I’m here in Shanghai, it’s about three in the morning, I have a six o’clock flight to Shenzhen to meet with a potential client, and then I’m off to Beijing for a couple of days, then to Dalian, then finally to Shandong.
I’ve been hearing a lot about the “China Bubble” over here. Well, you know that’s what it is—it’s just talk—China Bubble talk.
It’s true that they are limiting some of their lending to companies in China, no question about that. There is a fear of inflation. But there are always those trying to find a bubble. There have been two bubbles in the last ten years or so here in the U.S. One is the housing market and one is, of course, the Internet bubble which burst in 2000.
The Internet bubble, if you remember, was based upon companies in the Internet space, most of which had no revenues and were hemorrhaging losses, but also had very high valuations and were looking at extraordinary expected earnings, in most cases earnings that never materialized. So you had a market that was overbought—I should say it was clearly ten times overbought—certainly, many companies like Amazon, eBay, Yahoo, and other Internet companies did become very profitable, but most did not. So you had very high valuations all based on a bubble. There was no foundation, no fundamentals, and for every dollar produced in revenue, most of these Internet companies were hemorrhaging three to four dollars in losses.
The next bubble was the real estate bubble; that bubble was premised on the idea that property values would always increase and would keep increasing and appreciating. That was a false premise. You had the overvaluation of property, a tangible asset, just as you had the overvaluation of an intangible asset in the Internet companies—and those are bubbles—overvaluation of either intangible or tangible assets. At some point, they do burst.
Obviously, the real estate bubble here in the U.S. affected countries worldwide because a lot of exotic instruments were created based on these mortgage-backed securities, so institutions in Europe and the U.S. and all over the world had pieces of these exotic credit-swapped derivatives that were basically insurance policies on a bet, a gamble, on whether these properties would be defaulted upon and, of course, you had homeowners buying properties that they really could not afford.
You do not have this situation in China, particularly in the small-cap sector where RedChip operates. The companies represented in the U.S. markets that are based in China are fundamentally very solid companies. They’re not trading at extraordinary P/E’s. Most of the companies in our portfolio are trading below a P/E of 10. The average P/E for the S&P over the last 20 years is about 17.
These are fundamentally sound companies that are not getting loans from the government. The companies in China getting loans are typically big, state-owned enterprises. These smaller, fast-growing companies like China Natural Gas (CHNG), China New Media (CMDI), China Gengsheng (CHGS), American Lorain (ALN), China Education Alliance (CEU)—they are not getting loans from Chinese banks. They’re getting money from the U.S. capital markets. They are not dependent on these loans to grow their business. They can raise as much money as they need in the U.S. In fact, over the last 12 months, in the RedChip portfolio of companies, they’ve raised over $150 million to grow their companies from the U.S. capital markets.
So, even if the slowdown in lending in China slows the productivity by one percent, which is possible, you still have an 8–8.5% GDP, and the fastest-growing economy in the world. They’re going to continue to make two-thirds of the world’s shoes. They’re going to be the number-one maker of automobiles. They’re going to continue to put a high focus on the education of their people. They’re going to continue to dominate manufacturing for years to come, whether their GDP grows at or 6%, 10%, or 8% a year. You could see some inflation, but to say that this is a bubble that is going to affect these Chinese companies listed in the U.S. is untrue. This is not a bubble.
The companies in China listed in the U.S that we represent, and the many that we don’t, are fundamentally very strong. They get as much capital as they want. They’re going to continue to grow their business. If there is an economic slowdown in China, maybe these companies don’t grow their top and bottom line at 30, 40, and 50%—which is what we’re seeing—maybe they only grow at 20%. It’s still a great place to put your money.
I would say take advantage of the opportunity because this is irrational fear—this exodus we’re seeing from some of these China stocks. This is a great time to go back into them and build your positions and be patient—because these stocks will recover, the fundamentals are strong, and these companies will continue to grow.
At RedChip, we are focused on the micro picture—with small-cap stocks listed in the U.S. that are Chinese companies. But clearly, the market in China is not a bubble. The companies both here and there are not overvalued by any metric. This country benefits from a very cheap supply of labor, and 500 million people have been lifted out of poverty over the last 20 years. You have an endless supply of cheap labor in the countryside of China. There are hundreds of millions of peasants who can work in these factories for $200 a month, and no country in the world can compete against this cheap labor.
When you’re working with small-cap companies, there’s always going to be some surprises. But, if you’re buying a cornucopia, buying a basket of these stocks in the small-cap space, particularly in China—of which we represent about 12 Chinese companies and will represent about another 10 in the next 6 months—if you get some of these companies, you’ve diversified yourself nicely, then you will see those stocks like L & L Energy that went from $1.00 to $7.50 over a 12-month period—quite a gain. You will see those stocks like China Education Alliance that went from $2.75 to $7.50. You’re going to see these opportunities like Longwei Petroleum that went from 25 cents to $3.00.
Now is the time to get back in. Buy that China New Media (CMDI), that’s a great play. China Natural Gas is a great play at $10, with a $20 price target—Janney Montgomery Scott analysts put that target on the company a couple of weeks ago. It’s trading at $10. Take advantage of these situations now while they’re down.
China is the place to be. If you’re in the market, you need to be in these China stocks. Get into the companies that are making money and growing and park your money there. Not to have some of your money in the China sector is to miss out on some huge opportunities. There are investors making a fortune by investing in these China stocks early as they go public in the United States. Every one is going to be a major homerun.
Again, we always want to make the point that when we talk about these RedChip clients, they are actually clients. They do hire us to go out and tell their story. We are paid to go out and tell their story and so we want to be very clear. But also realize that we’re very selective, that we have a reputation. We’ve been in business for 19 years, and we want to bring only the best companies to you, those that have the biggest propensity for appreciation in the long term and sometimes in a very short period of time.
Editor’s note: This article is based on a radio interview with Dave Gentry and Gary McKenzie conducted on RedChip Small-Cap Radio on January 29, 2010. For full radio show archives, please click here.
Disclosure: The subject securities are clients of RedChip Companies, Inc. RedChip Companies, Inc., employees and affiliates may have positions and affect transactions in the securities or options of the issuers mentioned herein. For full financial disclosures for all RedChip clients, please visit http://www.redchip.com/disclosures.asp?src=rcv.
