We are invested in China Chemical Corp ("CCC"), a delaware corporation that owns 100% of Gold Champs Consultants Limited (NYSE:HK) ("Gold Champs) who owns 100% of a subsidiary of Zibo Costar Information Consulting ("Zibo"). Zibo, in the PRC, is a wholly owned foreign enterprise that entered into a variable interest entity ("VIE") with Zibo Jiazhou Chemical ("ZJ"). Zibo which has contractual arrangements with the operating management teams provides all services to ZJ. In return Zibo receives all profit of ZJ, pledge all rights and an equity pledge agreement to Zibo. Note this structure was created by Grandall Legal Group and top reputable China law firm. This structure is regulated and misunderstood by many American retail investors.
ZJ is based on Zibo City, China that manufactures organic chemical compounds used in high performance plastics, PVC, electric fibers, paints, tires, insulation, flooring, adhesives, medicines, food processing, ink and paper. They have two products, 1) Phthalic Anhydride (PA) and 2) Maleic Anhydride (MAH). Their capacity is 60,000 tons of MAH and 50,000 tons of PAH. They are currently building another co-generation plant given their demand. Overall, PA and MAH are used in all industrials and construction businesses or industries that are targeted by China's 5 Year Plans!
ZJ is just a manufacturer and have not yet created a chemical distribution network. Basically, they sell their products based on market prices (which are increasing) and must be picked up by the customer. Further, they are an upstream manufacturer meaning they dont sell to retail.
In 2011, the CEO, Lu Feng offered to purchase the company at $1.50/share. However, we believe that the company received terrible financial and structuring advice as a management buyout is a very new phenomenon in Asia, especially China. I would presume that Grandall, is not experts in understand MBOs or litigation regarding a shareholder such as PAMCO. PAMCO was an advisor that received equity for their advisory services. CCC stated that the merger agreement was canceled due to PAMCO and litigation in the PRC.
So with all this noise, why are we invested in CCC? We believe the stock is been unduly punished by management's lack of ability to communicate, their weak advisors and the noise regarding Chinese companies as fraud. CCC was thrown out with the baby in the bath water. ZJ is the largest chemical manufacturer in the Shandong Province. They state that they have approximately 5-6 competitors in the region, but their capacity is about 20% of CCC and they appear to be so small that financing is very limited for them to expand. Management decided to stop filing updated information to keep the stock price down as we believe it products are highly in demand and their facilities are operating at full capacity based on energy readings from the province. Further they been expanding and those facilities are getting close to peak.
CCC's revenues based on conversations with management will top $150MM in 2014 with EBITDA $30-40MM from 80%-90% expected utlization of their capacity and ongoing expansion. However, they do have a need for long term financing. They currently rely on 12 month credit from reputable banks such as Agriculture Bank of China and Bank of Austria which is secured by their restricted cash. Management stated that their short term debt balance of approximately $50MM is covered by their cash on balance sheet, but they would like to access term loan bank debt which we believe they can price at a very cheap rate given their cash flow ability. To date, the have solid relationships with their lenders as they keep rolling it over. Estimated debt is approximately $105MM where their total cash is $75MM or net debt of approximately $30MM. This translates into a Net Debt/EBITDA ratio of approximately 1x. Further if there was cash needed for the business, the CEO has been known to step in and write a no-interest unsecured loan.
Stock price is currently under 10 cents or a valuation that is ludicrous. You can do the metrics yourself but this is a golden needle in a hay stack. Feel free to call the company or IR firm and they will talk to you about their business. Further this company is not a fraud b/c they actually had a credible fairness opinion by a US firm. If another LBO comes about, we hope that its greater than the low ball bid of $1.50. Chinese reverse mergers need some activism! Note we are long the stock and other US chemical stocks too!
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: CHCC - China Chemical