Friday, April 17, 2009

Chinese Dragons

Anyone paying the least amount of attention to investment news has certainly noticed the mushroom of Chinese operations tapping into the U.S. capital markets. The larger China concerns have opted for joint Taiwan or Singapore listings along side a U.S. national market listing or sometimes the OTC/BB (Bulletin Board / Over-the-Counter) listing of an ADR (American Deposit Receipt). The smaller concerns appear to favor a reverse merger into a U.S.-based public shell company followed with an OTC/BB listing.

There has also been a proliferation of commentary about “China Mania” and “China Bubbles.” A fair amount of caution appears to be warranted given the excesses that have played out in the U.S. housing and mortgage credit markets over the last two years. Those two recent bubbles have had the direst of consequences for nearly everyone.

Information is the best protection against risk, so we have been looking closely at several Chinese operations. As with U.S. public companies, Chinese companies run the gamut in terms of products or services. The first thing that stands out is the level of profitability among the smaller players. Small, lean, and profitable with low- or no-debt balance sheets. The next eye-opener is the capital constraint that many of these companies struggle against. Several of the companies we have reviewed recently have products or services distinguished from their competitors, operate in strong growth situations or have new products to place in the market, but cannot find the sufficient working capital or investment capital to expand.

It would seem that despite China’s strong savings rate, they have not perfected a good system for aggregating capital and putting it in the hands of entrepreneurs. Instead China’s savings is going into U.S. Treasuries and the Chinese businesses are coming across the Pacific to tap the U.S. capital market to get it back.

Hmmm! For the discriminating investor this little bit of capital market inefficiency is begging for exploitation. It will take homework….lots of homework.

Next post - two new Chinese Dragons to consider. They may be small in size but they are armed with plenty of fire.

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