Is NAIBU GLOBAL INTERNATIONAL, the most undervalued stock in the market? Yes says Simon Thompson (Bull) Vs No says Lucien Miers (bear)

7th Mar '14 by Orangetree

7 comments 13089 reads

For those who are not familiar with Naibu, it is a Chinese sportswear manufacturer and supplier that has over 3,100 stores and sales outlet across China (all of them are franchises), the focus of these stores are in tier 3 and 4 cities in the country. The company made its debut on 05-Apr-12 in the London AIM market at a placing price of 124 pence per share. Although the stock initially surged to 149p/share the company’s shares since then has a torrid time and reach a low of 55p/share before Simon Thompson’s picked the company for his share pick 2014 in the Investor Chronicle and the shares have bounced back to settle around 84p/share.

WHO’S RIGHT?

After much thorough research on the company I got to say that I am veering towards Lucian Miers’s point of views, you can check out his piece below:

http://www.shareprophets.advfn.com/views/3716/devastating-new-naibu-analysis-target-price-buttons

Lucian Miers has stated several points on why the company should be looked at suspiciously:

Original shareholders sold out early, despite the owner insurances that they have agreed to a lock-in not to sell their shares;
Naibu’s competitors are also in the third and fourth tier cities and they’re all struggling;
It has gone through six auditors in six years and among other things.

Simon Thompson’s bull case for the company is mostly based on the fundamental of the business vs. the current valuation that the market is giving it right now and his points for being bullish are:

The shares are trading below cash and a third of book value;
The company’s paying a dividend of 10% and the P/E is 1 (possibly the cheapest share in the whole market);
Their half-year results saw revenue rising by a fifth to £95m and pre-tax profits up by 16% to £21.5m, a margin of over 23%.

IS NAIBU THE MOST UNDERVALUED STOCK?

In order for me to be unbiased towards this stock I decided to do my due diligence just like any corporations would do before making an acquisition.

After sieving through their accounts, I could honestly say there’s something that doesn’t smell right and here’s why:

1). Company’s net margins are higher than well-known sports brand like: Nike and Li Ning (No 1 Chinese sports brand). I have produced a table below to make my point:

Company

NAIBU

Li-Ning

…

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BrianGeee

9th Mar '14

I'm not sure where you've seen the list of questions from the AGM, but here is one list. You will see that the list of answers published on the company website is totally inadequate.

1. What has happened to the RMB10m deposit paid to Fujian Jun Xiang Bau Company Ltd (Fujian Jun Xiang) for the Quanzhou factory, and also the commitment to pay the remainder of sums outstanding for the factory and the staff hostel?
2. What is the intention relating to full payment of the share capital in Naibu China? There appears to be about RMB50m unpaid.
3. Given what is stated in the AIM admission document about historic dividends, could the company confirm what is the current situation regarding unpaid withholding tax? The Naibu HK accounts in the Admission Document seem to confirm that these dividends were paid through Naibu HK.
4. How are the expenses of the Hong Kong and Jersey holding companies paid, given the capital controls mentioned, and difficulty in transferring funds out of China? It was mentioned that money can be ‘lent’, but that doesn’t seem a likely solution for paying expenses. As a further observation, the Admission Document says: “Under the current regulations on foreign exchange control in the PRC, foreign investment enterprises are allowed to distribute their profits or dividends in foreign currencies to foreign investors through designated foreign exchange banks without the prior approval of the State Administration for Foreign Exchange of the PRC. However, the exchange of the RMB into foreign currencies for capital items such as direct investment, loans and security investment, is under strict control and requires the approval of the State Administration for Foreign Exchange of the PRC. The distribution of the Group’s profits and dividends may be adversely affected if the Chinese Government imposes greater control on the ability of the RMB to be exchanged into foreign currencies. There can be no assurance that the Group will be able to obtain sufficient foreign exchange to pay dividends or satisfy other foreign exchange requirements in the future.” I’m not sure how to correlate this statement with what was said about the permissions required to pay dividends.
5. One topic that was discussed at some length, and relates to a dividend question I wanted to ask, but left it until the Q&A session, and then forgot. The company paid I think RMB224m of dividends over the period 2008 – 2010 when it was a foreign owned enterprise, and a private company, during a period when it was considerably less profitable than it is now, and with a considerably lower cash balance. The company is currently highly profitable, has absolutely no requirement for raising further capital, and has no requirement for bank debt. Its reasonably stated main reason for being a listed company is for status and transparency. I take the point about conservatism, but it would be good if you could make a more credible statement on conservation of cash, as the history of the company pre-floatation doesn’t tie with the current statements regarding need to conserve cash. This is important to clarify.
6. Further to this point, the scrip dividend was also discussed at length. It was mentioned that it was non-dilutive as it was available to all. Superficially that seems a reasonable point. However, the share price is currently a very long way from what might be considered normal, and at the same time there exists a substantial asymmetry of information (not in a regulatory sense, but in a detail sense, which leads to difference in confidence) between insiders and wider market holders of securities. Therefore, those with lesser knowledge and confidence who take the dividend will end up being diluted by those with greater knowledge and confidence. I strongly feel it is not fair to wider market holders for insiders to take advantage of the scrip dividend at this time of highly distorted prices and information availability. As I suggested, I feel it would be reasonable, and very desirable, for all to take the cash dividend. Then those who wish to can re-invest the dividend in the very lowly priced shares in the market. Please seriously consider this proposal. It would help in multiple regards – a. it establishes the company has the available cash to pay the full dividend, b. those people wishing to have more shares can buy in the market to soak up the loose holders, c. it avoids what appears unfair dilution based upon current information and confidence asymmetry. I take the point also about HK peer companies, but the valuation situation here is extreme by comparison.
7. Just prior to the AIM listing, at the time of incorporation in Jersey, Mr Lin appeared to choose to give away approximately half of the company. A small part of this was to strategic and financial advisors, but the larger part is a mystery, indicating a hole in the due diligence or disclosure by those bringing the company to market. Mr Lin owned 100% of Naibu HK prior to its purchase by the Jersey limited company, so why should new individuals with no previous ownership, suddenly appear as owners? Then as soon as possible, those new owners are part of a large block scrambling to sell shares at almost any price. This sort of activity is reported to be a classic type of Chinese IPO fraud, and with the lack of credible explanation causes significant concern. Without any doubt, this issue should have been fully investigated, clarified, and documented as part of the admission process. Whatever explanation is finally given, should be verifiable by the non-executive directors.
8. Can we have agreement to have an updated version of the Frost and Sullivan report or similar, which will provide real feet on the ground verification of random samples of the stores and factory production. It would be helpful if there was some non-executive or reputable private investor direct involvement in the preparation and validation of the report methodology. Either a the whole report or if considered commercially sensitive, a summary of the report should be made available to investors.
9. Who owns the brands used by Naibu, and what is Naibu’s contractual control of those brands? There is a licence over 53 trademarks – what do we know about the licence? If they’re not fully owned by the PLC or its wholly owned subsidiary, is there a legally solid contract in place for their used for a fixed period. It’s an important issue of security for the business.
10. The corporate history of the company is unclear, and should be clarified. I can piece together the following items from the admission document, but some questions remain.
Mr Congdeng Lin was the production manager of the Quanzhou Naibu Sportswear Company Ltd
Ms Zhenzhi Lin was an accountant at the Quanzhou Naibu Sportswear Company Ltd
Mr Huoyan Lin was a shareholder in Quanzhou Naibu Sportswear Company Ltd until 2010, when he transferred his shareholding to his mother.
Quanzhou Naibu Sportswear Company Ltd changed name to Fujian Jun Xiang Bau Company Ltd (Fujian Jun Xiang).
Naibu China agreed to purchase the Quanzhou factory premises for RMB20m from Fujian Jun Xiang Bau Company Ltd (Fujian Jun Xiang) and the staff hostel for RMB8m from Zaiqing and Huoyan Lin on 24th June 2011.
Mr Huoyan Lin is a former director of Fujian Junxiang Bags Company Limited.
Apart from a general clarification of the corporate history, I would ask:
• What are the total commercial or other connections between Fujian Jun Xiang and Naibu China?
• What (if any) are the commercial and corporate connections between Fujian Junxiang Bags Company Limited and Naibu China? Is it simply coincidence that its name Fujian Junxiang Bags Company is quite similar to Fujian Jun Xiang Bau Company?
• Is there any commercial or present / historic connection with Quanzhou Naibu Shoes http://nibu.shoes.net.cn/ . It’s odd how similar the decoration of the buildings appear to our larger Shishi building.
• Are there any other Naibu related companies that are producing shoes or sportswear?
• Is there any production undertaken in either of the two current factories for any companies other than Naibu China?
11. The issue of payments to suppliers (cooperation relationships?) is certainly not well described, and has very much come out of the blue. Could we please have a description of what this large sum was spent on, and some indication that the non-exec directors have verified the matter.
12. An advertising company with which the company is said to have spent a large but unspecified sum (RMB12m in 20011, but more since), Quanzhou Guan Mei Te Advertising Co., Ltd, cannot be identified on an international company database. Can you please verify that the company exists, and is in no way a related party. Can you also clarify what they actually do, and verify the money is well spent.
13. Can you clarify if the current 25 main distributors and 3150 outlets (or whatever the number is now), are Naibu monopolies, or are they selling multiple brands? If so, how many are of the different types? Are any of the distributors or sub-distributors internet distributors, rather than owning physical shops? I can see lots of Naibu shoes for sale online in China on B->C sites, and auction sites such as Taobao. Note that you need to use the Chinese characters to get the full lists.
14. Can the list of 3150 stores with their addresses be made available? If not to investors, I think non-execs at least should have a full list by City. If they have a full list, then at least investors could select say 10 random addresses, or may all the addresses in a certain town, and check them for themselves.

A few other notes, but not questions for clarification.
1. Warrants should have appeared in the accounts, but auditors took the view that it was not necessary to re-issue the accounts as effect on diluted EPS is immaterial. Exercise conditions on warrants are 3-10 years from issue, at the IPO price of 124p.
2. Leo Malkin, the Senior Statutory Auditor of Crowe Clark Whitehill LLP stated that they take responsibility for the group audit, but the local Chinese audit was undertaken by a part of Crowe Horwath International, which is a network of independent auditors. They work together with CCW at the primary and completion stages of the audit.
3. What steps taken to confirm the cash balances, and at which banks are they held? The auditor indicated that they have to confirm the balances, and have to go through an exercise to confirm the cash balances. In the case of entities based in China, more detailed steps are required, and are undertaken in conjunction with the independent subsidiary auditor. The auditor didn’t know the names of the banks with which the balances are kept, but suggested the company could confirm. Simon Willis of DS said the majority of the cash was held with the Agricultural Bank of China.
4. The Chinese authorities will not permit any transfer of funds to Naibu HK in excess of the cash dividend required to be paid to shareholders, so the company’s free cash balance cannot be held in Hong Kong.
5. There is no withholding taxation associated with the creation of new shares via the scrip dividend.
6. If a Chinese customer visits the Naibu website, they would not even be able to find a single shop. That may be just how things work in China, but it seems astounding to a Western investor.

Orangetree

8th Mar '14

Hi all, calling on all stockopedia readers out there if there is any companies (listed in the UK) that they think is interesting to write an article about, please give me a shout!

William Partridge

Hi - did Simon Thompson get to see your analysis. I rather presumed his recommendations would cover off a lot of your points and was not just simply one dimensional value screening. I would be intrigued to hear his responses.

mpat89

I appreciate that you have put time into this but it is quite irresponsible of you to promote discussion of any investment case for this company.

shipoffrogs

Well I don't know about that mpat, but it could be more succinct. All you need to know - 6 auditors in 6 years.

Hi William Partridge - I try to find the best approach to contact ST, but I couldn't find any contact details, apart from the IC website. If you know how to contact ST directly please let me know.

Hi BrianGeee - The Q&A section question is in the company's website under 'Investor Relations' and click on shareholder Q&A. There should be a total of 28 questions. I don't know if u attended the AGM or not so I can't comment on how management answered these questions.
Just like I said in the article these breadcrumbs that are picked up by investors could be left by management and the answers given, well let say u can't seem to verify it whether they are telling truth or not. So to ask the tough questions one need to go off-script and focus on the company's operations and their accounts. One point I made in the article was how would the company differentiate their products instead of talking about the brand logo which as far as I am concern do not make a superior business. So you would be thinking about their Unique Selling Point, product designs, would u buy Naibu products over li-Ning or Nike and so forth. Also in the company's accounts i was surprised NOBODY picked up the cash conversion cycle and point out why the company is piling up cash whilst at the same time the cash cycle WAS INCREASING but NOT DECREASING. Hope this helps.

Is NAIBU GLOBAL INTERNATIONAL, the most undervalued stock in the market? Yes says Simon Thompson (Bull) Vs No says Lucien Miers (bear)

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