TONGXIN INTERNATIONAL LTD TXIC
July 06, 2010 - 6:16pm EST by
rjm59
2010 2011
Price: 4.10 EPS $1.40 $1.70
Shares Out. (in M): 13 P/E 3.0x 3.0x
Market Cap (in $M): 52 P/FCF 3.0x 3.0x
Net Debt (in $M): 0 EBIT 30 37
TEV ($): 52 TEV/EBIT 3.0x 3.0x

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Description

This has an imminent catalyst that should take place July 15th when they are required to file their 2009 results (after filing a 15 day extension).


The special situation:


The company is based in China and has had its stock hammered down 50% over the past two months along with many other things, particularly China. The biggest risk with any US Listed Chinese small cap is fraud risk, which I believe is totally justified as several intelligent and informed investors estimate 2/3rd of US listed Chinese co's have some kind of fraud (sometimes due to dumbness, sometimes evil...). A combination (though these are correlated) of the Shanghai being beaten down this year by over 25% and a number of US-listed Chinese co's being exposed as frauds (ONP, CSKI, IDI, NEP, etc.) has lead to a great deal of fear and irrational pricing of this category with little differentiation in valuations between clearly sketchy and very solid companies. TXIC is one of the very solid companies in a sea of sketchy OTC companies with little history and yet is valued alongside them - this makes no sense.


The stock now trades at a 40% discount to tangible book value and at a PE of about 4 with little debt. The company has confirmed their revenue and growth guidance for 2010 despite not releasing specific financials yet, as they are currently still working with their new auditor - BDO Seidman LLP (the main US entity, not the smaller foreign 'franchises' that have been fooled in the past), which they upgraded to in 2009.


Some quick background on the company:

TXIC designs engineered vehicle body structures ("EVBS"), designs and fabricates the dies used in the manufacturing process, and stamps panels, assembles and completely finishes EVBS. Every on-road automotive vehicles is equipped with one of two types of EVBS including:


-Body-on-frame (BOF): Mounting a separate body (also referred to as a "Cab" for commercial trucks) to a rigid frame which supports the drivetrain. It has become the main technique for chassis assembly for all commercial trucks, most sport utility vehicles ("SUV"), multipurpose vehicles ("MPV") and some larger passenger cars; and 
-Body-in- frame (BIF): All members of the vehicle body (also referred to as body-in-white or unibody) are load carrying and are integrated with each other. Here the chassis is integral with the BIF itself and there is no separate chassis. BIF is found on generally most passenger vehicles.


Their business isn't Coca Cola but it strikes me as a defensible niche that will be around for a very long time (they have been around since 1984). Specifically, as cars and trucks move toward making internal combustion obsolete, they will not be impaired, as their business is the body work. Their sales are 85% domestic and 15% import, so also shouldn't be hurt with the rising Yuan expected over the next few years. So I don't see any big forces that could kill their business anytime in the near future.


From a competitive point of view, they are the largest independent supplier and as tooling is very expensive with high fixed costs, there are economies of scale required. Also, they become tightly integrated with their customers supply chains which makes switching to a competitor more difficult, which further enhances their competitive position (and thus margins). One potential risk is that, as they mainly compete with the in-house EVBS manufacturing, if the car industry consolidates substantially in China, they may get squeezed out.


The Fraud Risk:


-While this is the biggest risk for any US Listed Chinese company, TXIC doesn't really have any of the red flags associated with frauds that I have studied. I haven't seen any frauds with only a single red flag, there have always been multiple cockroaches in the kitchen, so to speak...


Key Points: 
-They have been around since 1984 and from that I have heard from trusted colleagues who have investigated further, they are well respected in the industry (I don't speak Chinese unfortunately). 
-They have US managers so there isn't the "cultural" risk and misinterpretation ("We said we made $100M in 2009 because we were really optimistic we'd make that much in 2011, don't take us too literally..." - China has some interesting indirect approaches to communication). 
-They went public through a SPAC in mid 2008, not a reverse merger, so there was DD done by the SPAC people (not that this is a huge point on its own, but it at least removes a large degree of the adverse selection bias of reverse mergers). 
-Their margins are reasonable for their business and not unbelievable. 
-Their SAIC filings match their SEC filings (most US listed Chinese co's don't - this on its own doesn't guarantee fraud, as I don't believe anybody has been in trouble for false filings, but it's a good sign that they are the same). 
-They chose to upgrade to a very large and reputable auditor (BDO Seidman, they could also have easily used BDO HK which is much smaller and given a similar impression to the public, but they chose to use the larger US entity). 
-They haven't done any silly capital raises (selling at way below market, etc. has to me been the single biggest sign of fraud).


Valuation:


Assuming the financials are all accurate (as I do), they are really obviously cheap by any metric. Their last financial statements are from Q3 2009. They made $12.3M net in the first 9 months of 2009 on $91.5M of revenues. Annualized (they have said that Q4 went very well) conservatively to $16M, that's $1.33 (12M shares out) at the current share price or just under $1/sh if the 5M warrants were all converted at $5. That's a PE of between 3 and 4 for 2009 depending on your assumptions on the warrants (they expire March 2011 and strike at $5, I expect they will all be exercised).


Tangible book value is about $8/sh ($7 with warrant conversion), double the current share price.


So bottom line you are getting a company that is a leader in their market that is growing at about 20% a year (and has been for some time) at a PE of about 4, with an imminent catalyst by July 15th to clarify a confusing but very unlikely to be nefarious situation over the past 6 months as they have improved their auditor. The warrants at $1.27 close today are out of the money at the moment but could provide some extra leverage on the stock, though they are less liquid than the stock itself.

Catalyst

July 15 filing deadline for 2009 results (and probably Q1 2010 results). They have been held up by SOX compliance and other issues related to having a new and thorough auditor.  Many other Chinese companies have had issues filing late due to fraudulent activity but I believe this is very unlikely due to the reasons listed.
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