Margin and Safety

Margin and Safety
Contributor since: 2011
Interesting article, I agree Monster is very cheap on a near term basis (I am less confident regarding their market position in the out years).
Regardless, I am long and expect shares to rebound following the arbing around the convert deal (for instance if the base convert deal contained 50% arb purchasers, and they wanted to fully hedge their position they would have had to short over $60 million of MWW stock). For context this is more than 15x avg daily volumes for monster so clearly this put pressure on the stock.
Additionally, to your point regarding the convert, the effective conversion price is actually $7.04 due to the convertible note hedge that MWW executed. See link below for details:
The convert was an effective way for them to term out their debt which was due in May of 2015 and now has been extended to '17 for the term loan/revolving credit facility and '19 for the converts. With an effective conversion price over $7, the dilution is irrelevant to a near term play on the inexpensive valuation and potentially improving operating trends (i.e. the stock has to appreciate 75% before the effective strike price is reached)
Also, maybe we see one last bash from Carson Block and team?
I hope so, and if so will be sure to load up on some more $7.5 calls
Patience anyone? Practically stealing a company from shareholders takes time; need to shake out the higher cost basis institutions (Fidelity and GMT) and give the appearance that all possible alternatives were explored during this 18 month debacle - Congrats to Fu and all that have been long through this process... a more timely resolution would have been nice but the April selloff was literally a gift

Muddy Waters pretty much has no credibility anymore. I hope any weak hands enjoyed selling their stock to MW's clients at sub $7 prices despite the deal being in process... nice return in short order for the hit piece players. How far away the April hit piece seems today

Plenty of opportunities to make money in FSIN long and/or short in the past and going forward. Expect that shares likely pull back a little from here before trending toward the offer price through the shareholder vote and closing
The offer was revised downward on November 25th to $9.25/share and was rejected by the Special Committee.
Subsequently, Fu/Abax raised their bid to $9.50 on December 28th.
This had been under consideration by the Special Committee for the past 6 months and has now been accepted.
The agreement took forever to reach and had many managers scratching their heads. Paid to be patient here (although 18 months patient is slightly ludicrous)
FSIN encountered problems in sourcing sufficient copper wiring in the configuration best used in the CCS production process. Typically supply side issues of this nature can be resolved and represent a short term negative but should be comforting that demand at the Dalian facility continues to outpace supplies. Please some details below from FSIN's earnings call:
"In addition, we continued to face delays in the CCS
production, as securing a consistent supply of copper strip required to produce quality CCS has been more difficult that we anticipated, resulting in significantly lower than anticipated sales and lower contributions to the bottom line of approximately $0.03 for the quarter. We are focused on resolving the supplier problem and are working diligently to identify a regional provider."
Also below is the response to a related question - "What component is it that you've had trouble sourcing at this point?"
"It's a copper portion of the CCS, and it's not a supply of the type of copper we need, it's in the configuration that we need, that will allow us to produce the same quality product we do in the United States. So what it is it's actually a shaped wire is what we use. So it's just become difficult to source a good, reliable source, to the volumes that we need."
As for the valuation allowance this is a result of fairly conservative accounting practices with FSIN essentially writing down the entirety of its Deferred Income Tax Assets. While valuation allowances can take in to account future business prospects they are more often focused on historical results. Below is from FSIN's 10-K with respect to their treatment of the valuation allowance:
"Sufficient negative evidence, such as a cumulative net loss during a three-year period that includes the current year and the prior two years, may require that a valuation allowance be established with respect to existing and future deferred income tax assets. Differences in actual results from available evidence used in determining the valuation allowances could result in future adjustments to the allowance. In view of the cumulative losses for the entities concerned, full valuation allowances were provided against their deferred income tax assets as of December 31, 2010, which in the judgment of the management, are not more likely than not to be realized."
It appears they elected to leave the full valuation allowance as established in 2010. Note that there may also be tax nuances that limit FSIN's ability to deduct prior losses from future taxable income due to the legal organization of entities which realize the losses/gains.
This conservative accounting practice around the DTA allowance could be management not wanting to boost GAAP earnings or increase book value (DTA represent >$0.50/share) given the MBO under consideration.
Regardless of the motive behind the valuation allowance, it is evident that FSIN's effective tax rate represents an area of uncertainty. However, with the shares already reflecting fairly conservative tax rate assumptions and additional upside related to any potential future PRC tax breaks (see below from earnings call) or revaluation of DTA, I do not consider FSIN's income tax situation to be of material concern.
"As you know, we have reapplied for high and new technology company status for Fushi International Dalian which, if granted, could lead to future tax breaks for 2011 and beyond. We continue to expect to have a decision on this, from the tax authorities, during their 2011 tax audit."
The agreement to which I believe you are referring was actually just a Consortium Agreement (see below) that provided Abax exclusivity in pursuing the buyout so that Fu could not seek other potential partners.
This agreement was actually terminated by Fu/Abax on February 28, 2011 at the request of the Special Committee of the Board (See below).
This was done to allow FSIN to solicit other potential buyout partners for Fu that would be willing to pay a higher price. This was a matter of fiduciary duty of the board of directors and special committee, given that they must seek the highest possible price for the company and the consortium agreement stood in the way.
As for the proposal, Fushi's CEO confirmed that the "board appointed special committee continues to work with the buyers group, on the proposal"
FSIN put up a weak earnings print this morning primarily driven by higher taxes and increased expenses including higher audit and professional service fees, and advisor fees related to the ongoing privatization proposal (with a combined impact of ~$0.10 on Q3 EPS).
Despite the earnings miss and revised guidance, revenue growth (up 11.7% yoy) and cashflow remains strong with net cash generated from operations of $19.9 million in Q3, resulting in a cash position as of 9/30 of $163.6 million.
With an equity value of less than $100mm as of Wednesday's close ($257mm market cap less $158.4 in net cash) and $4.13 in net cash per share, implying an adjusted '11 P/E of just 2.8x based on the midpoint of FSIN's revised '11 guidance as well as the reaffirmation of the MBO proposal I will continue to be a buyer on any weakness
Your comment almost warrants no response, but I'll entertain your jibe. Your misplaced comment is completely off base. The above article maintains that there are great opportunities in the space - not that you should take the opposite side of Citron's trades (although you would have made a killing doing just so on HRBN).
For the record, I have been short QIHU since mid-may and have done quite well. My point was that you can find attractive long opportunities when you do your homework. Not to go long every Chinese company (I would recommend quite the opposite). Use your brain and you will see that QIHU has been overvalued since the IPO and certainly does not represent an attractive long play.
For an example fitting the mold, see FSIN
I've followed your comments, which for the most part have been quite insightful and it is unfortunate for you that factors other than fundamentals or fraud ultimately dictated the outcome in HRBN. But given the background of the buyout, this should have been increasingly apparent in recent months as the market seems to have handicapped.

As for HRBN there is plenty of evidence pointing to fraud, but once the financing was arranged and the proxy was filed that was no longer the trade.

Regardless of whether HRBN was legitimate or not (I lean towards the latter), there are other companies that are legit and some of these represent very compelling opportunities, you just have to do your homework. As for the regulatory issues, I welcome greater transparency, but alas once this occurs the greatest opportunities will have already passed...

Buy Fear, Sell Greed
You seem to miss the point. The RTO universe does remain a minefield, as you put it, and there are plenty of fraudulent companies which has kept many players on the sidelines. However, where you and I differ is that I now believe that there are very attractive returns to be had by identifying the legitimate and transparent businesses that continue to trade at absurdly cheap valuations (note that HRBN never fell into this category, but made money for the longs nonetheless).
The lack of market participants on the long side and abundance of short sellers almost guarantees you a bargain once you identify the companies that are worth buying via an extensive diligence process, careful analysis of underlying numbers and scrutiny of management practices. The degree of mispricing simply represents an opportunity for those that are willing to wade through the masses of unsuitable investments to find those that warrant attention (the short piggyback trade is a very lazy approach). Essentially, those who can navigate the minefield will make a killing on the long side given the very limited competition in pursuing this strategy.
For one example take a look at FSIN
Curtain Call...
"the Company currently anticipates the "going private" transaction will be completed on November 2, 2011 (U.S. time). The Company intends to publicly announce when the closing of the transaction is completed."
Thanks, glad you agree. Baron Rothschild would likely be a buyer here as there's certainly blood in the streets... hopefully soon to be the shorts'
First off, I certainly would not characterize myself as a pumper. I have been long and short various Chinese stocks over the past year or so. As for Fushi Copperweld, I have been consistently invested on the long side to varying degrees since the special committee provided the update on 5/27, 4 days after the Reuters article you reference which incorrectly stated that talks had been broken off (undertaking due diligence is certainly not breaking off talks). The 5/27 press release, which was made with Abax's approval was meant to provide an update and public response to investor inquiries:
"The Special Committee and its independent financial and legal advisors are currently facilitating the due diligence investigation of the Company by Mr. Fu and Abax so that they can be in a position to submit a firm, fully financed offer to the Special Committee."
While I cannot confirm that a fully financed offer will ultimately be made, I am able to share the response from Fushi's IR team (see above), which confirmed "that the offer is still valid, and under consideration by the Special Committee".
Given the fundamentals alone are attractive enough to warrant attention, I think of the potential buyout as more of a potential catalyst to accelerate returns. Yes there is risk of there not being a deal (as with any offer) and in that event shares would take some hit in the short term, but given the incredibly cheap valuation, the huge gap to the $11.50 offer price and the fact that a buyer would only have to put up limited (or no) equity given the huge cash balance and almost nonexistent debt, Fushi Copperweld truly does represent an attractive buyout target - in fact more so than any other Chinese deal that has closed or is closing (CSR, FTLK, CFSG, HRBN).
I'll leave you with a little food for thought - what would you do if you want to make sure you could take your company private at a ridiculous valuation? The best strategy for Li Fu is to not provide any update unless necessary and to let the shares trade at steep discounts to the offer price (which they have done well) while quietly getting their ducks in a row. The longer the shares trade in the $5-$7 range the lower an average shareholder's cost basis becomes and increases the likelihood of a vote in favor of the buyout - everyone will be willing to vote for >50% upside.

My thesis remains: Shares are incredibly cheap and have plenty of positive catalysts as well as upside potential (~80% to the buyout and >50% to book value)... not sure how you can argue with that
LOL. You're obviously short brains as well as the shares that you might as well cover
Words and empty gestures? How about the millions of dollars spent on advisors, proxy services, etc
Come back from imagination land. Deal closes this week (confirmed by HRBN IR) and funds come right to my account from CDB/Abax. Just like CSR... bank on it
First off, apologies for not replying sooner. The expiration is somewhat irrelevant since if they (management/Abax) want to buy the company they can just enter into another agreement. Also note that FSIN's Q3 earnings release is conveniently on Nov 3, the same day the original agreement is set to expire. Might they be planning to provide an update?
Regardless, it is in the buyer groups advantage to have the shares trade at such a steep discount to the offer price, as the longer they do the lower shareholders cost basis becomes and makes the buyout even more feasible (everyone will be willing to vote for that much upside).
As for what keeps Abax from walking away is that a buyout at $11.50 is a steal for them (as explained above) with a book value of $9.70 as of 6/30 (so would be paying only a $1.80 premium to book) and an implied EV/'12 EBITDA of 3.5x with double digit revenue growth
Well written. Bottom line is deal is likely closing and all these other short-seller shenanigans are moot. Only gating item is the vote which seems a foregone conclusion given that the shareholders of record (as of 9/14) stood to make >175% annualized returns by just holding and voting in favor. A vote against the MBO seems quite implausible given that shareholders would be acting against their own financial interest... assuming broker non-votes don't overwhelm the vote
The MBO is still being evaluated by the Special Committee and their advisors (BofA Merrill and Gibson, Dunn and Crutcher LLP). FSIN spent $124k on advisory fees in the second quarter. I suspect that either the company is holding out for a higher price and/or the buyout team is looking for greater visibility into Fushi's H2 '11 performance (the most active part of the year) before pulling the trigger. They could also still be in the process of finishing their due diligence on FSIN and/or arranging financing, with a number of likely candidates (CDB, BofA, Regions, etc). The only comfort I can provide is that if the dialogue had been broken off they would be required to indicate this to investors given the materiality of that news.
The cash situation is quite frustrating for both investors and for FSIN's management team. The primary issue is that the majority of the cash balance is located in China ($130mm) and subject to US taxes (~34%) as well as other limitations imposed by the Chinese Government on PRC subsidiaries making it very difficult and uneconomical to repatriate FSIN's Renminbi denominated cash. (See below from the most recent 10-Q)
"Our PRC subsidiaries have cash balance of USD 129.9 million as of June 30, 2011 which is planned to be permanently reinvested in the PRC. The distributions from our PRC subsidiaries are subject to the US federal income tax at 34%, less any applicable foreign tax credits."
You will find this issue throughout the sector of US listed Chinese companies and it is one of the reasons that many names have been shorted so aggressively - the only way for management to defend their company's shares is to take themselves private.

Also, from a legal perspective, you rarely see companies in the process of evaluating MBO proposals engage in share repurchases, given the conflicts that may arise. (If the company repurchases shares below the offer price of $11.50 they are effectively reducing the total purchase price for the bidder). Although, in the event the buyout proposal were to be withdrawn, I would not be surprised if FSIN entered into a larger Dollar denominated credit facility and initiated a share repurchase program.

Thanks for your comment and thoughtful questions

Glad you enjoyed the article and hopefully market participants will continue to realize how undervalued Fushi currently is. The results posted yesterday morning were fairly in line with my expectations with continued cash generation and decent revenue growth (+14% yoy).
Management also reaffirmed earnings guidance of $1.15-$1.25, which on a cash adjusted basis translates to a '11 P/E multiple of just 2x based on the midpoint of management's guidance ($1.20).
Furthermore this guidance suggests management is quite comfortable with their H2 '11 backlog of business and expects to generate in excess of $0.70 in eps in the remainder of the 2011.
Also, note that Fushi's cash position as of 6/30 was ~$142mm; when added to the ~$5mm of outstanding debt and subtracted from yesterdays closing market cap of ~$237mm implies an equity value of just $100mm.
This is very cheap given Fushi is entering its historically most active half of the year and will continue to generate in excess of $5mm of cash a quarter (which will likely be higher in Q3 and Q4).
Furthermore, FSIN is participating in a Jefferies Global Industrials conference next Tuesday (link below) which should provide an opportunity for management to illustrate to a wide audience of institutional investors how undervalued shares are.
At these levels I continue to be buyer and strongly suggest others follow suit as anything less than $9/share should be considered a steal. I will follow up with a subsequent article with more detailed analysis once Fushi has filed their 10-Q for the 2nd quarter.
Nice move today, about time...
Studioso, glad you liked the article. Your analysis does a good job of highlighting the further dilution that will occur upon conversion of the convertible notes.
With 1.9 billion to be issued in connection with the exchange and over 2.8 billion underlying the convertible notes, YRCW still has tons of room to go lower - still over $4.5bn implied equity valuation including the shares underlying the converts as of noon on Wednesday
Quite the oppostite, if YRC's restructuring is sucessful then the company will continue to operate. This article is just meant to highlight that the current valuation for YRCW is completely unrealistic and will inevitably trade to fundamental value well below $1
Animal, just to clarify I was not attempting to blame unionized labor for YRC's troubles. Instead I was just highlighting the problematic nature of collective bargaining in the context of corporate cost structures as evidenced by the troubles encountered in a number of industries with similar labor arrangements (automotive, airlines, etc).
Without the flexibility to manage variable costs such as labor effectively, many companies cannot be appropriately nimble to react to changing environments (such as demand, pricing, competition, etc).
As for how management has run the company into the ground, I agree completely and believe that most of the blame lies with their poor decision making and general ineptitude. Making risky acquisitions at the top of the market for aggressive prices and failing to extract value anywhere close to the consideration paid is just one of the many missteps enacted by management that has left the company in the situation it is in today.