“Discover the Secret ‘Hidden Value’ of Chinese Companies”

Robert Hsu’s copywriters can tease your credit card out of your wallet as quick as just about anyone, but the clues I wanted to dig through today are from something that Robert Hsu wrote that poses as an actual “article” on his AsiaInsider site — this is all about one of his China stocks that he teases as having a couple of the key traits that often appeal to me, including insider buying and “hidden” real estate value, so I thought it might be worth unearthing the name of the stock for you (in the end the article is as much a tease as his florid email ads, of course, since he wants your subscription money before the name and ticker are revealed).

So what are we working with? First, his explanation of this “hidden value:”

“Now, the reason this value is such an unknown when it comes to many analysts following China stocks is because it isn’t readily evident when you look at a company’s balance sheet. And, far too often, that’s all these so-called “China analysts” look at.

“No surprise that many of these China pundits haven’t even actually visited China.

“As for me, I’d rather have every edge that I can get when it comes to investing in the world’s fastest-growing and most volatile emerging market. Which is why I make regular visits to China and employ a team of on-the-ground researchers and analysts on the Mainland in order to fully understand our opportunities and avoid pitfalls that will trap other investors.

“And one such edge comes from knowing the “hidden value” of the real estate owned by many Chinese companies.”

I’ve got no complaints about Hsu claiming that his “boots on the ground” visits to China and in-person research add value to his recommendations — lots of the big newsletter folks travel heavily to visit the companies they’re considering to get a “feel” for the business, though it’s also worth noting that I know some analysts and managers actively prefer not to visit with their clients because they prefer not to be lied to by overoptimistic CEOs (assuming, of course, that the person lies more than the SEC filings).

So what has his “edge” told him this time?

“… one of our top Asia Edge companies recently acquired a university sitting on a huge piece of prime downtown land — that is to say, valuable downtown land. If this land was rezoned, it could be worth as much as $300 million — and this company, the leader in China’s e-learning business — snatched the entire university up for about $66 million.

“There is so much wealth locked up in the value of this real estate that the company could theoretically sell some of its biggest properties to developers for a huge profit, and then just open up new campus locations on less expensive land….

” While the senior management told me that they aren’t precisely sure how the leveraging of their real estate holdings will play out, they do realize that they’re sitting on a huge pile of cash that can be used for even greater expansion — both internally and via acquisition.”

OK, so that’s the “hidden value” … how about the insider buying, and some more specific clues?

“I wasn’t surprised at all when the senior managers that I spoke with told me that they had very recently purchased a not-insignificant amount of common stock in the company on the open market. This is the kind of insider buying that speaks extremely well for the company, and it was a more than just a pleasant surprise to hear just how personally invested senior management are in the success of the company.

“Not to mention that the company recently reported excellent financial results for the first quarter of 2010 — with total revenues increasing 42% over the same quarter a year ago, and gross profits surging 30%. The company is rapidly expanding and saw particularly strong revenues from its recent acquisitions.

“In fact, nearly all the fiscal metrics for this leading company were positive — as was the company’s guidance for full-year 2010. The company is on target to achieve year-on-year revenue growth of more than 50% — hugely bullish for our trade.”

So we’ve got a Chinese education company, with a lot of valuable real estate, 42% revenue increase year over year, and some insider buying. Who is it?

Thinkolator sez: ChinaCast Education Corporation (CAST)

This has been a Hsu pick for a while, with a somewhat spotty record teaser-wise — he picked it about a year ago and promised it would double from $4 to $8 … which it did, briefly, though it seems unlikely that he sold it before it gave up half of those gains because back in January he promised it was a $7 stock that would double to $14 — he’s still got six months or so for that second promise to come true, but the shares have bounced around between $6.50-$8.50 for most of the last year, and right now they’re at the bottom of that range, around $6.35 as I type.

And there has been a nice spike in insider buying this year — the biggest buy was by the CEO back in January, when he picked up about $4.5 million worth of shares at $7.22 (he now owns about 2.7 million shares, far more than anyone else except for Fir Tree — more on that below), and two other executives and two board members have bought substantial chunks of shares (a little less than $2 million overall) over the last six months, with the other executives buying also in January and the directors jumping on board over the last few weeks. This is notable not just because insider buying generally indicates a good future for the stock (all else being equal), but also because there’s a big chunk of selling possibly underway — their biggest institutional shareholder, one of the Fir Tree hedge funds, owns about 13% of the company and filed a registration statement to sell those shares.

And yes, Virginia, they do own a lot of real estate — that campus that they are in the process of buying now is Hubei Industrial University Business College (HIUBC), which they’re buying in a somewhat complicated transaction with the controlling investor, Wu Shi Xin, he’s buying into CAST with an investment of about $29 million (at a share price close to $8) and then CAST is buying the university for about $66 million in cash. This makes three large urban universities that they’ll own, and the real estate is significant (almost 200 acres in total for the three campuses, and millions of square feet of office and classroom space), though I have no idea what kind of zoning or other rules might restrict the usage of those big chunks of land.

It’s kind of fun to see the “hidden real estate” argument again — that was the key behind the vast fortunes made by Eddie Lampert and early investors in Sears/Kmart when their real estate value was “unlocked,” and I hear similar murmurings about Radio Shack these days with the auction for that company attracting some private equity bidders, but “hidden” real estate value isn’t as sexy as it was five years ago … perhaps because so much of a company’s “hidden” real estate exposure in recent hears has been very much better kept under wraps.

That investment in HIUBC used up about half of their stockpile of cash, from the looks of it, and the investment from Wu Shi Xin brings some dilution and a new large shareholder (he’ll be the largest single shareholder now), so that combined with a quarter where the earnings came in a bit short of analyst estimates (10 cents versus the 12 cent estimate), with a dollop of China worry on top for good measure, probably goes some way to explain why the shares have fallen to these recent lows near $6, though most of that fall came before the earnings announcement.

Analysts expect them to earn 42 cents per share this year, which would give a 2010 PE of about 15, and they think earnings will jump about 25% next year. So it’s not dirt cheap, but it’s certainly not expensive … and given the high margins it is a little surprising that it trades at such a huge discount to market leader and investor darling New Oriental Education (EDU), though EDU is known mostly as a language school and none of these companies are really easy to compare directly.

CAST started in business as a satellite broadband company, which is probably why they still have a number of tech and satellite folks on the board, and they continue to be a mix of both traditional and online educator and e-learning vendor (sort of like combining Apollo’s University of Phoenix or the Washington Post’s Kaplan unit with e-learning software company Blackboard) … that service side, their e-learning network that works with about 15 state-owned universities, is where the higher margins come in that allow them to pull dramatically more from a dollar of sales than do most for-profit education companies (profit margin of 25%+ vs. 10-15% for most for profit educators in the US or China … though New Oriental Education (EDU) comes close at about 20%)

And they do have some other potential growth triggers — including their 43% ownership in China Post Media, which is following in the footsteps of on-premise advertising companies like Focus Media by putting LCD screens in Chinese post offices for advertising, and also leveraging that to do direct TV sales with post office fulfillment. Their numbers aren’t consolidated with CAST now and this doesn’t appear to figure substantially into the company’s value, but it’s possible that this could become significant in the years to come (and at least provide some more advertising push for CAST’s education offerings).

If you’d like to listen to management yourself and see what they say, you don’t necessarily have to go to China — you can check out their recent presentations here on their website, they’ve made the rounds of investor conferences over the last year to share their story, and if you’d like to see the latest numbers (released about three weeks ago) their quarterly press release is available here.

So what do you think? Does CAST have the “hidden value” you want, or are they too busy diluting and growing to turn that “value” into earnings? Any other for-profit education favorites, in China or elsewhere? Let us know with a comment below.

And, of course, if you’ve ever subscribed to Hsu’s Asia Edge newsletter we want to hear your opinion — just click here to review it for your fellow investors. Thanks!

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9 Comments on "“Discover the Secret ‘Hidden Value’ of Chinese Companies”"

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Mary Ann
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Mary Ann
June 2, 2010 5:03 pm

The so called hidden value doesn't attract me, but their core mission does. I own 500 shares of CAST, and I certainly haven't made any money on it. It is down a little bit.

I keep thinking I should sell it and take the loss.. Now that I've read this analysis, I'm wondering if I should keep it. Hmmmnnn…..

dlst
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dlst
June 2, 2010 5:31 pm

Thanks for your detailed assessment, Travis. The boots-on-the-ground mantra has become less persuasive to me over the last 2-3 years as Robert doesn't seem to do better at picking China stocks than do stay-at-home folks like the Cabot guy (Paul Goodwin). Hsu's followers would have done better to have kept EDU (sold for ~$80 in early Jan. after which it rose, hitting $100 briefly in April) and sold CAST which since early Jan. has dropped substantially.

bill
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bill
June 2, 2010 5:48 pm

thailands cpfoods looks to me like a screaming buy

dlst
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dlst
June 2, 2010 7:40 pm

I have subscribed to China Strategy for several years but currently own none of his picks. He failed to get his subscribers out of the mkt in 2008 even as the bottom was dropping out, and did not get them out after the start of the current China downturn; although to be fair, neither did Paul Goodwin, whose service has also not been doing very well in the last month or so.

kbam
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June 3, 2010 6:27 am

CPF on the THailand stock exchange is 17.60 baht

Chengduexpress
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Chengduexpress
June 3, 2010 8:05 pm
"And yes, Virginia, they do own a lot of real estate." Hold on, Virginia. They own zero real estate. Nothin'. Yi wu suo you! You cannot own land in China. You can only lease. Leases for residential property are short. 70 years. Leases for commercial or business land–shorter. 50 years or less. If you don't develop the land as the govt. wants, you lose it. Someone else more in tune with govt. thinking comes along. Goodbye, lease. Ask McDonald's about their experience in Beijing. Chinese tend to park their money in 'real' estate because at least there is no property… Read more »
shanghaiedrick
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shanghaiedrick
June 11, 2010 2:23 am
i am new to this website (awesome site) and not trying to create arguments or be negative, but i am an American living in China and from I see, China is all a front. its all pay offs, and showing of wealth while robbing peter to pay paul. the Chinese way to do business seems to be "get as much as you can, as fast as you can and run" how do you value companies in China when dealing with business practices such as these? what do you look at when you can't believe the management, nor the financials?
Jack dash
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Jack dash
May 28, 2013 3:09 pm

I was persuaded by Hsu’s persuasive patter but have virtually lost ALL my money following his recommendations. The ‘boots on the ground’ stuff is all BS when it comes to actuality.

Gravity Switch
Admin
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June 4, 2010 1:19 am

Good point, thanks! A long-term lease can still be a valuable asset, and it seems like land reform in the country will move faster than in the city,
But at the very least it does add some uncertainty.

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