November 13, 2009 - 2:41pm EST by
2009 2010
Price: 9.57 EPS $1.32 $1.50
Shares Out. (in M): 20 P/E 7.3x 6.4x
Market Cap (in $M): 187 P/FCF NM 37.3x
Net Debt (in $M): -48 EBIT 32 38
TEV (in $M): 139 TEV/EBIT 4.3x 3.7x

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After experiencing one of the biggest bull runs in history, I am surely not alone in my pursuit of investments with well defined catalysts and low correlations with the market. Over the past several months, there have been a number of China-related SPAC acquisitions which have offered such an appeal: deep value-oriented special situations with well defined catalysts (the deals themselves) that at least in theory have low market correlation. The most successful of these deals have had a common thread: solid growth potential and very compelling valuations. These small cap stocks have no Wall Street research coverage and typically undergo a process of investor turnover (from the original SPAC arb hedge funds to fundamental investors) - conditions which create fertile opportunities to invest in companies at significant discounts to intrinsic value.

2 examples of recent SPACs follow: while the underlying stocks of both of these deals have provided short term upside...

EDS up 54% in 4 days post shareholder vote
TMI up 48% in 6 days post shareholder vote

... the warrants have provided the real firepower (the best trade in these 2 instances has been to buy well before the vote and hold until the following week)

EDSWW up 155% from one week before to one week after vote
TMI/WS up 920% from one week before to one week after vote

New Idea:
An upcoming SPAC deal which possesses some of the similar above-mentioned characteristics is China Holdings Acquisition Corp ("HOL" - AMEX). HOL is a special purpose acquisition company which raised approximately $121 million in November 2007. HOL recently announced its intention to acquire JinJiang Hengda Ceramics Co ("Hengda"), subject to a shareholder vote on November 20, 2009. If greater than 33% of current common shareholders vote against the deal, HOL will be liquidated and the trust redeemed at $9.79 per share. As mentioned in a later section, I am highly confident that the shareholder vote will be a success.

Recommended Trade: Buy HOL stock and warrants (HOL/WS)

HOL is acquiring Hengda, a company experiencing strong secular tailwinds, at a very attractive valuation. The stock, currently at $9.56 trades at about 6X FY08 EPS and 4X FY08 EBITDA. This compares against the China construction materials peer group average of 40x and 19x, respectively. At 10-12x conservative FY10E EPS (see valuation section below), which I deem fair given my conservative assumptions of high-teens EPS growth, I get fair value of $15-16 per share.

At the current share price, if the deal gets approved, investors will likely see significant upside from the company's strong fundamental growth. If the deal does not go through, investors can lock in a gain of greater than 10% in a week, as the stock will rise to the trust value of $9.79 per share (with confidence, as arbs will move into the stock if there's a disparity).

The warrants, currently at $0.89, trade at a deep discount to intrinsic value: using the current price of $9.56, with a strike price of $7.50, expiration of 11/16/2012, an implied vol of 30% and the 10 yr yield of 3.4%, I get an intrinsic value of $3.40. At fair value for the underlying stock of $15, the intrinsic value of the warrants would be over $8 but for technical reasons (HOL warrants are callable by the company at $13.50) upside of the warrants is capped at $6.00.

Investing in warrants of SPACs has somewhat of a binary outcome. If the deal is not approved by shareholders, the SPAC trust is liquidated and common stock holders are redeemed at $9.79 per share; warrants, in this scenario, will be worthless.

Summary Company Description:
The investment target, Hengda, was founded in 1993 and is a leading regional manufacturer of ceramic tiles located in Fujian province, in the southeastern region of China. The company estimates that it maintains an approximate 3-4% market share in the $5 billion ceramic tile industry in China. Hengda mainly caters to the domestic Chinese market (95% of revenues) and its products are available in over 2,000 styles, colors and size combinations and are used for exterior siding and for interior flooring and design in residential and commercial buildings. Currently, porcelain tiles account for about 80% of company revenues with glazed ceramic, rustic, and ultra-thin tiles rounding out its product base. In China, exterior ceramic tiles are widely used in commercial and residential buildings. These buildings are considered to be more modern and are generally regarded as being better constructed.

Hengda's manufacturing facility is located in JinJiang city, Fujian province with an aggregate annual production capacity of 28 million square meters using nine production lines. The company is in the process of building a new production facility, which will increase production capacity by 42 million square meters (for total of 70 mm sq meters) by 2012. Hengda primarily sells its products through an exclusive distributor network (currently 31 distributors) and directly to property developers. Furthermore, the company has maintained long-term relationships with its customers with nine of its top ten clients having purchased products for the past 9-11 years.

Hengda attempted to go public in Singapore in 2008 but subsequently withdrew its offering due to poor market conditions. As part of the IPO process, the company retained Grant Thornton as its auditor and hired a CFO with auditing experience at a publicly listed company in Hong Kong as well as at a Big 4 accounting firm.

The Ceramics industry in China has the following key characteristics:

  • Ceramic tiles industry has grown approximately 20% (by revenue) over the past 3 years and is expected to grow 10-15% over the next 5 years.
  • The industry is fragmented with hundreds of small mom and pop factories with varying quality levels. The top 10 manufacturers account for only 20% of industry revenues.
  • Ceramics are widely used in the PRC as a construction material for both residential and commercial buildings given its durability and ease of maintenance.
  • Rapid growth of construction materials sector in China has been driven by:  
  1.  Population growth and urbanization - 350 million people (equivalent to entire population of USA) are expected to be added to China's urban population by 2025. Currently only 45% of the Chinese population live in urban areas. This compares to about 50% for Indonesia, 70% for Malaysia, 81% for the US, and 90% of the UK
  2. Increase in living standards - per capita living space in urban population has nearly doubled from 13.7 square meters in 1990 to 27.1 sq meters in 2007. This compares against 30-50 sq meters in European countries.
  3. Government stimulus - central and provincial governments plan to invest approximately $130 billion in current stimulus plan to build affordable housing and promote the construction industry.

Investment Thesis:
An investment in Hengda has the following merits:

  • Hengda will be a beneficiary of positive secular growth trends affecting the Chinese construction materials industry: urbanization, increasing rate of home ownership, continued population growth, and developing mortgage market.
  • Hengda operates in a fragmented industry with opportunities for consolidation and gain market share from smaller mom and pop operators.
  • The company plans to spend nearly $80 million in capex over the next 3 years to expand capacity by 150% to meet increasing demand (current capacity utilization is 115% as Hengda outsources some production). Most manufacturers do not have the financial resources to take on such expansion
  • The company's products are recognized for its quality and innovation. New products, such as the ultra-thin tile, have approximately 50% higher gross margins than corporate average.
  • Increased capacity should allow company to expand geographically and target new distributors in northern and western provinces in China which will further enhance growth.
  • Attractive valuation - while there are no pure-play public comps, Hengda is being acquired at approximately 6X my 2010 EPS estimates and 3X EBITDA (see more at valuation section below). This compares against average of 26X P/E and 9X EBITDA for Chinese construction materials and cement companies.
  • Approximately 60% of the deal consideration (8.1 mm additional shares) is in the form of earnouts related to earnings growth. I view this as an extremely solid incentive system for management to achieve its financial goals.


  • Hengda's management team has provided very aggressive guidance for the next 3 years. Given its capacity expansion plans, new distribution strategy and underlying construction spending growth, management expects approximately 20-25% topline and nearly 35% bottom line growth from 2009-2012. I am using more conservative assumptions, but there is risk that the market may be disappointed if the growth rate is less stellar than management anticipates.
  • There is a potential bubble brewing in the Chinese property sector, especially in Tier 2 and 3 cities. Bubble deflation could be exacerbated by potential government mandated slowdown in bank lending.
  • Ceramic tiles are largely commoditized products. Price competition could be prevalent if residential and commercial construction slows significantly. Mitigating factor: tiles only account for 2% of total expenses in a construction project so pricing pressure may be lower relative to other building material products.

My estimates assume mid-teens topline growth and flat to modest margin expansion. Under such a scenario, 2010 EPS and EBITDA would be about US$1.50 and US$40mm. Applying a 10-12x forward P/E multiple and 5-6x EBITDA multiple (which seems fair for a mid-teens grower) yields in a $15-16 share price.

This deep value opportunity exists because there is no Street coverage, it is below the radar screen, and it exists because this is below the radar screen (market cap of $140M pre-dilution) and as with any SPAC, there is deal risk. Opportunities like this are rare, especially after wild run-ups in the market such as this.



  • Shareholder vote on November 20, 2009. The SPAC sponsors have done a good job of communicating with fundamental investors and the current stock price volatility is likely as a result of some investor turnover (risk arb funds and smaller shareholders selling out).


  • Release of preliminary 3Q operating and financial data sometime before shareholder vote.
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