I finally read the 10K and the posts on multiple boards and listened to the conference call last night. Here is my initial reaction.
Chokingstones has a right to be upset about the Beijing delay. That facility was to be the growth driver of 2011. Because the building is not operational LTUS has no GMP manufacturing facility so now they can not manufacture 3 of their 5 self branded highest margin producing drugs. Muxin alone accounted for 8% of sales in 2010. The lack of warehouse space causes logistical problems for the fast growing OTC segment of LTUS adding pressure to margins on that side of the business, and the Beijing wholesale market, which is where LTUS is "transitioning" will have to wait another 6 months.
Retail revenues will take the place of lost wholesale revenues, but they carry only a 25% gross profit margin as opposed the 70% for the wholesale drug business. The result is guidance is for 70 million in revenues and 14 million in profits for 2011, equal to or slightly lower than 2010 which includes the 6 million dollar write off for the land in Inner Mongolia.
The write off appears to cover 90% (they now intend to use just 100 of the 100 Mu) of the monies spent improving the land. It looks like the best offer they have for the aforementioned land is a development deal where someone will build their 40-50 million dollar facility in exchange for the additional 900 Mu of land.
To me this is positive in many way and questionable in others. The positive is that the someone believes the land is worth 40 to 50 million dollars. Also LTUS will be able to keep the tax incentives (100% credit for 6 years and 50% deduction for 6 additional years)LTUS saves 5 million in 2009 and 6 million in 2010. Extrapolate that out and LTUS will save an additional 42 million over the course of the next 10 years. The questionable side is whether or not LTUS needs an additional facility as opposed to using the cash to buy other entities which would add to the bottom line, or buy back stock at these rock bottom prices. 50 million could buy back the entire float at $4.00/share.
Although the numbers are at first a let down, I have to admit I feel much more confident in their validity. Freidman seemed to hold LTUS to a much higher standard which brought abl=out several of the write downs. The land in Iner Mongolia and over 2 million in professional fees. Apparantly, LTUS paid stock in exchange for 3 years of consultant work valued at over 2 million dollars. LTUS had been amortizing this expense, but as the stock became tradable in Dec. 2010, Freidman had them expense the entire amount this year. Freidman also validated the value of the Land in Inner Mongolia, buy letting it appear on the balance sheet at cost. The rule of thumb is the lower of cost or market.
This all being said, LTUS is trading just North of a 30 Million dollar market cap. They expect to earn 14 million this year and significantly more in 2012 as the new facility (knock on wood) comes online. 2013/2014 brings the hope of the new arthritis and diabetes drugs (combined estimated sales of 65 million).
Many China small caps are folding under the existing pressure of real numbers, UTA CCME SKBI CELM NIV CEU just to name a few. Eventually the real companies will be sorted from the fraudulent and those remaining will experience PE expansion. LTUS is working on its internal controls and if the stock can regain its value they will be up listed.
I am holding at these levels.
If they were smart they would find a loan to take the company private at these stock prices (assuming they are legitimate). Nonetheless, it is disconcerting that management is so poor at estimating the completion date of a facility. I can see being a few weeks off when you are within a couple months of completion. But they are shown to be a over a year off when they just said they were within a couple months of completion. Something's not right there. How can you be that far off from knowing when the facility will be done? That sounds like either incompetence or intentional delaying tactics, neither of which is acceptable. I wouldn't be surprised if the next announcement is that the facility is delayed until June 2012.
Thanks Guild, as always, for the detailed analysis. I think you are correct in that LTUS has a great business model poised for future growth.
As chokingstones and others have pointed out, however, it seems that management has been incompetent thus far in handling the PR/investor relations side of the house for the following reasons:
1. Repeated delays of the building completion - just one month after Shen had emailed you, indicating the schedule was on track for a 2Q move-in, they announce this date has been pushed back to the end of 2011. It's now about a year later than what the company initially said. Though I realize the building is large, I don't understand how their estimates could be so far off.
2. Timing of the Reverse Split - 3 months ago, the share price was the same and we had twice as many shares. In just 3 months, we have lost 50% due to poor timing of the reverse split. They should have had the uplisting request almost finalized before announcing the reverse split. According to Dr. Shen on the conference call, they didn't realize the reverse split would be approved much faster than their uplisting request. Again, that points to mgt incompetence.
Couple these missteps with the negative sentiment in Chinese Reverse Merger sector and you have the extremely low valuations we are now seeing. On the bright side, this points that share price isn't their primary concern (which it would be if the company were a pump-and-dump fraud). It seems like they are trying to execute their business model and let the market pick up on the results in due time. In addition, this is reflective in the recent write-down as they get their books in order.
In the short-term, however, it leaves us long-term holders sitting on large losses that won't be corrected in a month or two. But I agree with you, Guild, if we have the patience to wait several years, I think this investment with defintely pay off.
Thanks Mike, It is always valuable to read your view and your reasoning.
Regarding the Inner Mongolia land, they said in the past that this region is of strategic value to their growth strategy, so I must have faith in their judgment that developing a strong operational center there is a major investment for the future and a best use of their resources. So although $60 million in the bank seem to us so desirable (and I'm sure they considered it also), we must decide if we have appreciation for management or we should try and take over the company and run it ourselves… And for such a small growth company with constrained working capital it is compromising future growth if they use any cash to buy stock.
I also feel the critical issue of being honest and reliable is on more solid grounds, both by their own conduct (they intend to strengthen their internal controlling and accounting functions) and by the noticeable contribution of their highly professional accountants and attorneys. I am sure they advise them wisely.
I will wait until I feel the entire sector is reaching a sustainable floor with silent in the air and no more falling bricks for a while and then will buy more.
I agree with you Amy,
My questioning of the project in Inner Mongolia is that it is only a 2 1/2 hour drive from the Beijing HQ. The most recent words to describe the building are distribution center, so I question that necessity. Pharmaceuticals are not large and bulky and you could fit a near infinite amount in the 10,000 square meters of warehouse being built in Beijing.
The original plan for the I.M. land was to build an IV fluids factory capable of producing 240 million units a year. If that is the plan than I am all for it. If it is just to build an unnecessary structure to realize a tax benefit, then I am opposed.
I do believe in Dr. Liu's vision and I think he has built a great company from nothing. I also believe he is working in our best interest. He and his wife combine to have 13 million reasons to want to succeed.
Good rational analysis by guild in a very irrational market. I have a fill on my 1.02 shares. Looks like 1.01 is coming up next. (If we aren't seeing capitulation here, I wouldn't know what else to call it)
At the same time I have to admit it is hard to feel so right and be so wrong. I don't like much of what we learned this report and I understand the investors reaction to the news especially given the prevailing environment. Investors who were once comfortable in this space are no longer. It will take time to cultivate new investor fortitude. This space needs a winner where someone makes a lot of money so others will search out similar opportunities.
I am thinking about the consultants who were $2.25 million in stock that became free to trade in q4. I imagine they could put downward pressure on this stock for sometime if they are panicking about losing their payday and selling at any cost.
I still believe in LTUS and their potential as much as ever. I also have always expected to hold until at least 2014/2015 when all of the careful plans start to bear fruit.
We will see how this plays out.