Cornerstone IPO: Selling Shares At 400x EPS

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About: Cornerstone Management (CSCA)
by: Wilsonville Capital
Summary

Cornerstone Management is a private equity fund manager in China investing in China-based companies interested in being listed in the United States.

The company was incorporated in the British Islands, wherein the securities laws provide less shareholder protection as compared to the United States.

Cornerstone is selling shares at 25x its net asset per share, which cannot be justified as its gross profit margins are not that good.

The float is expected to be low. As a result, analysts should be expecting share price volatility. The company could deliver large stock returns or trading losses in a very short period of time.

The amount of institutional investors is very low.

Selling shares at 400x EPS and 23.52x forward sales, Cornerstone Management (CSCA) seems massively overvalued. The company’s revenue growth of 98% y/y and its solid balance sheet are fine, but the market capitalization seems completely unjustified. Keeping this in mind, the market capitalization equals $613 million, which is more than its assets under management, equal to $548.5 million. In addition, the fact that the company was incorporated in the British Virgin Islands is another risk to be taken into account. As a result, the shareholders are less protected than in the United States.

Source: Prospectus

Business And Due Diligence

Founded in 2015 and incorporated in the British Virgin Islands, Cornerstone is a private equity fund manager in China investing in China-based companies interested in being listed in the United States.

Source: Company’s Website

The image below provides further details regarding the business structure. Note that shareholders own shares of a company incorporated in the British Virgin Islands, which is the owner of another entity located in Hong Kong owning assets in China.

Source: Prospectus

It seems very relevant noting when these entities were created. According to the prospectus, most of them were created in 2017 or 2015. Read the following lines for further details on this matter:

Source: Prospectus

With that, according to the company’s website, the company “insisted” on bank investment and fund management in the last twenty years. The image below was taken from the website:

Source: Company’s Website

Cornerstone runs different funds. Some of them seemed to return fantastic performance in 2017 and 2018. East Value, for instance, reported net internal return of 39.9%. Other funds have reported less appealing performance. Unicorn, for instance, reported a net internal return of 21.1% in 2018. The image below provides further details on this matter:

Source: Prospectus

Regarding the assets under management, as of March 31, 2018, the company claimed to manage $548.5 million. Given that most entities were created in 2015 and 2017, the amount of millions managed is quite impressive. The lines below provide further details:

Source: Prospectus

That’s not all. It is also quite surprising that the CFO and CEO are both 32 years old. Most investors will expect more senior individuals managing a private equity with $548.5 million. The image below provides further details on this matter:

Source: Prospectus

Balance Sheet

With an asset/liability ratio of 1.33x, the company’s financial situation seems stable. The most relevant assets are cash in hand, equal to $5.6 million, and prepayment to service providers of $9 million. The total amount of assets is worth $25 million, a lot more than that in 2017, when this figure was equal to $7.28 million. Investors should appreciate this increase in the amount of assets. The image below provides further details on the list of assets reported in the prospectus:

Source: Prospectus

On the liability side, it is beneficial that the financial debt seems non-existent. The total amount of liabilities equals $18.7 million with almost $13 million in deferred revenue. The image below provides further details on this matter:

Source: Prospectus

98% y/y Revenue Increase And Positive CFO

The income statement is what investors will appreciate the most. In 2018, Cornerstone released 98% y/y increase in total net revenues amounting to $12.7 million. The private equity fund managers seemed to raise more capital as both the subscription fees and the management fees increased by more than 200% in 2018. It is a beneficial feature. With that, the total expenses also increased from $2.8 million in 2017 to $9.1 million in 2018. On the bottom line, Cornerstone was able to deliver similar net income. It was equal to $2.7 million in 2017 and $2.8 million in 2018, which value investors should appreciate. The image below provides further details on the income statement:

Source: Prospectus

On top of it, the cash flow from operations also increased from $2.74 million to $4.04 million exhibiting a 47% increase y/y. Those making DCF models should appreciate this feature. The image below shows the cash flow statement:

Source: Prospectus

Use Of Proceeds

Cornerstone will use the proceeds from the IPO to increase its marketing efforts as well as for the expansion of its operations. It seems like boilerplate text. However, it seems beneficial that the proceeds will not serve to pay debts or any existing shareholder. The image below provides further details on this matter:

“We plan to use the net proceeds of this offering primarily to support the expansion of our operations and for general corporate purposes, which may include hiring additional sales, marketing and fund management personnel, and investing in sales and marketing activities, capital expenditures and other general and administrative matters.” Source: Prospectus

Expected Capitalization And Valuation

With the company selling 5 million shares at $4.0, Cornerstone expects to obtain proceeds equal to $20 million. With 153.39 million shares after the offering at $4, the expected market capitalization equals $613 million. Assuming $25 million in total cash, the enterprise value should be $588 million. Assuming $25 million in forward revenues, the company will trade at 23.52x forward sales, which seems too much.

Using a net income of $2.8 million and dividing by 153.39 million shares outstanding, the earnings per share equals $0.01. This means that Cornerstone will be selling shares at 400x EPS. Adding $20 million from the IPO, the net asset equals $26 million or $0.16. With this in mind, Cornerstone is selling shares at 25x its net asset per share, which cannot be justified as its gross profit margins are not that good.

Using other companies with assets in China and trading in the U.S., the valuation of Cornerstone seems quite absurd. The price/book value per share is never higher than 10x. Take a look at it in the image below:

Source: Seeking Alpha

Cornerstone is a private equity. It invests in Chinese companies like those shown in the image above. The company should be making great returns as it buys equity of companies and sells them in the public markets. However, Cornerstone should not be trading at such high valuations. $4 per share implies more than ten times the Price/Book ratio of other companies in China. The difference does not seem justifiable.

Board Of Directors And Rights Of Minority Shareholders

The assessment of shareholders does not look beneficial. Investors should not appreciate that one director controls more than 64.10%. In addition, the company was not successful in selling equity stakes. The amount of institutional investors is very low. The image below provides further details on this matter:

Source: Prospectus

With this information in mind, the float is expected to be low. As a result, analysts should be expecting share price volatility. It is a serious risk that investors should understand. The company could deliver large stock returns or trading losses in a very short period of time.

In addition, the Board of Directors could be non-independent in the future. Keep in mind that directors could take decisions to benefit the largest shareholders, which could harm the interests of minority shareholders. With that, the company released that as of today, the majority of directors are independent. The lines below provide further details on this matter:

Source: Prospectus

There is another very serious risk on this name. Like many other companies trading in the United States, Cornerstone was not incorporated in the U.S., but in the British Islands. This is a serious issue because the securities laws that should apply are those of the British Islands, which are not very developed. Shareholders need to understand clearly that they are less protected than in the United States. The image below provides further details on this matter:

Source: Prospectus

That’s not all. The assets are not located in the United States, which means that judges in the U.S. will not be able to act against the directors, the company, or the management. Cornerstone provides a warning about this matter in the prospectus. The most relevant part of this warrant is shown below:

Source: Prospectus

Conclusion

The company presents a solid balance sheet, large revenue growth and no financial risk. With that, the share price seems very expensive at $4. Trading at 25x its net asset per share, 400x EPS and 23.52x forward sales, Cornerstone seems massively overvalued.

In addition, the fact that one shareholder owns more than a 50% stake in the company is not beneficial. The Board of Directors could work for this shareholder damaging the interest of minority shareholders. The company was incorporated in the British Islands, wherein the securities laws provide less shareholder protection as compared to the United States. On top of it, its assets are in China, which means that judges will not be able to act against the company or the management. The risk is quite high because of this feature.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.