Tuesday, September 17, 2013

A Great Value Play: Lihua International, Inc. (LIWA)

Just took a position in Lihua International (NASDAQ: LIWA) and I usually like to do some sort of writeup so I can remember in the future why I took particular positions. Lihua International is a Chinese reverse-merger company that is in the copper wiring/electrical arena. They're currently trading at about $5.07 per share ($158M market capitalization).

Asset Valuation

First thing that jumped out to me about this company is that while the market is valuing them at $158M, they have $144M in cash equivalents alone in the bank. Ignoring the $854M in revenue in 2012, this at first glance seemed to be a complete misvaluation by the market because if you divided up the cash alone, each share outstanding would receive about $4.80. In fact if you look back to 2011, if all assets were liquidated and debt paid off, net current assets per share alone are worth $11.69, and that was over two years ago:

Lihua's Net Current Asset Value/Share (2011)
(click to enlarge)

Attractive Margins

Another thing worth noting is Lihua's supply chain management. Unlike its competitors, Lihua isn't making its wiring from virgin copper, but instead scrap copper. The benefit of this is that its margins are not compressed like it's competition's because its costs are not as high, so its management of scrap copper suppliers has given it a competitive advantage:

Chinese Copper Suppliers
(click to enlarge)

Product Mix

Besides it's supply chain management, Lihua also has the benefit of focusing on one of its core product innovations, copper-clad aluminum wiring (CCA). Their high-quality pure copper wiring alternative is priced much cheaper than pure copper wiring (almost 1/3) which provides significant cost advantages in larger projects from the lower commodity price of aluminum.

Copper-Clad Aluminum (CCA) Wiring Structure

Why is this important? Because the PRC government just approved $240B to be invested in the development of China's Smart Grid infrastructure over the next five years so all of its citizens are able to receive affordable power. Along with this comes miles and miles of necessary wiring and cable running, and what better use of CCA wiring/cables than for large projects over thousands of miles. Why is Lihua set up best to benefit from this? Because they currently are the only company that has the proper license in place to import scrap copper to China from places like the United States, which makes them the only company currently able to even approach filling such large orders. Besides CCA wiring, its product mix does still include pure copper wiring, in addition to copper anodes, rods, and magnetic wiring.

In addition to China's investment in its infrastructure, China is the number one consumer and importer of copper:

Copper Demand By Region
(click to enlarge)

The trend is in no way slowing down either, current predictions are that given the trend, China's consumption and utilization of copper could soon exceed world supply, which means scrap copper suppliers are going to become vital, and Lihua is already in position to benefit from this. As far as copper commodity fluctuations go, even though copper pricing is expected to remain stable with the growing demand, Lihua's products are all priced on a cost-plus basis, which means any movement of commodity prices would not erode its profit margins.


So why does this price of $5.07/share seem too good to be true? Well, its China, which means shady business practices, and its a Chinese reverse-merger, which means potentially even shadier accounting practices. However, due to the fate of its fellow reverse-merger companies such as China MediaExpress Holdings (CCME), all Chinese reverse-mergers are being painted with the same brush by institutional investors.

In 2011, Absaroka Capital, who had taken a short position on Lihua, released a study it commissioned on Lihua trashing the company's practices and accounting methods. Among things claimed in the study included doubt regarding Lihua's financial statements, its executives' backgrounds, supplier relations, and its auditor's track record. In response to this allegations, Lihua's CFO directly addressed all claims (seen here) made by Absaroka, which in my opinion rendered them moot. In addition to that, Lihua has made strides over the past year to be as transparent as possible to the market regarding its accounting methods, even going so far as to having forensic accounting firms such as John Lees Associates do a full investigative confirmation of its cash balances. Besides this, its auditor is Crowe Horwath. While technically using Crowe Horwath's Hong Kong division, Crowe Horwath has a reputation here as one of the top ten auditing firms in the US.

Also, since these allegations were made two years ago in 2011, I'd presume Absaroka has already left its short position by now after the stock tumbled 22% from its study. In other words, they made their money, and now with Lihua's transparency of accounting practices, there's little more to gain for Absaroka or any other institution with a short interest.


Taking a long position in LIWA, committed half my capital allocated to this position for now in case of a dip in the price, this will allow me to average down a bit for a bigger return later. My estimated fair value of the stock is about $15, with a hedge of at least $11.69 from a net asset valuation. Expected time for value manifestation is about 2-3 years, with a option for future review of fundamentals at the $12/share mark.