Jiangbo (JGBO) is a pharmaceutical and health supplement company based in China. It trades for $86 million despite a net cash position (cash minus debt) of $95 million. If an American company traded at a similar discount to its net cash, it would either be March of 2009, or the company would be losing money hand over fist. But Jiangbo is not only not losing money, but has generated net income of $44 million over the last year. As such, the stock looks like a downright steal. So should value investors jump in with both feet, or is there more to this than meets the eye?
First of all, it's worth noting that Jiangbo is one of the many Chinese companies that listed in the US using a reverse merger. This is significant because a number of such companies have turned out to be frauds! As such, investors are currently shunning or shorting companies of that ilk, which is either creating a huge buying opportunity or exposing these companies for the frauds that they are. Jiangbo has seen its stock price fall almost 50% from its highs some five months ago.
Because of Jiangbo's apparent wide discount to its cash and earnings, the most important factor in determining whether this is a worthwhile investment is the accuracy of the company's financial statements. Investors here are not counting on some new product, new market or competitive advantage; they will make money without all that stuff as long as the company's financials are for real.
The first step in determining the veracity of the financials requires identification and study of the company's independent auditors. These guys are charged with, among other things, checking the company's bank balances (and not just relying on the company's paper statements, which can be falsified), so their character and integrity is important.
Jiangbo is audited by Moore Stephens Wurth Frazer and Torbet LLP, which just last month was barred from accepting new Chinese clients. The SEC found that the accounting firm "encountered audit conditions that should have caused them to exercise heightened skepticism, including the discovery of problems with China Energy's internal controls and difficulties completing audit field work, such as inventory not being located where the company said it would be." Not a good sign!
Besides the track record of the auditors, there are other signs that not all is well with the company. For example, the company has been unable to pay its debt holders, despite an apparent cash balance of $124 million! The company claims the money is there, but that the reason for the lack of payment is "partially due to the stricter foreign exchange restrictions and regulations imposed in the PRC starting in December 2008". Other Chinese companies have had no problem paying millions of dollars back to their North American investors. If Jiangbo can't even pay $4 million in interest, what hope do North American shareholders have of ever seeing that cash?
Value investors believe that to ensure strong long-term returns, they must first protect downside risk. But what looks good on the surface may look anything but underneath. Investors must dig under the hood to identify potential risks to what might otherwise seem like obvious winners. A deeper dive into Jiangbo reveals much more risk to the downside than a cursory look can provide.