“How Communist Paranoia Could Fund Your Retirement”

by Travis Johnson, Stock Gumshoe | November 22, 2010 1:37 pm

Today I’m looking at an ad from Michael Robinson[1] for his American Wealth Underground[2] newsletter, he’s pitching the idea of investing in China[3]’s surveillance state and getting involved in a stock that has tight connections with the government, both of which probably make at least some US investors feel a bit like holding their nose (or, with the recent uproar about airport screening, maybe we’re all just getting more used to Big Brother).

Robinson has made a bunch of bold predictions with his teaser picks over the last couple years, since he took over what used to be called BreakAway Investor, and they certainly haven’t all been right — but he gets a fair amount of attention from my readers because his big push for rare earth elements[4] stocks happened just as many of those stocks were gathering steam for the huge run that they’ve had in the last couple months. Of course, the rare earths have been frequently touted by lots of other folks over the last couple years, too, but the timing worked out nicely this time around.

So what is it that he’s pitching now as a hot idea?

Well, his new report for subscribers is reportedly called “How the Lucrative Retirement Secret of China’s ‘Top Cop’ Could Pay You 400%,” and it’s all about how Chinese paranoia and Chinese business/government connections — he tells us that Chinese leaders are so worried that the growing middle class will help foment (another) revolution that they’re pushing the state’s surveillance of its citizens to new levels, and that the company he likes in that sector has a tight connection to the government, including the “top cop” who was behind the success of China’s “great firewall.”

So that might be enough to give you some idea of which stock this is, but let’s look quickly at some detailed clues, too.

He first spins the tale of a gala party, which included a presentation by this “top cop” person …

“… gathering was to celebrate the Central Party’s granting of ‘preferred’ status to a rising surveillance company…

“This company is China’s new domestic security ‘national champion.’

“The Communist leaders are putting this company at the forefront of a $75-billion-a-year project: the creation of the largest, most sophisticated police state in the history of civilization.

“All of China’s 660 largest cities will be outfitted as quickly as possible with cutting-edge spy technology, so the Chinese can keep better track of their 1.3 billion citizens. While that would be a breach of security by U.S. standards… we all know the Chinese have been controlling their citizens for years.

“But whether it’s fair or not for the Chinese people, it creates a remarkable opportunity for a small group of savvy folks who could turn China’s paranoia into a 400% payday.

“That’s because the contracts for an infrastructure project of this magnitude will be worth a lot of money.

“And having ‘preferred’ status puts this company in prime position when it comes to landing these contracts.

“Right now, this company already has $180 million worth of work on its schedule.”

He goes on to say that this “top cop” guy, who Robinson calls “Mr. Le” because he just can’t possibly leak his real name to non-subscribers, got an offer from the Communist Party and from this particular company. Here’s how Robinson tells the story:

“He had come to the Great Hall to endorse the security company “preferred” to begin building China’s newest phase of domestic spying.

“As the head of the Ministry of Public Security’s science and technology wing, institutional investors took his endorsement seriously.

“But it’s what took place after his speech that changed ‘Mr. Le’s’ life.

“‘Mr. Le’ was enthusiastically met backstage by company executives and other high-ranking officials from the Ministry of Public Security.

“They had an offer for ‘Mr. Le’… a potentially lucrative reward for a job well done, a ‘golden handshake’ agreement.

“You see, ‘Mr. Le’ is 74 years old. His time as a public official must be coming to an end.

“This offer was a chance for him to make a windfall profit, courtesy of the grateful leaders of the Communist Party.

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“Now he would be able to live a life of wealth and comfort he could have only dreamed about as a young man in Mao’s China.

“The modern-day version is much different. China’s leaders have learned to harness capitalist forces inside their country. They can make anyone they want as weak or poor as they choose. They have absolute power.

“In the next six months, I think the Chinese government will act to make ‘Mr. Le’ a very rich man.

“As one of the few American investors who know about ‘Mr. Le’s golden handshake’ deal, you have the chance to profit alongside him… to the tune of as much as 400% or more in the next year.”

How did this “golden handshake” work? According to Robinson, “Mr. Le” was “quietly” put on the board of directors of the company the next year, and has been accumulating grants of stock at no cost for his service. We’re told that …

“Just in the last eight months, ‘Mr. Le’s’ total shares in this company have more than doubled. His stake is now worth nearly $600,000.”

After that we hear quite a bit more about the surveillance and security initiatives — Ordinance 458, which requires surveillance in public entertainment spots (nightclubs, etc), the Safe City initiative to install surveillance on public buildings and street corners, and then we get some more useful tidbits for identifying the company … such as that they were involved in the Safe City initiative in Shenzen, which is apparently one of the early adopters of the “police state” surveillance.

And we get another push about the urgency of the situation — we have to rush! (Why else would you subscribe RIGHT NOW, after all?):

“The groundwork has been laid. Tests of the first systems have been run in the early cities, like Shenzhen…

“The next phase of construction is set to kick in at any time.

“Contract awards will start coming thick and fast.

“Like I mentioned before, I don’t know everything about the Communist Party’s plans. Especially when it comes to public security, they keep things close to the vest.

“But, ‘Mr. Le’ knows… and his recent accumulation of shares in this company is a glaring signal. The old Internet czar got the nod and wink from his pals at the Ministry of Public Security to start expecting this stock to go up, quickly.

“He hasn’t added any more shares since August, which leads me to believe he expects the boost any time now…

“In fact, the stock is already up 19% since he received his last shares.”

So that’s about it for the details, other than the fact that the company is listed on the New York Stock Exchange … and that, in order to quell possible subscriber concerns, Robinson tells us that this company helps just domestic spying, he doesn’t think they’re attempting to harm the United States (they don’t do military contracts, apparently).

So all that gets trundled right into the ‘ol Thinkolator, which is admittedly a little rusty on this Monday morning, and the answer comes out clear as day: this must be …

China Security and Surveillance Technology (CSR)

This one has been a favorite of some of the China focused newsletters in the past, with mixed results — the shares were in nosebleed territory during the China bubble in late 2007, before they got their NYSE listing (they used to trade at CSCT over the counter), and then after they got hammered a bit and were trading in the mid-teens in the Summer of 2008 Robert Hsu[5] and Bill Mann[6] got on board and identified it as a value proposition … also because of their low PE ratio and tight government connections.

The shares are down by about 2/3 since that last flurry of newsletter attention, and CSR looks absolutely dirt cheap today: They trade now at a trailing PE of 5 and, though they’ve recently cut their guidance they’re still telling investors to expect at least a dollar per share in earnings next year, which, with a forward PE of also just around 5 (or a bit less, if you believe the somewhat more optimistic analyst estimates).

And CSR is indeed one of the leading surveillance companies — their big segment is installations, which is integrating systems and installing cameras, recording and tracking devices, and other security equipment, so revenue is certainly a bit lumpy sometimes as they depend on new sales and new contracts to keep driving that revenue number higher. Over the past couple years it seems, from my fairly superficial glance at the numbers and a few articles I read today, that their government contracts move more slowly than most investors and analysts expect … and, from their financials, what stands out is that though revenue has been climbing nicely, it has plateaued a little bit in the last year or two as they’ve hit higher levels and their expenses have climbed consderably as well, cutting margins. More importantly, though, they’ve also grown through acquisition over the years and issued a LOT of new stock, so investors who’ve been holding on for years of revenue growth haven’t enjoyed much in the way of per-share earnings growth for their patience.

That’s part of why existing investors have been burned a bit by these shares, but that’s not to say that the stock isn’t worth looking at now — CSR is Chinese, so there’s always a concern about insider behavior and transparency, but they are certainly better than many small Chinese companies at sharing information with investors, and they are in a business that’s driven by government policy to a large degree (though half of their sales are non-governmental) … but still, they’ve grown the top line (revenues) and look cheap on the bottom line (earnings), and that makes it hard to argue against at least taking a little look-see.

And I forgot one thing: yes, there is a “Mr. Le” — although the veil is not terribly thick on that one, his name is actually Runsen Li, and he is in his mid-70s and has been on the board for a few years and had formerly been at the security ministry in charge of the “Golden Shield” (that’s what the Chinese call their massive internet blocking/firewall system that keeps out nasties like Google).

I have no idea what leverage[7], if any, Mr. Li might have over the timing of his stock grants, or whether it’s true that the government is trying to make him rich. Absent some kind of mild conspiracy like that, I always think it’s a stretch to consider any insider activity other than insider purchases at market prices (ie, they paid their own money) to be meaningful, and he’s certainly not paying for his shares (he also, on a glance at the filings, appears to get pretty much the same stock grants that are given to the other board members). His last stock grant was on August 11, when most of the board and execs got grants, and the stock is currently at just about exactly the same price it was then — though when this teaser was probably written, a few weeks ago, it was briefly about 20% higher before a somewhat disappointing earnings announcement in October … so that matches the teaser info just fine. Runsen Li currently has just under 96,000 shares of CSR, so that’s valued right around a half million dollars today — far smaller than the shareholdings of the executives and founders, the CEO and CFO between them own about 4.5 million shares (still a relatively small 6% or so of the company), and they increased their holdings by 50% with stock grants back in August, too.

So … I have no idea whether or not Runsen Li’s presence on the board will mean much more business, or faster growth for CSR, but the shares do trade at a tiny multiple for a profitable and consistently growing (sales, at least) company. There’s plenty of reason for investors to be wary, the company seems to have had a pattern of diluting shareholders and issuing pretty generous stock grants to executives, and it’s a competitive industry dominated by one customer, but still … that’s cheap. Cheap for a reason, perhaps, but still … cheap.

Whaddya think? Too many concerns? Or too cheap to ignore? Let us know with a comment below.

And if you’ve ever subscribed to Robinson’s newsletter, please click here to review American Wealth Underground[8] and let your fellow investors know what you think (the reviews we have on file now[9] are for the previous iterations of this letter under different editors, so may not mean much about current performance).

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