Article / 19 November 2012 at 5:49 GMT

China Finance: A shortlist of possible equity delisting plays

Fredrik Oqvist Fredrik Oqvist
Founder / ChinaRAI
China

Executive summary

  • Undervaluation is driving Chinese companies away from the US markets
  • Low P/B and P/E numbers are used as selling points to try to get companies to go private and relist in Hong Kong, so looking at these can give us some idea who might be considering a deal
  • LPH looks relatively solid and has analyst coverage, which should mean it has already been subject to some due diligence on which investors can piggy-back
  • Four possible targets for a delisting play

 

Chinese companies' delisting transactions are something I’ve written about here earlier, and they present a very interesting opportunity for traders. Spotting them isn’t always easy and there are certainly no guarantees in this game. But there are a few things we can look for when attempting to find good candidates for a possible going private play.

The reason many Chinese companies listed on US exchanges are looking to go private is undervaluation. This, coupled with the cost of maintaining the listing, means the cost-benefit analysis just doesn’t make sense any more. Further, there are plenty of people telling these companies that they can get significantly better valuations in Hong Kong if they make the switch.

Tagged onto this you have a PE industry in China that by some accounts has only invested about half of the funds it's raised during the last few years. So there’s plenty of money interested in getting involved in the potential payoff from a delist-relist deal. The fact that we have yet to see any of the companies that have gone private do a relist (at least to the best of my knowledge) does not seem to deter potential investors.

Look for low P/B and P/E

So we’re looking for undervalued Chinese companies, predominantly on the US exchanges. There is certainly no lack of these so if we put a Chinese company trading at P/B under 1 into the Saxo Bank stock screener we get an almost unworkable number of companies. Given the instances of fraud in the past we have to assume that at least some of these companies will be legitimately trading under book value.

It is important to note that investing in this space requires going through a lot of financial data and preferably also conducting some due diligence. However, investors willing to take the time are likely to find some really good trades here. It comes down to focusing your attention on a few targets that you can study in more detail.

There are many ways to check for serious red flags in Chinese companies but for the purpose of creating a shortlist of interesting companies for further examination we can let the market help us. I set the P/B to be between 0.3 and 1 in order to help weed out companies that are valued so low the market seems virtually certain they are frauds.

There’s another factor that I’ve often heard mentioned by people involved in these deals, and that is the P/E multiple companies are getting in the US. This seems to be part of the sales pitch to get these companies to consider a going private deal, and so companies that have low P/E multiples should be more susceptible to this argument.

Setting the P/E between 0 and 2, in combination with the P/B range we get a list of just four companies, three of which are listed in the US and thus the likeliest candidates: China New Borun (NYSE: BORN), Longwei Petroleum (AMEX: LPH) and Tianli Agritech (NASDAQ: OINK). These companies all fall in a range where we have seen a lot of action in the going private sphere and thus they look like statistically good plays.

Shortlist for Going Private deals

Of the companies generated by the list I have previously looked at Longwei Petroleum which seems to have a legitimate and growing business. The company still has a few red flags, such as a CFO who doesn’t live in China. But overall the numbers are looking pretty solid. With Longwei you also have the benefit of some analyst coverage, which hopefully comes with some due diligence, something adds some more legitimacy to the company's claim of being undervalued.

From a trading perspective this company also offers something of interest as the price has fluctuated wildly over the past few weeks, usually around the time of announcements from the company. Longwei has also received a target price of $5.18-$5.87 from the analyst covering the stock. Assuming there has been due diligence conducted in respect to this valuation, the target price does not seem off by much.

LPH has seen a lot of volatility of late

 There appears to be a lot of movement in this sphere behind the scenes with plenty of PE people, lawyers etc talking to companies about the posibility of going private. This coupled with some factors I've previously discussed means I think this market will heat up soon. At such a point in time these companies should all be decent plays for a going private offer. And if combined with some due diligence, at least you can invest in market sentiment turning, because a correction towards fair value for any of these companies should yield as much if not more than a going private deal.

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Fredrik Oqvist writes regularly about Chinese equities, mainly those listed on foreign exchanges. If you'd like to comment on this story or be notified by email whenever a new China Finance story is published, become a member - it's free, and you can use your Twitter, Facebook, Google or LinkedIn login - and "follow" the China Finance blog during the signup process. You can also bookmark the China Finance blog page.

1y
KCAnalyst KCAnalyst
Fredrik,

Another nice article. Are you planning to attend Longwei's investor and analyst day in January? It would be nice to meet you there.

At least one more analytical house and two big investors' groups already told me that they will go (and a super size fund out from Canada may go too). I also heard that they are getting more new funds and banks signing up through their new IR company Weitian Group (http://www.weitian-ir.com). In addition to seeing current status of Longwei's operations, this will be a big social event for serious analysts/investors of Chinese small caps. :)

Kevin
1y
Fredrik Oqvist Fredrik Oqvist
Hi Kevin,

I'm considering going but it'll depend on what my schedule looks like at the time.
1y
KCAnalyst KCAnalyst
Fredrik,

Just back from a long Thanksgiving vacation and have been busy over the past couple days. Sounds good. Let's see which date they pick.

Kevin

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