The street consensus is that most china stocks are prune are frauds, especially the ones that landed in the US stock exchanges through so called the RTO process.
Most investors choose to stay away from these stocks, in spite of their attractive valuations. The concern over safety overrules the prospective of profit, as it should. “Rule No. 1: never lose money”, says Warren Buffett. Fraud causes investors to lose money.
Some Chinese companies do not like to see their stock be so poorly valuated, so they want to take themselves off the market. Harbin Electric (HRBN, Financial) is one of them.
In early October, the company’s founder, chairman and CEO together with a hedge fund abased in HongKong made an offer to buy the shares that the CEO did not own for $24 per share. According to the announcement:
Currently, the risk arbitrage premium is about 12.5%. If the deal can consummate, it offer investors a healthy return. So the question is: Is the company’s Chairman and CEO serious about the offer?
If the deal fail, HRBN will join its China RTO comrades and claim a P/E ratio of 3 to 5, which means a stock price of about $9 to $15, a substantial drop from where it is today.
Let’s bring out the screening criteria of John Paulson for risk arbitrage opportunities.
First off, Paulson will not deal with the deal as the company and the acquirers have not signed the definitive agreement yet. But will they? The lack of a definitive agreement is precisely why the risk arbitrage premium is so high, so let’s give it a pass and see if everything else makes sense.
The second criteria Paulson likes to see is that whether the deal has strategic rationale.
There are actually several, but I just want to dwell on one point: the company needs an capital market that treat it fairly so it can raise capital for business expansion.
That is to say, the US market is not treating it fairly, for one thing, the company is trading at 7.9 times of its 2010 earning. The company almost doubled its revenue in 2010, its fully diluted earnings per share grew from $0.77 per share in 2009 to $2.46 per share in 2010. To raise capital through equity, the company is going to dilute its current shareholders, something the company’s management does not want to do.
But China is growing leaps and bounds, the company is in the capital market constantly. In July of 2008, the company spent $54.7 million to purchase a State Owned Enterprises, which now become the company’s subsidiary Weihai Tech Full Simo Motor Co., and in October of 2009, it spent about $122 million to purchase another SOE, which became the company’s subsidiary Xi’an Tech Full Simo Motor Co..
Weihai and Xi’an subsidiary contributed 22% and 44% of the company’s revenue as of 2010, and 11.6% and 29.4% of gross margin respectively.
Company also funded a buildout of entirely new factory in Shanghai and that facility is commission in 2010.
The company had decent cash earnings from operations, in 2008, 2009, and 2010, company’s operation provided $42, $65, and $93 million of cash, respectively. But the company spent even more on acquisitions, plants and equipment, $81, $89, $111 million respectively, according to the 2010 annual report.
It is hard to see where the next acquisition target might be, and what the next capital intensive project the company is going to engage in. In the press release for the 4Q10 and 2010 annual result, the company’s CEO disclosed the following growth opportunity:
In order to capture the opportunity, the company needs to raise capital, and the US market is providing the capital at a low cost, so the CEO is taking the company private and shopping around to see who can provide capital at lower cost.
That is strategic enough.
Most investors choose to stay away from these stocks, in spite of their attractive valuations. The concern over safety overrules the prospective of profit, as it should. “Rule No. 1: never lose money”, says Warren Buffett. Fraud causes investors to lose money.
Some Chinese companies do not like to see their stock be so poorly valuated, so they want to take themselves off the market. Harbin Electric (HRBN, Financial) is one of them.
In early October, the company’s founder, chairman and CEO together with a hedge fund abased in HongKong made an offer to buy the shares that the CEO did not own for $24 per share. According to the announcement:
On October 11, 2010, Harbin Electric, Inc. (the “Company”) issued a press release announcing that its Board of Directors has received a proposal letter from its Chairman and Chief Executive Officer of the Company, Mr. Tianfu Yang ("Mr. Yang") and Baring Private Equity Asia Group Limited ("Baring") for Mr. Yang and an investment fund advised by Baring (the "Baring Fund") to acquire all of the outstanding shares of common stock, par value $0.00001 per share (“Common Stock”) of the Company not currently owned by Mr. Yang and his affiliates in a going private transaction for $24.00 per share in cash, subject to certain conditions. Mr. Yang owns 31.1% of the Company’s Common Stock.The deal is almost six months in the making and only recently the stock has been showing some life. Stock is changing hand at $21 per share at the moment, but for a long time, it did not cross the $19 line. Towards the end of the year, when the HongKong hedge fund appeared to have some second thought, the stock tanked to as low as $15 per share, leaving a risk arbitrage spread of about 60%. American investors have been hurt by the China RTOs so they see the buyout as a possible ploy to sustain the company’s stock price.
Currently, the risk arbitrage premium is about 12.5%. If the deal can consummate, it offer investors a healthy return. So the question is: Is the company’s Chairman and CEO serious about the offer?
If the deal fail, HRBN will join its China RTO comrades and claim a P/E ratio of 3 to 5, which means a stock price of about $9 to $15, a substantial drop from where it is today.
Let’s bring out the screening criteria of John Paulson for risk arbitrage opportunities.
First off, Paulson will not deal with the deal as the company and the acquirers have not signed the definitive agreement yet. But will they? The lack of a definitive agreement is precisely why the risk arbitrage premium is so high, so let’s give it a pass and see if everything else makes sense.
The second criteria Paulson likes to see is that whether the deal has strategic rationale.
There are actually several, but I just want to dwell on one point: the company needs an capital market that treat it fairly so it can raise capital for business expansion.
That is to say, the US market is not treating it fairly, for one thing, the company is trading at 7.9 times of its 2010 earning. The company almost doubled its revenue in 2010, its fully diluted earnings per share grew from $0.77 per share in 2009 to $2.46 per share in 2010. To raise capital through equity, the company is going to dilute its current shareholders, something the company’s management does not want to do.
But China is growing leaps and bounds, the company is in the capital market constantly. In July of 2008, the company spent $54.7 million to purchase a State Owned Enterprises, which now become the company’s subsidiary Weihai Tech Full Simo Motor Co., and in October of 2009, it spent about $122 million to purchase another SOE, which became the company’s subsidiary Xi’an Tech Full Simo Motor Co..
Weihai and Xi’an subsidiary contributed 22% and 44% of the company’s revenue as of 2010, and 11.6% and 29.4% of gross margin respectively.
Company also funded a buildout of entirely new factory in Shanghai and that facility is commission in 2010.
The company had decent cash earnings from operations, in 2008, 2009, and 2010, company’s operation provided $42, $65, and $93 million of cash, respectively. But the company spent even more on acquisitions, plants and equipment, $81, $89, $111 million respectively, according to the 2010 annual report.
It is hard to see where the next acquisition target might be, and what the next capital intensive project the company is going to engage in. In the press release for the 4Q10 and 2010 annual result, the company’s CEO disclosed the following growth opportunity:
We expect to deliver continued growth in top and bottom lines in 2011. We expect our rotary motors business to keep its momentum as capacity expansions both at Weihai and Xi'an Simo kick in during the year. In specialty micro motors, we expect increased contribution from the newly launched micro motors and possibly the launch of other new products recently developed. In linear motors, we reported around this time last year that a single-car test metro train was launched for testing with a linear motor driven system developed and manufactured by our company. Now we are glad to report that we recently received the first order from Beijing Airport Express Operating Co., Ltd. or eight linear motor propulsion systems to be installed in the four cars of the first train fully "made-in-China." This train will be placed on trial operations on the Beijing Airport Express Way. We expect mass production of metro trains to begin when this trial operation is successfully completed.Since there is a buyout offer on the table, the company is rather tight-lipped on what it meant to do and not to do, by this paragraph offers a glimpse as to what kind of opportunities the company has in front of it.
In order to capture the opportunity, the company needs to raise capital, and the US market is providing the capital at a low cost, so the CEO is taking the company private and shopping around to see who can provide capital at lower cost.
That is strategic enough.
