lihua LIWA
April 15, 2011 - 8:37am EST by
2011 2012
Price: 7.46 EPS $1.00 $1.50
Shares Out. (in M): 39 P/E 4.0x 2.7x
Market Cap (in $M): 291 P/FCF 5.0x 3.0x
Net Debt (in $M): -142 EBIT 53 73
TEV (in $M): 148 TEV/EBIT 3.0x 2.0x

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I am recommending the purchase of Lihua (LIWA), on the thesis that it is not fraudulent.  Readers of this website know that I have been quite skeptical on the truthiness of Chinese companies' financials, but I am sticking my neck out here and positing that LIWA might be the exception.


First, here is the short/fraud thesis, and my take on the various points:


1) speeded up insider unlock in 2009- no opinion

2) discrepancies with a radio show interview- troubling, but I cannot imagine that people perpetrating a fraud would then use different numbers in public speeches

3) discrepancies versus fushi on cogs- basically, the incorrect assumption here was that all of COGS is CCA (copper-clad aluminum wire), which clearly doesn't make sense

4) CCA price discrepancy in S-1 filed august 2009- yes, this didn't make sense-the segment data was mislabeled, and the revenues should have been for both CCA and copper wire

5) A/R and A/P discrepancy with fushi- they are different businesses, and it is unclear that fushi is reliable, so I'm not sure this is meaningful

6) discrepancy with SAIC filings- it is unclear where the original SAIC filings came from, but current filings, which have been reviewed by 3rd parties, show no discrepancies

7) margins- this is the big leap of faith, IMO.  Margins seem too good for what is essentially a service business (taking large gauge CCA and drawing down to super-fine wire).  I had this same concern when this company was first making the rounds 2 years ago, and never got comfort.  That said, at the time they were very up front about the margins, and said that the reason they could capture these margins was that drawing wire down to such tiny diameters actually was extremely difficult, and it was very tough to get customers to approve the quality of the wire.  Since CCA is cheaper than copper, customers prefer it, but since it is bimetallic, pulling it out in a uniform matter is tricky (the wire can break, etc).  So, that is their claim.  I am still a bit skeptical, but they have been saying the same thing for many years now.


So, those are the "fraud" arguments.  Relative to other companies in this space, they seem unconvincing.  For instance, there are none of the following warning signs:


1) insider dealings or insider selling of stock

2) large property transactions

3) a business that makes no sense

4) interviews with customers that imply shadiness

5) financial statements that are not signed off on by a legitimate auditor


A sell-side firm, Global Hunter, has basically staked their reputation on this one.  They have gone to the company's facilities six times, examined every one of their bank accounts, spoken to all their large customers, the local government, regulators, etc.  So, that is encouraging. 


I would argue that the people involved have something to lose.  There are three independent board members-one is the managing director of mizuho capital markets, one is the head of media banking for oppenheimer, and one is the president of oakmont advisory.  The treasurer/IR contact has an MBA from NYU, so I'm not sure she wants to end her career at such an early age.  The company has opened itself up to visits from foreign investors and is buying back stock.


So, on balance, this could definitely be a fraud.  But it seems much less likely than other companies described here.  And as a result, you have a stock that is trading at 2.5x earnings, ex-cash  (note, I have assumed all options are exercised, this year's capex is spent, but cashflow for 2011 is included also).  The company will be buying back stock after their earnings report in early May, and I suspect working on other ways to convince investors that the company is legitimate.


earnings and buyback resumption
proactive stance by company to alleviate concerns
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