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A serial entrepreneur, I use the experience of my own success and failures to identify opportunity in the market. Comparing cash flows to income statements and balance sheets often reveal discrepancies in stock price vs. true value. In the end price and value will always reconcile.
  • Lotus Pharmaceuticals – A Recap of a Impressive Business Plan or The Building of a Money Machine. 10 comments
    Feb 9, 2011 5:36 PM | about stocks: LTUS

    Lotus Pharmaceutical (OTCPK:LTUS) – Price $1.92 - 2010 est. earnings $0.80 – 2011 est. earnings $1.00 -  PE ratio 2.40 – forward PE 1.92– PEG ratio .096 – Price to sales ratio .72 - Book value $3.40

    In adopting Western style capitalism, China is experiencing it’s equivalent of our industrial revolution - on steroids.  In opening its borders China also gets a taste of a Western lifestyle.  Millions are moving from a poor agrarian existence to a world of factory jobs in congested cities. High stress, long hours, poor eating habits and pollution have become a part of everyday life.  With the Western lifestyle comes a new set of chronic illnesses such as cardiovascular problems, diabetes, hypertension and asthma.  How does one treat a Western Style chronic illness?  With Western style medicine, of course, and that means pharmaceuticals.

    LTUS is not a biotech company hoping to find that one blockbuster drug.  They instead, are building a profitable pharmaceutical distribution infrastructure in the worlds most populous and 2nd largest economy.  Lotus Pharmaceuticals is, of course not the biggest pharmaceutical company in China, in fact I doubt they are in the top 100.  However, for a Western investor they have the most potential and here is why; LTUS is essentially building a money machine.


    Here in a nutshell is the LTUS business plan.

     

    1)      Build a pharmaceutical distribution network that serves both hospitals & pharmacies throughout the PRC, in big cities as well as outlying areas, and treat these relationships as the core asset of the company. 

     

    Currently LTUS sells its prescription medicines (which are covered by Chinese health insurance) directly to over 50 Hospitals and indirectly through 150 independent drug distributors covering 80 provinces within China.  In the PRC most pharmaceuticals are still sold through the countries hospitals.  Therefore, the direct relationship with those hospitals, or the indirect relationship, for those hospitals serviced by LTUS’s distributors, hold the key to the company’s success.  Likewise, growing this customer base is a key part of the company’s future expansion.

    The People’s Republic of China is now the 2nd largest economy in the world. However, with 1.3 billion people, their per capita income ranks 97th.  China is at once rich and poor.  It is also at once capitalist and communist.  The capitalist side grows the economy and the communist side redistributes some of the newly created wealth.  One of these redistributions is through a 125 billion dollar health care initiative. Through this initiative, those who have never before received it, are being given access to modern healthcare.  Hundreds of millions of beneficiaries of this medicinal largess do not live in modern cities, but in the outlying areas of China, and with no formal distribution system the medicine provided must find it’s way to those who need it.  As we speak LTUS distributors are combing the far reaches of the China landscape to build relationships with this new customer, and the hospitals that service them, to become the supplier of choice in these remote areas.

    The other segment of Lotus’s distribution plan involves pharmacies.  Although most pharmaceuticals are currently distributed through hospitals, this is something the PRC Health Ministry would like to change.  Just like in the US, when it comes to pharmaceuticals, the hospitals are not the most convenient or lowest cost providers, local pharmacies are.

    Presently Lotus owns and operates 10 pharmacies within Beijing, which is a small stagnant business.  However, by combining the expertise of running these pharmacies with the expertise of distributing pharmaceuticals, Lotus has added significantly to its distribution reach by selling directly to pharmacies throughout China.  Not only does Lotus sell its own products, but they have also formed relationships with 3rd party manufactures (Western pharmaceutical manufacturers who want access to this huge market) and distribute their wares as well.  Currently LTUS distributes over 1000 over the counter products to more than 1000 independent drugstores throughout China.  This new business now accounts for about 28% of sales and is growing at over 100% per year.

     

    2)      Support these distribution networks with world-class infrastructure.

     

    This June LTUS is expected to open its brand new 366,000 square ft (over 8 acres) GMP certified headquarters in Beijing.  The building will house all of the manufacturing, R&D and administrative functions of the company as well as a 100,000 square foot Warehouse, which is important, because with this added warehouse space, LTUS will then be able to bid on hospital contracts within China’s larger cities, including Beijing. 

    The facility will also house the company’s managers and employees in the 100+ apartments that are being constructed on the top two floors.  With the Beijing real estate market being what it is (expensive) and travel within the city being what it is (congested), these apartments will provide LTUS an employment incentive that will create a very loyal and motivated workforce.  Furthermore in China’s inflationary environment, providing these apartments will fix a portion of their labor expenses, as housing will undoubtedly become part of the compensation package.

    When finished, this complex is expected to cost $48 million dollars.  $36 million of this is already paid for and the additional 12 million will come out of the next two quarters internal cash flow.  That’s right; LTUS will hold no mortgage on this property.  Even better, current real estate prices within Beijing are such that the market value of this building will be between 100 and 120 million dollars – more than double the stocks entire market cap.

     

    3)      (The Money Machine Part) Through R&D, purchasing drug rights through the open market, signing distribution deals with 3rd party Western drug manufacturers or even acquiring entire organizations, LTUS can easily add new product lines to it’s distribution network and create substantial incremental income streams.

     

    Currently LTUS is involved in Phase I clinical trials for the Class 1 asthma drug R-Bambuterol.  LTUS bought the rights for about 8 million dollars plus the cost of the clinical trials.  The drug is so promising that the clinical trial has been fast tracked for expected completion in 2014.  Once on the market LTUS will hold exclusive rights to the drug and expects revenue of 50 million dollars a year.  In addition to R-Bambuterol, Lotus has other drugs in development to treat diabetes, cardiovascular disease and other chronic illnesses.

    It is easy to see that LTUS could significantly add to it its revenue streams by plugging any number scenarios into its distribution network.  They could develop more drugs in their state of the art facility, purchase the rights to more promising drugs already in development, sign distribution contracts with Western manufacturers who want access to the huge Chinese market, or just buy entire companies with complementary product lines or services.  One could imagine acquiring other drug distributors that would increase both the reach of distribution and the breadth of product offerings, drug development companies, or even a marketing firm to improve brand awareness.

    The money for such acquisitions will come from two places: Internal cash flow or from the sale of a 167-acre parcel of land LTUS owns in Inner Mongolia.  Once the construction of the Beijing facility is complete LTUS will be still be generating upwards of 8 million dollars a quarter in free cash flow.  The company asserts the land in Inner Mongolia is worth 60 to 90 million dollars.  They own it free and clear.  With these two sources of revenue the likelihood of an additional stock offering is remote.  In fact LTUS has expressed that they will not offer any stock for sale at current valuations.  They have backed this sentiment up by canceling a recent pipe offering and choosing instead to finance their current projects from cash flow.

     

    •   4) improve shareholder value through revenue growth and corporate transparency.

     

     

    Recently, LTUS executed a 2 for 1 reverse split in order to bring the share price of LTUS above the $2.00 need for up listing to the NYSE/AMEX.  This follows moths of work to become Sarbanes Oxley compliant.  They have also hired an English speaking  Director of Corporate Development to act as a liaison between the company and the investing public.  I recommend that anyone who has any questions what so ever regarding LTUS contact Dr. Xing Shen at shen@lotuspharma.com.  I have communicated with him on a number of occasions and he has proven to be very helpful.

    As with any investment there are risks, LTUS is no exception, so here are three things to look out for. 

    1)      The price of medication is set by the PRC.  The prices that LTUS is allowed to charge could be reduced which would hurt profit margins.

    2)      LTUS became a US traded stock by way of a reverse merger.  Recently, China based RM stocks have come under fire from many sources which has negatively affected theses stocks share prices.

    3)      One of these accusations was aimed at LTUS claiming that the value of the land in Inner Mongolia is not as great as LTUS claims.  LTUS claims they are in active negotiations to sell the land, pay attention to he final sales price.

    I contend that at this point the worst outcomes have already been priced into price of the stock.  With a PE below 3, LTUS is poised to benefit from significant PE expansion as sentiment changes.  That combined with revenues and income that are expected to double every 3 years and a business plan that could exceed even those expectations, makes this stock a candidate for impressive market returns.

    Disclaimer: I am Currently Long LTUS
    Stocks: LTUS
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Comments (10)
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  • MJJP
    , contributor
    Comments (177) | Send Message
     
    This stock was close to $4.00 at one time . Having a reverse split so you can be listed somewhere else in hopes of raising the share price is foolish. Stock price should be based on earnings and likely potential. I have seen other reverse splits do the same thing as LTUS. The price falls back to where it was before the split. So far I am right and managed to break even on my investment as the stock continues to fall below my sale price.
    9 Feb 2011, 05:49 PM Reply Like
  • Guildcrantz
    , contributor
    Comments (11) | Send Message
     
    Author’s reply » LTUS has done a spectacular job of building earnings and as my article points out the potential of future earnings is extremely bright. If the market chooses to devalue this stock based on the irrational fear of a 2 for 1 split, then consider it a buying opportunity.

     

    Best,
    9 Feb 2011, 07:00 PM Reply Like
  • JoeNatural
    , contributor
    Comments (813) | Send Message
     
    MJJP, get a clue dude. There are many many China small-caps that executed a R/S to be able to uplist to a senior exchange and those companies saw their PPS rise. You obviously haven't been around the sector for very long.
    10 Feb 2011, 10:32 AM Reply Like
  • Cliff B.
    , contributor
    Comments (7) | Send Message
     
    Excellent write-up on Lotus. This one is definitely my favorite in the sector. The CEO has fulfilled all of his previous promises to stockholders and I expect he will continue to do so going forward. Lotus is not diluting while they are growing cash flow and earnings impressively. A trailing PE of 2.4, a forward PE of less than 2 while the shares are selling for only about 60% of book value. Everyone seems to be negative on the entire chinese sector right now but the tide will turn and LTUS could well be selling at $10/ share in a year.

     

    To the poster who complained about the reverse split and how it never works:
    Numerous companies have done a reverse split to get off the bulletin boards and qualify for a listing on an exchange. Two that come to mind are NEWN and GFRE. NEWN has tripled since their reverse 1:10 split even though it has sold off lately along with many other chinese stocks lately. At any rate, it sure makes sense to me to do a reverse split to move up to an exchange listing.
    9 Feb 2011, 09:05 PM Reply Like
  • friendly
    , contributor
    Comments (9) | Send Message
     
    Great article on PERHAPS a truly great company.

     

    BUT, and this is a BIG BUT: I keep reading many articles that advocate quit rigorously (read that of Shaun Rein) that THE LARGE MAJORITY of the small Chinese companies that came to Wall Street via Reverse Take Over are the bottom of the pack in China, where successful private companies are urged to go public and have ample possibilities to raise funds, and these losers manage to get listed here as Last Resort while MOST PROBABLY having manipulated their reported information, so we get extra high risk of dealing with fraudsters whose actual companies in China are failures or even, god forbid, non existent, like some wrote about ONP, CHBT, CEU and at least two dozen others.

     

    What say you about this PRIME CONCERN when dealing with these small RTO Chinese companies?!

     

    DO you have any concrete evidence that this particular company is absolutely genuine and real and of top quality as their TOLD STORY suggests?

     

    It is obviously very tempting to buy such a seemingly great growth company from the big yellow land that reinvented growth on a mega scale, but is it too good to be true, as the poor valuation of the company may suggest...?
    10 Feb 2011, 03:54 AM Reply Like
  • Guildcrantz
    , contributor
    Comments (11) | Send Message
     
    Author’s reply » I understand your concern, and I also feel like I am swimming upstream against the popular sentiment. In fact my motivation to write this piece was in fact to respond to the incessant negativity to which you refer. I wanted to show that in fact there are companies with solid business plans behind at least this Chinese RM company.

     

    There was an excellent post on the LTUS Yahoo message board by a writer name amirstern. I recommend you read it.

     

    messages.finance.yahoo...

     

    I personally believe we are showing Chinese companies the same bias that was shown to Japan when they rose to greatness. "They are taking our jobs, they are cheating the system, greed and corruption are just a part of their culture blah blah blah...."

     

    I would also say that the opposition has done a masterful job of playing on and profiting from our fears.

     

    As to LTUS specifically I have this to say:

     

    I can not attest to their entire existence, however I do know that in the fourth quarter of 2009 LTUS tore down its manufacturing facility and started construction on their future 366,000 square foot home. Since then they say they have paid $36 million dollars in costs associated with the construction. As evidence to this there is 75% of a 366,000 square foot building sitting atop the land at their address. The 36 million dollars came from somewhere. The most reasonable explanation is that it came from cash flow generated from their profitable pharmaceutical business.

     

    Best,
    10 Feb 2011, 11:30 AM Reply Like
  • Guildcrantz
    , contributor
    Comments (11) | Send Message
     
    Author’s reply » I received this response from Xing Shen:

     

    Hi Mike,

     

    I read it and like it. Given current low sentiment towards Chinese small caps, I think the timing is just right, as we do need some good analysis to explore fundamental value of these companies. Just hope more people could read it.

     

    Just two facts that are not completely accurate. Nothing major but I want to get them right. First, our OTC division is currently serving Beijing area, not the whole country yet. Second, we are not SOX compliant yet. Overall it is job well done. Thank you for put it together.

     

    Best regards,

     

    Xing
    10 Feb 2011, 11:59 AM Reply Like
  • nicolnj
    , contributor
    Comments (42) | Send Message
     
    hey, whats ur opinion on the latest earnings, doesnt look positive at all
    24 May 2011, 04:15 PM Reply Like
  • nicolnj
    , contributor
    Comments (42) | Send Message
     
    Regarding Lotus Pharmaceuticals, I hate to say this but the latest quarterly result is far from pleasing to see, especially with the current issue of falling stock prices. There are some concerns on my part which I hope you can help me clarify.

     

    I had a discussion with a fellow Main Street investor that I know the other that. He has been involved alot in the Chinese RTOs market as much as I do, though he is more in-depth than I am.

     

    He mentioned that in most fraudulent companies there's this similar pattern on each one of them. Those are:

     

    1) Decreasing share price
    2) Decreasing Revenue quarter by quarter (Sudden)
    3) Increased Salary Expenses (this so that the management can take money away from shareholders, but the opposite of company performance)
    4) The management making a statement of trouble going forward with the company

     

    I saw those red flags in Lotus so it is actually becoming a concern to me. The website does not really tell us any details as in location of the company and where the building is and how does it look like.

     

    I would like to know if anyone has visited the company site before and check if the company is indeed real and in operation.

     

    Also, do you know what happens to the project with Wu Lan Cha Bu Emergency Hospital? Last I heard it's supposed to be completed sometime last year, but I have not heard anything from it yet.

     

    Your response will be deeply appreciated.
    24 May 2011, 04:16 PM Reply Like
  • Humble Value Miner
    , contributor
    Comments (407) | Send Message
     
    ok. I would love better controls so we could separate bad guys from good guys. I am sure there are a lot of good Chinese smallcaps... but lately I am a bit delusional on some of my choices. I hope there will be better times, with the ones working hard better rewarded :)
    18 Mar 2011, 02:47 PM Reply Like
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