price of $1.60 per ordinary share. (NYSEMKT:ALN) rose 11.66% on Monday on 8.5 times average volume, closing at $1.39.

The case for taking private extremely undervalued China-based growth companies with US listings continues to grow. I believe that these companies and particularly (OTCPK:CHGI) can't stay at current valuations and not be taken private. (OTCPK:CHGI) is more than ever in the sweet spot of this inevitable trend.

As my list of recent deals mentioned above clearly portrays we are now seeing acceleration in the trend with Nasdaq and NYSE-listed Chinese companies involved in 'going-private' takeouts, not just the below the radar OTC traded stocks.

All of the recent deals fit the (OTCPK:CHGI) model:

  • Existing management owns >45% of shares ― (OTCPK:CHGI) is at 46-48%.
  • P/E valuations are 60-80% under peers - (OTCPK:CHGI) 3.9 trailing p/e vs. other public graphite players at 8-12 time trailing twelve month earnings.
  • Big sales revenue catalysts coming in the next 12-18 months - in (OTCPK:CHGI)'s case the beginning of selling high priced nuclear grade Isostatic graphite to the Chinese nuclear power industry.

Risk and Hell

A word or two about the hell almost all Chinese companies listed in the USA have experienced over the last year. Generally speaking, the entire complex of China stocks got bombed in the play-out of the scandal; "the baby did indeed go out with the bathwater." It needs to be said that risk always exists in markets and from what we know China is in a slowdown from a growth rate of over 11.9% to the just reported 7.4%. The world is undoubtedly in a state of uncertainly, but big picture it's muddling through.

Without doubt investing in small-cap companies in emerging markets and those in China can be chancy and may not be suitable for many investors. Investors should due their due diligence and examine any potential risk.

Yet

Let's also remember that CHGI just rolled over $14.8 million of debt further validating its solvency. Also, and central to my thesis is that because power is so critical to the Chinese economy and with so many nuclear plants under construction, it is unlikely that CHGI will be affected fundamentally by the slowdown. The good news is that it has been a year now and the fraud cases are exposed; private equity players and inside management buyouts are well into the process of taking advantage of the situation, sorting out the good from the bad in what was a chaotic landscape. Major USA financial institutions are now also in the hunt, as an investment consortium of U.S. and Chinese private equity funds led by the Carlyle Group made an offer of $3.1 billion on Focus Media (FMCN) - that's $27 for each ADR. Just prior to the offer was at $18.

China Carbon Graphite is a U.S. reporting company and subject to the reporting requirements of the U.S. Securities and Exchange Commission [SEC] so U.S. transparency and disclosure is available to investors.

Also relevant

The Chinese stock market is cheap by any standard. The Shanghai Composite is at 12 times expected 2012 earnings, about half its five-year average. The Shanghai index is down 3.9% this year and trades at 'only' 9.9 times estimated earnings for this year, about half its five-year average. The Index is off from over 6,036 in 2007 to now 2,115. Fabled international market maven Marc Faber earlier this week said that he is now focusing on Asia and stated that, "I think China and Japan could have a rebound here." I agree.

Disclosure: I am long OTCPK:CHGI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.