The article in Chinese has been published in my company's website on May 2012 and here: http://xueqiu.com/6977823556/23300689 on 15 Mar 2013. I've long position of YONG and will intend to maintain it in the next 72 hours. Below is its simple translation.
In Oct 2011, we found Yong was deeply undervalued @ around $4.5, with 2012/13EPS=$1.6/$2.3, 2012 PE=1.5 PB=0.3 PEG=0.02. It's 20 times cheaper than its international peers (MON, SYT) and 50 times cheaper than its domestic peers. The book looks great and has been audited by KPMG. It should absolutely worth a shot if the book is clean. "Shengminsu" is a liquid nutrient for crop, the company's sole product, meaning "life essential".
We decided to test the product while at the same time carry on our due diligences.
2011.10, I tried it on an unknown flower at my apartment's balcony. Meanwhile, I bought it in dozens of bottles and gave it to the farmers in my hometown village. They used it on the following crops: peanuts, rice, cucumber, sugar cane and taro. Of course, it was a comparative trial. 6 months later, the farmers told me that the product did work. My own test also showed that the flower (F1) on which Shengminsu was sprayed grew much better and faster than the one (F2) on which Shengminsu was not sprayed. In fact, F2 withered and died within 2 months while F1 still grew lushly as of this moment in May 2012.
2012.01-03, we spent 3 months on the due diligence.
To verify the company's sales figures, we decided to have a test check and so picked up 2 of its 27 sales provinces. We visited more than 20 of its retail branded shops in the 2 provinces and disguised ourselves as customers to get their sales figures. The total 2 provinces sales volume we got from the shops matched the figures disclosed by Yong. We also talked to the farmers who've used Shengminsu. Most of their feedbacks were quite positive, except complaining about the relatively higher price than that of its peers.
To verify its net profit margin, I compared its net margin with its domestic peers. Yong's average gross margin and net margin are 56% and 19% from 2008 to 2011; CGA's 44% and 26%; Penshibao's around 70% and 40%. In terms of sales revenue in China's crop nutrient sector, Yong is No.1, CGA No.3, Penshibao's sales figure is not disclosed, probably No.4, since it is a private-owned company. Nomura once invested $6m into and owned 16% of Penshibao. Nomura then restructured Penshibao's whole management team. Except for the chairman, all other key positions, including CEO and CFO, were appointed by Nomura. Soon these insiders found that the company's book had been cooked. So Nomura sued Penshibao and claimed in the court that " Penshibao's net margin is only 40%, instead of 80%, which is what Penshibao's book cooked". Penshibao's 40% net margin claimed by Nomura should be reliable, at least not exaggerated. Therefore, compared with its domestic peers, I believed Yong's net margin is not cooked. We also compared Yong's other financial ratios with its peers, but found nothing weird, except it is deeply undervalued.
Morgan Stanley has also done an extensive due diligence and finally bought $50m of Yong's convertible bond with a strike price of $8.8 and bought $12m of Yong's ADR @$5.1 in the open market in late 2011 and early 2012. One of my MBA classmates working for MS told me that since US-listed Chinese companies have totally lost trust from investors, MS's team working on this deal were under lots of pressure, very skeptical and cautious, checked more than 400 of Yong's retail branded shops and talked to hundreds of farmers in Guangdong and some other provinces. They even hired KPMG to audit Yong.
The company's chairman and CEO, Mr Wu zisheng, bought back $3m @$5.5, quite a decent amount compared with its market cap of less than $300m.
Everything seemed to look great, even too good to be true, but why undervalued? I need to find the reasons, otherwise I won't take the shot.
The following reasons may explain why it's undervalued.
Reason 1. Short sellers' accusation and attacks.
Reason 2. Overseas investors have lost confidence and trust in almost all the US-listed Chinese companies because of a series of their accounting scandals in recent years.
The accusations include the following.
Accusation 1. Yong's SEC filing does not match with SAIC filing. In China, except for state-owned companies, almost all the companies each has at least 4 different books, for tax bureau, bank, SAIC, and itself, respectively.
Accusation 2. Yong fabricated Stanford's certificate to prove its product's effectiveness. Yong had denied.
Accusation 3. Yong spent $30m to buy a customer list from the Hebei provincial distributor. It's true. Yong explained that it's much cheaper this way than to take over the distributor. By skipping the distributor, Yong can sell the products to the customers on the list directly and thus increase gross profit margin. I compared the gross profit margin and found it did increase.
Accusation 4. Yong spent $35m to purchase a lignite ore from a company which legal representative is a farmer. It's true. We checked with China's Ministry of Land & Resource and got confirmed that Yong have already obtained the exploration right and was expecting the mining right as of May 2012. The ore is estimated to be worth more than $200m and will secure the company's lignite supply for the next 10 years. I don't care where the $35m is going, all I care is whether the ore is worth $35m and whether Yong can get the ore.
Last, but not the least, I asked a couple of my friends in this sector for their insightful comments, I also did a negative check via Baidu. All ended up with nothing negative.
Now that the homework is done, let's have a summary.
1. Back door listing via reverse take-over.
2. Weak trust and no catalyst in US-listed Chinese companies.
3. VIE issue (variable interest entity).
4. Some management members' professional background not strong.
5. No dividend.
1. Audited by KPMG.
2. Deeply undervalued.
3. $50m + $12m investment from Morgan Stanley.
4. Product patents and technology secrets.
5. Management's $3m buyback.
6. Huge potential growth. (as the No.1 player, Yong has a market share of only 2%. China has arable land of 2bn mu, each mu needs 5 bottles of Shengminsu per year, and each bottle's price is RMB15, so the market is RMB150b in total. 1% increase in market share, means RMB1.5bn sales increase.)
7. Government policy in favor of green crop, green food.
8. Survived from short sellers' attack before 2012.
9. Extensive due diligence done by KPMG, MS and more important, by ourselves.
I believed Yong's current stock price has already factored in most of the negative elements, but apparently, not the positive ones. Therefore, from Mar to Apr 2011, we bought Yong @$3.7, much lower than MS's entry cost of $8.8, $5.1 and Yong CEO's buyback cost of $5.5.
Disclosure: I am long YONG.