Ya' know, for better or worse, I've been in the investing business long enough to have seen, heard, and done it all (most of it at least twice). I'm grizzled to the point where I thought there was nothing left that could - metaphorically as well as literally - make me roll my eyes again. As it turns out, I was wrong. Some of the most recent bashing of Lihua International (LIWA) has just moved to the "too stupid to be permitted" stage.
I want to take a step back and look at a few of the dumbest and most desperate bearish arguments in a second, but first I want to make something clear...
If you're short the stock or bearish on the company, that's fine. If you own the stock or are bullish, that's fine too - I don't really care either way. The only thing I want is for our SmallCap Network readers to be able to make an informed and logical decision. And, with a lot of bad and misleading information out there, that's a major challenge right now.
With this as the backdrop, I specifically want to address the two most ridiculous bearish arguments so we can take the debate back to an intelligent level.
Stupid Bearish Argument #1
"The gross margins are too high and capital expenditures are too low to be believable (for a copper company)."
Just as a refresher, Lihua International is a Chinese-based copper company, making copper wire for a variety of purposes. And, if Lihua were a traditional copper company that bought virgin copper and turned it into a final product, the suspicion would make sense. See, gross margins of more than 20% (which Lihua has traditionally generated) are WAY too high in comparison to, oh.... say Encore Wire (WIRE), which boasts a gross margin of about 7.4% for the last four quarters, which is a fairly typical number.
The thing is, it's almost like these shorts are trying to ignore the fact that Lihua isn't a traditional copper company. How's that? If they'd remove their head from you-know-where, they'd realize LIWA gets its raw material in the form of recycled copper, which it then refines itself by firing it.
Now, how can I say this in a way that sinks in..... recycled and scrap copper is cheaper to come by (about 25% cheaper), which makes gross margins look abnormally high. And, while that wide gross margin has historically led to a higher-than average net margin, don't be fooled - the cost of recycling and corporate growth is taking a toll in a different spot on the income statement. By my math, Lihua's net profit margin for the last four quarter's is 8.5%, which is solid, but nowhere near fraudulent levels. [A fraud would post a bigger lie than that.]
Conclusion? While the historical net margin numbers were stunning, as the company grew, it started to produce more tepid numbers in line with peers and competitors. That's not a cheap shot at the company's management, nor is it a reason not to buy. It's just a reality... LIWA's margin numbers really don't look all that abnormal any more.
As for the capital expenditures being 'too low' ($12 million in Cap Ex, or 2.4%, last year to generate more than $500 million in revenue), Encore Wire committed about $22 million (2.4%) in capital expenditures in 2010 to produce $910 million in revenue. And, though it's not perfect apples-to-apples, General Cable Corp. committed about 2.6% of its revenue last year to capital expenditures as well. If Encore and General Cable are fair comparisons - and they are - then Lihua is committing the right amount towards Cap Ex. Capital expenditures aren't its only expenses though.
But hey... the short sellers never have to let relevant facts and figures get in the way of a good story, right?
Stupid Bearish Argument #2
"The independent report prepared by China 360 is still biased, since it was paid for by a group with a vested interest in a positive report."
Actually, I understand the idea here. It's wrong, but I still understand it.
Just a wee bit of background may be merited on this front.
Lihua has long been battling critics and questions. Nobody wants to believe that the company can be what its numbers say it is. So, Lihua's first response was to get John Lees Associates - independently - to confirm LIWA's cash balances. Lees did, and everything checked out as reported. To that the shorts said "Fine, but the income statements can't possibly be real, so it's a sham." So, China 360 was hired to verify that the company's customers, products, employees, and everything else was indeed accurately reflected on the company's SEC filings. Sure enough, it all jived. To that the shorts said "Fine, but the SEC filing results are fraudulent since they don't match the SAIC (China's State Administration for Industry and Commerce) numbers." So, China 360's analysts described in vivid detail bout how they themselves went to the SAIC office and had the agency print Lihua's SAIC filings and hand them directly to China 360's inspectors. They all matched up too.* To that, the shorts said "Fine, but it can only mean that the local SAIC officials in Lihua's district are in on the fraud, and are being bribed."
And at that point it becomes clear it doesn't matter what Lihua International does... somebody's going to fabricate something else to be wrong no matter how many audits and inspections are done, because some people are willing to believe that an entire region and all its government officials are in on the same fraud. You can't argue with anyone with that vivid of an imagination.
Anyway, as far as the China 360 report goes, look very closely at the folks who are trying to discredit it, mostly via SeekingAlpha.com... they ALL have short positions.
Now, who's biased again? At least China 360 went to China to look at things, and it doesn't own any shares. The short sellers simply wrote articles saying China's 360's conclusions shouldn't be believed, and then touted their opinions as verified facts.
That's one of the downsides to an open forum like SeekingAlpha or ZeroHedge - anybody can chime in, and isn't held accountable. Must be nice.
Look, you ultimately have to come to your own conclusions about whether or not LIWA is the real deal. If you just don't see it, that's fine, but please don't choose to not see it just because someone else convinced you to drink the Kool-Aid too. Find out for yourself what may actually be wrong with the company. So far, I've found little. My only concern is the limited barrier to entry for competitors, though it hasn't been a problem yet.
As for where this is ultimately going to lead for LIWA, I have to have faith that eventually the truth will shine through, for better or worse, and the stock will reflect it. I'm a 'better' man myself, but you never really know. I just know that most of the bearish arguments so far have been very weak.
In the meantime, the shorts continue to chip away. When the bashing effort is this strong, truth and results can take a back seat to hysteria, and the stock's price can slide lower. And that's what's really scary about this whole thing... the shorts' "smack down" effort seems to be working, even though it's far less founded than the bullish one. That won't last forever though, and I suspect the short-covering rally will announce itself clearly when it arrives. Stay tuned - we'll be covering that too.
Anyway, that's just one trader's opinion. What do you think? You can add your two cents by e-mail, or better yet, publicly post your response to this edition at the bottom of its archive at the SCN site.
*The Chapski numbers have turned out to not be the complete SAIC numbers, and may not be SAIC figures at all.