The Investment Opportunity of a Lifetime

If you've never followed George Soros, now is the time to reconsider. 

See, Soros has spent nearly 50 years studying boom-bust cycles, including the international banking crisis, the collapse of the British pound sterling, and the Asian financial crisis. He's made billions both on the upside of those bubbles and during the panic on the downside.

In fact, he predicted that a housing crash following years of overspending would fuel a severe recession, and he emerged from retirement to earn a 32% gain in 2007 and a positive return in 2008.

In the aftermath of the housing and credit bubbles, we would do well to ask him what opportunities he sees these days.

The short answer: China
In his book The New Paradigm for Financial Markets, Soros reveals that during his visit to China in late 2005, he "saw greater opportunity than at any other time in my career." He called China -- with its rapid GDP growth and the potentially lucrative privatization of state-owned enterprises (SOEs) -- "the opportunity of a lifetime."

The recent sell-off in emerging-market stocks hasn't changed his mind. In a recent speech at Shanghai's Fudan University, he said he believes "China has been recovering, and its pace of recovery will be faster than the rest of the world."

Despite the considerable rise in the Chinese stock market since Soros' visit, we still have the opportunity to pick up some high-growth names at reasonable multiples -- cheaper even then Soros was touting in 2006.

China Mobile (NYSE: CHL  ) , the dominant mobile phone provider in China; Guangshen Railway (NYSE: GSH  ) , the dominant freight rail provider in the populous Guangdong province; and Sohu (NYSE: SOHU  ) , which is growing online ad and gaming revenue, come to mind.

So what has Soros so interested in China? It's largely the same moneymaking trends he saw in the U.S. during the 1980s.

How it went down here
Between the mid-1970s and the mid-1980s, the combination of high interest rates and an oil shock led to a long period of stock undervaluation. From 1977 to 1984, the S&P 500 mostly traded between six and 10 times earnings -- the average P/E since 1936 is around 16.

This phenomenon resulted in a number of highly profitable, undervalued cash cows. An acquiring company could sell shares or borrow money to purchase these cash cows on the cheap, and then use the acquired cash flows to pay down debt or sell more shares -- ultimately increasing its own net worth.

How it will go down there
There are around 100,000 Chinese SOEs -- about a third as many as during Mao Tse-tung's time -- many of them inefficient and unprofitable. To promote efficiency and economic growth, the government forces them out of business by barring state-owned banks from lending them money or by simply transferring their assets to more efficiently run subsidiaries.

In short, companies with superior managerial skills and access to capital can swallow poorly run companies for a tiny fraction of their true worth, turn them to profitability, pay down their debt or issue new shares, and repeat the process.

And a market environment that is adding pressure on the least-profitable SOEs is only accelerating this phenomenon. The result is one of the fastest-growing economies in history -- and the winners have largely been predetermined.

What to look for
Soros points to what he calls "super state-owned-enterprises," spinoffs from state-owned enterprises, which are:

  • Well-managed.
  • Run by motivated leaders.
  • Blessed by the government.
  • Able to access parent-company assets.

Soros' thesis is astonishingly close to the conclusion our analysts reached upon returning from its second trip to China. Advisors Nathan Parmelee and Million Dollar Portfolio's Tim Hanson recommend a number of "state-sponsored enterprises," their terminology for companies with:

  • Good management.
  • Motivated entrepreneurial leadership.
  • Government backing.
  • Access to capital.

Here's a name
When our team visited General Steel (NYSE: GSI  ) at its Shaanxi facility, management told the team that the government is working hard to reduce the number of steel companies in China, which is around 1,000.

General Steel's strategy has been to borrow money at modest interest rates and purchase controlling stakes in SOEs at massive discounts. That strategy is paying off -- sales have risen more than threefold over the past three years. For some context, compare that to domestic legacy steel mills -- U.S. Steel's (NYSE: X  ) sales have been stagnant over that period.

The company's facilities are in prime locations to take advantage of growth plans. For instance, one rebar plant that General Steel acquired is in Shaanxi province. Since rebar is expensive to ship, and there are no competitors nearby, the company's competition is limited.

So remember the advice of Soros and our Million Dollar Portfolio team for what may be the investment opportunity of our lifetimes: well-managed Chinese companies with motivated leadership, government backing, and access to capital.

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This article was originally published June 15, 2009. It has been updated.

Ilan Moscovitz doesn't own shares of any company mentioned. Sohu.com is a Motley Fool Rule Breakers pick. Guangshen Railway and General Steel Holdings are Motley Fool Global Gains recommendations. The Fool owns shares of China Mobile. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 18, 2010, at 11:13 AM, TheSecretHistory wrote:

    Investors should be aware that the domestic political situation in China has changed somewhat since 2005. There has definitely been a reactionary swing away from open markets, foreign investment, and the free exchange of ideas.

    One should also be aware that China is a Communist country, the stated goal of the government is the destruction of capitalism and proletarian revolution, and there is no government policy in China that cannot literally be changed overnight.

    To get a feel for the political bent of China, take a look at the official English language newspaper of the ruling party of the country, http://www.chinadaily.com.cn/

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