Would you pay nine times earnings to buy shares of a company growing 48% annually? What about six times earnings for a company growing by 50%? How about six times for a company growing at greater than 80% per year?
Are there any companies out there that actually look this cheap?
The answer is yes, but my guess is that you have no interest in owning them.
Of course, you claim you like cheap stocks
The problem? These three companies are Chinese, and each has given American investors pretty good reasons to be skeptical. The first is China Fire & Security, a company that's been announcing new contracts left and right this month to install fire safety systems in power and industrial plants in China. However, it also came public via a questionable reverse merger, and its management team was featured in an unflattering light on Sharesleuth.com.
The second is American Oriental Bioengineering, a company that's been growing like gangbusters by using Western capital to consolidate the traditional-medicines business in China. It aims to become that country's Merck
The third company referenced above is China Security & Surveillance Technology, another serial acquirer in China that -- though it plans to become a branded-technology conglomerate along the likes of 3M
All is not cut and dry
While each of these companies offers a compelling price and an enormous growth opportunity, on the heels of the Satyam Computer accounting scandal, it's difficult for American investors to be comfortable with foreign companies that may not offer the same level of transparency as their U.S. counterparts. Furthermore, many American investors feel uncomfortable with the prospect of investing in a company that they can't visit, that makes products they can't check out for themselves, and which is run by a management team that may not speak our language.
If that's you, you're missing out on some fantastic opportunities. But before we get to that, let's revisit the AOB 8-K that spurred a 20% sell-off.
Here's how it went down
At 5 p.m. ET on Jan. 9, AOB filed an 8-K announcing that it had completed a $70 million acquisition of "buildings occupying 14,615 square meters of office space on 22,008 square meters of land ... in the New Economic & Technology Development Zone in Beijing." The company further noted in the filing that it "intends to use the properties as a Convention and Training Center."
Soon thereafter, Piper Jaffray downgraded the stock, saying, "We feel the investment is a significant deviation from the intended use of capitals, which is to acquire pharmaceutical companies in China. ... As such, we see the management's decision as disappointing," and investors started selling.
But was it warranted?
Now, there are certainly some negative aspects to AOB's announcement.
First, it made a major acquisition, investing more than 40% of its balance sheet, without issuing a press release to investors. Second, buying a convention center doesn't seem to fit with AOB's goal of becoming a top-five pharmaceutical company in China. Third, paying $445 per square foot of office space in a real estate downturn is expensive.
Since the market was already on edge about Satyam's attempt to mask a $1 billion cash shortfall on its balance sheet with an acquisition, AOB was not given the benefit of the doubt here.
AOB got that message
Fast-forward to the following Friday, when the company issued a press release explaining that the building "is a long-term investment in AOBO which builds out our multi-functional headquarters and centralizes our management in Beijing, while deepening our presence in a very important development region focused on attracting leading pharmaceutical companies."
The company further noted, "While we have not always elaborated on our motivations at the time, due to economic, competitive and other reasons, we consistently and effectively have navigated China's complex economic and competitive landscape, and have created significant shareholder value in the process. We believe this property purchase is no departure from AOBO's proven past."
This "trust us" argument may not hold water with American investors, given that many of us are predisposed -- for good reason, in many cases -- to be skeptical of all things Chinese. But AOB does have a solid operating track record, and it has consistently reaped shareholder value from its acquisitions.
What could be the benefits here?
Moreover, the company could reap some benefits from this move. For example, a permanent office building in Beijing helps the company prove to the government of China that it is, in fact, a domestic Chinese company.
While that may sound silly, until now, in the eyes of the PRC government, AOB has been nothing more than a foreign capital corporation that leased some space in Shenzhen and was buying Chinese assets. While this was fine when the Chinese economy was humming along, the country's current slowdown has prompted its government to focus on supporting domestic consumption and domestic job creators.
In order to continue to benefit from reduced tax rates and be given the opportunity to acquire Chinese state-owned enterprises (SOEs), access capital from state-run Chinese banks, and benefit from the country's domestic stimulus plan, AOB likely needed to show that it was a major Chinese pharmaceutical maker. Buying top office space in Beijing does that.
Summing up
This is not to say that the AOB acquisition is cut and dried. The price still looks expensive, and if we believe that AOB will get benefits from having a permanent Beijing office, we need to keep checking up on the company to make sure those benefits are realized.
Not coincidentally, however, the company announced a few million dollars' worth of savings on Tuesday, when it revealed that all of its subsidiaries would now benefit from China's reduced 15% high-technology tax rate. (The company had previously paid a blended rate closer to 20%.) While there's no clear cause-and-effect relationship here, it never hurts to have a good relationship with the government.
When it comes to investing in China, there will be communication problems, there may be transparency issues, and there are business norms that may make Western investors initially uncomfortable. But remember, these companies are trading at absurdly cheap levels relative to their growth prospects. The opportunities in China are so tantalizing that it's worth the effort to learn more about them, and to invest in a diversified basket of carefully chosen opportunities.
Find those opportunities
At Motley Fool Global Gains, we travel regularly to China to meet with management teams and investors in the country to closely vet all of our potential ideas. After all, the reason that the market will sell you a 50% grower for six times earnings is because it's uncomfortable. If you can get comfortable with owning that stock, you stand to make a lot of money.
That's what we can help you do at Global Gains, and you can click here to see all of our top China stock ideas free for 30 days.
This article was first published on January 15, 2009. It has been updated.
Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of AOB, China Fire, and 3M. AOB is a Motley Fool Hidden Gems recommendation. China Fire is a Global Gains pick. 3M is an Inside Value selection. The Motley Fool owns shares of AOB. The Fool's disclosure policy is written in plain English.
