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.

Given the severity of the housing and credit bubbles that are now collapsing, and Soros' profit-making track record in crises like these, we would do well to ask him what opportunities he sees today.

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."

Last year's 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."

And that means the opportunity to buy names like Huaneng Power (NYSE: HNP  ) , Mindray Medical (NYSE: MR  ) , American Dairy (NYSE: ADY  ) , and Guangshen Railway (NYSE: GSH  ) at cheaper valuations than Soros was touting in 2006 won't last long.

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.

Some of the larger deals at the time included General Electric's purchase of NBC, Delta Air Lines' (NYSE: DAL  ) acquisition of Northeast Airlines, and DuPont's (NYSE: DD  ) multibillion-dollar purchase of Conoco (which was later spun off and merged to become ConocoPhillips (NYSE: COP  ) ). Some of these companies appreciated several-fold during that time.

How it will go down there
There are around 100,000 Chinese SOEs -- about a third as many as during Mao'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

That's astonishingly close to the conclusion our Motley Fool Global Gains team reached upon returning from its second trip to China. Advisors Tim Hanson and Nathan Parmelee 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 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 currently 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 nearly tripled over the past two years.

The company's facilities are in prime locations to take advantage of growth plans -- for instance, one rebar plant General Steel acquired is located 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 Global Gains team for what may be the investment opportunity of our lifetimes: well-managed Chinese companies with motivated leadership, government backing, and access to capital.

If you're looking for some more stock ideas, you can check out Nathan and Tim's favorite stocks from their travels to China, as well as their top 10 international stock ideas, free for the next 30 days. Just click here to get started. There's no obligation to subscribe.

Already a Global Gains member? Log in here.

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

Ilan Moscovitz doesn't own shares of any companies mentioned. Mindray Medical is a Motley Fool Rule Breakers recommendation. Guangshen and General Steel are Global Gains recommendations. The Fool has a daredevil disclosure policy.


Read/Post Comments (3) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 15, 2010, at 9:41 AM, Fool wrote:

    Love the recommendation for HNP which has stopped trading for over a week. Guess you can't jump in and buy this is you don't live in China.

  • Report this Comment On January 18, 2010, at 5:33 AM, lodestarcapital wrote:

    I have to admit that although the founders of Motley Fool were college classmates of mine, I have used their articles as contrarian indicators. If they recommend something to buy, I tend to short it, and vice versa. Here it is less clear. China obviously has trillions of pent-up demand and supply. Whether now is a good time to buy is another matter. I have seen this China craze before, though then it had a Japanese face. No one is impregnable. Not us, not Japan, not China, not the Euro. Human progress and stupidity are universal. Diversify, look for low cost in what you are buying and how you are buying, and be extremely suspicious of financial advice givers. In most cases, if they were really good, they wouldn't be sharing their advice.

  • Report this Comment On March 26, 2010, at 9:24 PM, cruiser9806 wrote:

    I really do not take hardly anyone's view. I look at all of them and make my own conclusions. However in this case i have to admit in a sense they are right. GSH pays a 2.6% dividend at 20. That's not a bad deal considering there are 1.5 billion chinese using train transportation. They yet have to really make airports. Add to that the need to transport goods as cheaply as possible. I believe GSH is going back to 70.

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