Monday, September 20, 2010

Too Good To Be True?

China Education Alliance (CEU) provides onsite training and online education to both children and adults in China. The company trades for $120 million, but earned $15 million in 2009, expects to increase revenues by 30% this year, and has a $75 million net cash position. Its P/E drops to 3 once you subtract out its cash position. This is a very cheap asking price for a growing company in a needed field in a high-growth economy, but it does have a few risks.

For one thing, the company may appear too good to be true for some investors wary of fraud. The company is not audited by a big-name firm; however, the auditors of this company do have several other clients, and do pick up their phones in both their New York and Florida offices, confirming their existence. However, they have been accused of being a little bit on the negligent side in the past. China Education Alliance management did state on their last conference call that it is considering switching to a more recognizable auditor now that it has grown considerably.

Another item that may scare investors is the dilution of the company's stock. The company has gone from 25 million to 31 million shares in the last year, due to conversion of preferred shares into common, and the exercise of warrants and options. The share count should be more stable going forward, as no more pref shares exist, there are no more warrants outstanding, and options are being issued at a more reasonable clip (and only 400,000 remain outstanding).

The company does trade at a premium to book value, so the investor does have to believe this company has some sort of advantage that can keep competition at bay. But there are other, well-capitalized companies that appear to compete with CEU.

Despite the fact that management believes its shares to be undervalued, it appears intent on using its large cash balance to continue to grow, which could be very good (if returns on that capital continue as they are currently) or very bad (if competition forces returns to more normal levels) for investors.

The upside for this company appears quite high. Investors will have to determine whether the downside risks are worth accepting in return.

Disclosure: None


Anonymous said...

Did you get anything out on AMEX:ALN?

Anonymous said...

It's another Chinese reverse merger (originally ABC Realty Co. from North Carolina) that have a high likelihood of fraud. They share their IR firm CCG IR with exposed firms. Their auditors have had serious problems with the PCAOB in the past and they are also the previous auditors for China Sky One Medical (John Bird aka WaldoMushman has done private investigation and exposed them by finding huge differences in figures reported to Chinese authorities and figures reported to SEC). China Sky One has since switched to another shady auditor, MSPC.

No matter how quickly these shady reverse mergers grow, no matter how successful they are, they find some excuse not to hire a Big-4 audit firm. There has to be a reason.

There seems to be no margin of safety because the downside is zero and you either have blind faith or you don't. At worst, they may be making up their numbers, including cash balance. There have been occurrences where Chinese companies don't allow their auditors to see their bank statements (recently DYP), big firms would resign but small firms may not. And management has no risk of jail time.

Mervyn said...

Such firms can only be dug out through deep screening of their current and past figures couple with rigorous grilling of their management repeatedly in different manner.

Note: To these firms, numbers are just numbers. A return of capital is more important than a return on capital.

Otherwise, I like your posts and have also linked your blog to mine. Thanks!

shb600 said...

What do you think of stock now?

Saj Karsan said...

Hi shb,

It looks even more like a fraud now. Check out this update to this post.

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