This one comes in from Bill Mann at the Motley Fool’s Global Gains service, which I’ve looked at several times before — and I’ve also liked a lot of their picks and have invested in a few of the same companies personally, so I usually pay extra attention to their ads.
Which doesn’t make them any shorter, unfortunately — as with all Motley Fool email ads, this one would require a serious binding if printed out, and the felling of a few trees.
This is a follow-on to the general focus that Global Gains has had on “Tier Two Cities” in China and India — focusing on companies that are poised to profit from the growing smaller cities that most of us haven’t yet heard of, and that most investment analysts don’t visit. Past picks along these lines have included Home Inns (HMIN), HDFC Bank (HDB), and a few others that don’t immediately spring to mind. As one might guess from the collapse of the Chinese and Indian markets, none of those picks are doing particularly great at this moment (I do own shares of HDB, for full disclosure).
The thesis is probably reasonable, though, since in China in particular there is a strong governmental focus on making sure that the hinterlands improve and rural poverty rates decrease, and regional cities get more appealing, to cut down on mass migration to the coastal cities and make sure there’s not a peasant uprising on the horizon.
And that’s part of what the Motley Fool is selling here — the regional buildup, with a particular focus on Xi’an, since Bill Mann and his analysts recently visited that area in their trip through China.
Let me give you a taste of the ad first.
The Global Gains folks call the companies they’re interested in “State Sponsored Enterprises”, which is a play on the State Owned Enterprises that are the huge, inefficient, lumbering giants of old Chinese industry. Like most folks, they want to stay away from state-owned firms because the entrepreneur-owned firms are generally much more profitable and predictable, but this is sort of a blend. The government realizes that their old national companies are being beaten out, so they’re trying to nurture the strongest ones and push for mergers in the industry to get the strong players together and build up some really good companies.
So what we’re looking for here is …
“Billion Dollar SSE’ No. 1 — Locking down the planet’s largest steel industry”
“Does it surprise you to hear that China is the world’s largest consumer and producer of steel? It surprised me. Especially when I heard that more than 1,100 independent steel companies are stumbling over each other to get it done.
“That’s one problem Beijing is determined to fix, beginning by consolidating the hundreds of SOE steel producers. Even if it means allowing one private company a big piece of the action.
“By 2020, the State’s written goal is to concentrate a full 70% of domestic production among the top 10 producers — up from less than 35% today. There’s only one catch.
“In China, as elsewhere, mergers come at a cost, often including the loss of the primary local employer and source of tax revenue, not to mention the political cost to local officials.
“No wonder Beijing’s consolidation mandate met resistance at the provincial level. But again, that’s great news for investors like us.
“You see, I’ve uncovered one remarkable company that has found a way to gobble up China’s best-run SOE steel producers, while preserving jobs, tax revenues, and political clout at the local level.”
So that’s the company we seek — what are some specific clues we get?
“… the company is China’s oldest private steel producer.”
“…its charismatic leader rose from poverty to national hero, even earning a spot as one of two entrepreneurs representing China at the Asia Pacific Economic Cooperation forum.”
The company’s goal is to become the “largest, most profitable steel company in China — primarily by acquiring the nation’s best-managed steel manufacturers — leaving the weaker sister SOEs to wither on the vine.”
And they’re apparently doing this using “a strategy of entering into joint ventures with its acquisitions, thereby satisfying the provincial and State government, while keeping top managers on board and eliminating the tensions associated with all-out takeovers.”
Because the government is trying to weed out the weak state-owned enterpirses and spur consolidation, which is setting low prices for these companies, Mann believes that this is a “once in a lifetime opportunity” to build up these assets at low prices.
And remember that I mentioned Xi’an? That’s apparently one of the keys to this company’s future … in Bill Mann’s words:
“As fate would have it, Beijing has named Xi’an, capital of Shaanxi Province, as the beachhead for its “Go West” initiative. This year alone, the province will launch 150 infrastructure projects, including a new airport, a subway, six new highways, and three dams.”
“Why does this matter? It’s simple. Guess who has Xi’an virtually locked up?
“You got it. Because steel rebar is prohibitively expensive to ship long distances, this company’s primary subsidiary in Xi’an gives it a daunting advantage. With no competitors within 250 kilometers, the western beachhead is essentially theirs for the taking.”
There’s more, but that’s probably enough … both to get your salivary glands churning, and to allow the Thinkolator to churn a bit …
… this company is …
General Steel Holdings (GSI)
The shares fell over the Winter and traded for around $8 for much of the first part of the year, but in April started a nice climb that has them now up around $13.50. Their last quarter’s earnings were only 6 cents a share, but the few analysts who follow this one forecast rapid earnings growth, largely due to continuing large acquisitions, and that gives them a forward PE of about 10 on 2009 numbers (closer to a 20 PE on 2008 numbers). Note that this one is hard for analysts to project, apparently, they missed big on their most recent quarter but have outperformed dramatically in previous quarters.
GSI echoes some of the same themes as Bill Mann on their website — “Our vision is to become one of the largest and most profitable non-government owned steel company in China” …
… and they also note that their joint venture in Xi’an that owns Longmen Steel, a big rebar and infrastructure steel producer, is a key … in their words: “We are the largest steel producer in the province and, by our own estimate, have a 72% market share of all heavy construction and infrastructure projects in Xi’an city and the surrounding 15 largest cities.”
With all the construction going on in Xi’an and in surrounding areas, I can certainly see how growth might potentially be very nice for General Steel in that area — this is only one of their joint ventures so far, however, and they are primarily an acquisition-focused company. They are trying to quickly roll up steel producers around the country (there are plenty of targets), so there could certainly be operational risks as they grow very quickly and try to manage a far-flung empire of many smallish steel companies.
They have made a few other acquisitions in their relatively young life, with most of their other production focused on sheet steel for the automobile and appliance industries.
And while steel prices are high and perhaps heading higher, it might behoove us to look into the future — do you think steel prices will continue to climb? Is additional capacity coming online before too long that will normalize things? GSI is not going to be a major player in the international steel trade, at least not anytime real soon, so if they try to grow beyond being a local producer and supplier there’s certainly the possibility that they’ll run up against Arcelor Mittal and Posco and the other real giants of the steel business. They can probably run rings around the old state-owned enterprises, but if the business really opens up and outside players come in in strength, I don’t know how GSI would do against those truly seasoned multinational players.
That said, my inclination is to scratch my chin and say, “hmmm, maybe worth a gander” — I’ve got a fondness for Chinese companies with efficient management that have the potential to grow within a hot sector, all with some implicit or explicit government backing. That’s a nice tailwind, and the valuation — if you believe the growth that is predicted from their recent acquistions — is downright cheap at a forward PE of 10.
Of course, there is now and there will be in the future significant operational risk — their growth relies on integrating acquisitions, and on making many more acquisitions in the future. I don’t know any reason why they wouldn’t be successful, but also don’t particularly guess that it will be easy.
Finally, this is yet another company that is dominated by a single shareholder, Henry Yu, who can do essentially whatever he pleases. It also has lots of complicated transactions with related companies, which is not terribly uncommon in China or in the business, as far as I can tell, but it does get confusing. On the plus side, some of these subsidiaries and investments are in related companies in coking coal, transport, or other needed services, so that probably helps operationally.
I’d suggest anyone who’s interested in this one might want to read their latest 10-Q filing with the SEC — you can see the tremendous revenue growth (mostly from acquisitions), as well as the risks that management has identified and the charts and listings of their subsdiaries and interrelationships.
And finally, you might note that the company got a little bit of attention lately and the share price has poked up a bit — that’s thanks perhaps in part to Bill Mann and his folks, but probably more directly to a good article in Investors Business Daily last week. Also worth a read.
What comes after “finally?” A P.S., I guess …
P.S. Several bloggers write pretty actively about GSI, and of them a few contribute to SeekingAlpha, so you can see a couple decent, in-depth articles on GSI here.
And as always, if you’ve got anything exciting to share about these guys, feel free to let loose.