Finance Is Fun
(Editors' Note: This article covers a micro-cap stock. Please
be aware of the risks associated with these stocks.)
SPU is not a fraud: the juice is worth the
- The purpose of this first article is to explain my thesis
that, if SkyPeople Fruit Juice (
) is not a fraud, it must be a buy. Because I see such a massive
upside, I want to separate valuation potential from concerns
about fraud. I would like investors to have a chance to digest
the current situation before getting into SPU's potential.
- In my next article, I will get into SPU's valuation, its
growth prospects, and potential catalysts like buybacks
(including levering-up) and M&A. I also believe that
examination and debate of my conclusion about the absence of
fraud is likely to improve understanding and appreciation by
- A simple explanation seems to make sense: investors aren't
paying any attention. SPU is a micro-cap stock (which are
unusually inefficient and frequently mispriced) and SPU has no
analyst coverage. SPU suffers from 'sketchy Chinese stock'
syndrome, and is avoided without any analysis.
- SPU's cash exceeds its market cap (it has a negative
enterprise value, or 'EV') -but it's also profitable.
- SPU's valuation is absurd (I estimate between 200-400% upside
with conservative assumptions).
- SPU has strong, transparent, open management and good
corporate governance (just contact them).
- SPU's management owns just-over half of outstanding shares
(strong incentives, yet low exec comp).
- SPU is NOT a fraud (this is the most important element of the
investment thesis, in my view).
SPU is a micro-cap Chinese company listed in the US on the
NASDAQ, and uses US GAAP accounting. SPU is a solidly-growing
producer of fruit juice beverages and fruit concentrates (like
apple juice and pear puree). Investors are rightly skeptical of
Chinese stocks because of fraud concerns, but I conclude that SPU
is not a fraud. As a result, I believe that SPU's valuation is
entirely absurd, and the stock has extremely unusual upside
potential (well above 100%). I own SPU shares, it's my largest
SPU's cash exceeds its market cap:
SPU's market cap of ~$57Mn compares to ~$80Mn in net cash
(effectively zero debt). On a per share basis, SPU trades at
~$2.15 and has ~$3.00 in net cash.
SPU's valuation is absurd:
Using reported CY12 results, SPU currently trades at a mere 3x
EPS and cash flow. Despite its ~$57Mn market cap and (~$22Mn)
negative enterprise value, SPU has reported roughly $30Mn in
EBITDA in each of the last 3 years. If you ignore the ~$80Mn in
net cash, SPU would still be trading below 2x EBITDA. Further,
SPU trades below both tangible book value as well as my estimate
of liquidation value. From all angles, SPU has a very cheap
valuation, and SPU generates consistent, significant cash
SPU has strong management that owns a lot of
Based on my analysis, I have developed a very favorable opinion
of SPU and its management. Not only do I consider the company
well-run (good margins, smart decision making, appropriately
aggressive), but I particularly like management's 'skin in the
game.' SPU management owns just over 50% of SPU's stock and is
strongly incentivized to grow their wealth by running the company
Shareholder friendly management and good
I have found management to be very accessible and open to
investor communication. Based on my experience, I applaud SPU's
level of disclosure, and find their SEC filings to be unusually
detailed and forthright, providing specific details, metrics,
risks, and expense details.
Strong corporate governance:
I like SPU's strong, independent board. Somewhat unusual for a
'growth' company, two of SPU's independent board members are
accountants, one in the US, and one in China. Further, two of the
remaining independent board members are lawyers with litigation
experience, which presumably implies that both are experienced
with litigation risk assessment work. Overall, 5/7 board members
are independent -this is impressively high on a percentage basis
(analysis has uncovered very few Chinese frauds with a board
that's 50-75% independent). Recently, SPU separated the roles of
CEO and Chairman of the Board, which is universally considered a
positive (except for JPMorgan, perhaps).
In this article I will ignore positives/potential
Examples include: multiple expansion as the mix shifts towards
bottled beverages, declining seasonality associated with bottled
beverages, growth potential from exports and rising per-capita
domestic consumption, massive accretion potential from stock
buybacks, M&A valuation implications, USD/RMB translation
benefits, and new growth opportunities from PP&E used to
expand into new fruit segments.
Unless SPU is a fraud, I believe SPU is one of the most
undervalued stocks I've ever seen.
- Let's begin with the hypotheses that SPU's current valuation
is accurate and logically justified.
- The hypothesis is wrong if SPU is a fraud and goes to zero
(making SPU overvalued right now)
- As explained later in detail, I do NOT believe SPU is a
- The hypothesis is correct if the current valuation
accurately reflects the cash generation outlook.
- This means investors in a micro-cap stock have perfectly
predicted the future (unlikely).
- This hypothesis (valuation accurately reflects SPU's
outlook) is easily disproven by DCF.
- I believe that both hypotheses are wrong, neither logically
justifies the current valuation.
- My analytical conclusion: SPU is NOT a fraud.
- My efforts to 'uncover shenanigans' have made me bullish
on SPU, not cautious!
- The implication: If SPU is not a fraud, then it's very,
very undervalued and a great investment.
- A 'fair value' for SPU if it's not a fraud is MULTIPLES
of its current valuation.
- A simple explanation of SPU's silly valuation makes more
sense: Investors aren't paying any attention.
- SPU is a micro-cap stock: micro caps are unusually
inefficient and are frequently mispriced.
- SPU suffers from a lack of attention: it has no analyst
coverage, few shareholders, and is tiny.
- SPU suffers from 'sketchy Chinese stock' syndrome, and is
avoided without any analysis.
- There IS reason for skepticism, as Chinese stocks have a
higher incidence of fraud.
- Undervaluation persists because of a 'circular bias'
- Bias = 'too good to be true'
- Bias means that, the better SPU looks, the more
cynical/skeptical investors become.
- Noteworthy factoid: short interest just hit a 52wk bottom,
down ~55% y/y in the
Set aside the fraud factor for a moment - a simple DCF
underscores valuation absurdity.
- While I prefer multiple-based valuation, I appreciate the
usefulness of DCF analysis in certain situations.
- In the case of SPU, an extremely simple DCF analysis
illustrate SPU's absurd current valuation.
- Based on my experience, the greater the mismatch between
market valuation and intrinsic value, the more helpful a
simplistic DCF can be in illustrating undervaluation.
- In the case of SPU, the run-rate of >$20Mn in CFO annually
compares to a negative enterprise value (more cash than market
cap) and a market cap of ~$55Mn (or roughly 2-3 years worth of
A 'simple DCF' sanity check implies massive upside: let's
make some extremely conservative assumptions.
- First, assume SPU's cash flow never, ever grows (annual
run-rate of ~$24Mn in CFO, ~$15Mn in FCF)
- Second, let's pretend SPU's cash doesn't even exist - let's
ignore the ~$80Mn in net cash as of 1Q13.
- Price it like a preferred stock:
- Assume no growth - so FCFE is $15Mn every year and never
- Use a conservative discount rate - let's use 15% (more than
treasuries, about 2x S&P avg return)
The result: about 100% upside
(a double) using silly-conservative assumptions -and ignoring the
- Present value of $15Mn annually at 15% is $100Mn
- Buffett's words of wisdom (paraphrased): "You don't need
complex spreadsheets to find value"
This 'minimum upside' ignores any/all growth and
ignores SPU's ~$80Mn in net-cash.
Multiple-based valuation suggests upside of 200-400%
-even ignoring ~$3.00 per share in net-cash
Even 'haircutting' comparable valuations, SPU is
massively undervalued (using CY12 results)
SPU now: 3.1x, comps: 19x, target: 10x (CY12 EPS of $0.68)
- Implied price target: ~$7.00/share (ignoring my
estimate for CY13 EPS of ~$0.80)
SPU now: N/A, comps: 13x, target: 6.0x (CY12 EBITDA of
- Implied price target: ~$9.50/share
SPU now: N/A, comps: 2.0x, target: 1.3x (CY12 sales of
- Implied price target: ~$8.00/share
SPU now: 0.56x, comps: 2.2x, target: 1.6x (CY12 sales of
- Implied price target: ~$6.00/share
SPU now: 0.34x, comps: 2.3x, target: 1.3x (1Q13 book value of
- Implied price target: ~$8.25/share
I estimate $107Mn in liquidation (about 2/3 of current book
- Implied price target: ~$4.00/share
I prefer EV/EBITDA - it's comparable across capital
structures, tax rates, and is fairly specific
- Closest comps are listed in Hong Kong -EPS isn't really
comparable to a US GAAP company
- Some comps have net debt, but some have net cash
-EV/EBITDA is comparable for both
Bears wrong either way - contradictory short theses
cannot both be true
Short thesis #1 - the cash isn't real (net cash of
- As I explain later, my analysis leads me to the
conclusion that the cash is real.
- Even ignoring the cash, 5x EBITDA of ~$30Mn in CY12
implies almost 200% upside.
Short thesis #2 - the cash is real, but SPU will spend
it all on growing production facilities
- As SPU progresses with its expansion plans, they will
spend-down their cash (growing PP&E)
- SPU plans to grow their supply/production by expanding
into two new product lines
- SPU management has stated that they will pay for the
expansion over 2013 and 2014
- The cost to build the two new lines totals ~$120Mn - the
cash will become machines & buildings
- SPU can afford it: ~$90Mn in gross cash as of 1Q13,
plus ample cash flow generation
- Based on my analysis, the capex investment has two key
- Resolves uncertainty about 'real cash' -cash will
decline, long term assets increase
- Should remove the source of the 'fraud' overhang,
boosting SPU's valuation
- Enables substantial growth for SPU, with
quick/attractive cash return on investment
Winning record with previous capex investments
- Longer-term capex/PP&E trend reflects very well on
management's operational execution
- Let's compare CY12 with CY09 year-end results (pre-IPO,
pre-boost in investment into PP&E)
- PP&E grew by ~$28Mn to ~$52Mn at the end of CY12 vs.
~$24Mn at the end of CY09
- EBITDA generated in the next 3 years (CY10-CY12) was
- CFO generated in the next 3 years (CY10-CY12) was
- In other words:
- SPU generated almost 2x as much cash flow as they spent
- Exiting CY12, SPU generates ~$30Mn in annual EBITDA using
~$52Mn in PP&E
- That's a massive return-profile from capital invested
- Specific example: In December of 2011, SPU added another pear
juice production line costing ~$7.4Mn
- For CY2011, SPU generated pear-related sales of $13.4Mn and
gross profit of $3.2Mn.
- For CY2012, SPU generated pear-related sales of $28.9Mn and
gross profit of $8.5Mn.
- In other words, SPU saw an incremental ~$15.5Mn in sales
and $5.3Mn in gross profit the year after it completed the
enabling capex of $7.4Mn.
- If you can find other businesses with such rapid,
impressive returns on their capex investments, please do me a
favor and let me know so I can look into them.
SPU is not a fraud.
Verified cash balances: Conclusion of my analysis is
that SPU's cash is real.
- In 1H2012, Nasdaq (exercising impressive responsibility)
requested 'cash verification' from a very large number of
China-centric, US-listed companies, partially in response to
several fraud incidents, particularly among the RTOs (reverse
SPU slam-dunked the cash verification
SPU put out a press release/8-K on 4/20/12 stating that SPU's
independent auditor (quoting verbatim) "from January 5 to
January 9, 2012, independently verified the Company's cash
balances held in financial institutions in China in which the
Company and its subsidiaries maintain bank accounts (the
"Accounts"). "Independently verified" means that an audit
firm visited in person each of the institutions and
physically observed bank employees printing or otherwise
preparing or completing documentation, which substantiated
the cash balance for the Accounts. It does not mean that an
audit firm relied solely on documentation completed and
returned by bank personnel by mail or facsimile. Based on the
Audit Firm's independent verification, the verified cash
balances of the Accounts in aggregate represent substantially
all of the cash, cash equivalents and restricted cash amounts
as stated in the Company's 2011 financial statements as
reported in the Company's recent 10-K filing."
- SPU further noted in its press release that "Nasdaq has
reviewed the cash balance submitted and has no further
comments." This was not the case for other Chinese
companies, some of which remained halted pending
- Of importance: SPU specifically references in-person
visits to their banks, and they directly stated that their
auditor did NOT simply collect faxed/mailed statements.
Based on my analysis, of the few Chinese frauds that DID
overstate their cash balances, NONE of those frauds -that
I've uncovered in my research- were able to meet the same
'physical proof' standard that SPU did. Related examples
include China MediaExpress (CCME), the massive Satyam
blowup (India-based, but same issue), and ShengdaTech
(SDTH). Does this mean that fraud can totally be ruled-out?
No. However, unless about half a dozen banks all faked
statements that actually added-up correctly, I believe that
SPU's cash balances are accurately listed on their SEC
- SPU management GOT the message. The press release
contained the following bold, direct quote: "At a time when
there is speculation as to the credibility of certain Chinese
companies, SkyPeople investors can be reassured that our cash
balances have been independently verified and that we employ
of a high degree of financial integrity in terms of our
financial management systems," said Mr. Yongke Xue,
SkyPeople's CEO. "Investors can have confidence in the
strength of our balance sheet that enables us to take
advantage of the growth opportunities available to us in our
- A copy of the press release is available from the 8-K
filed with the
SPU has TWICE shot-down the 'cash is fake'
- In early June of 2011, SPU was accused of being a fraud
by a short seller that released a bearish report on SPU,
after initiating a short position in SPU (seller referred to
here as 'Absaroka'). Absaroka basically accused SPU of faking
its cash balance and actual level of sales.
- After SPU was accused of being a fraud in early June of
2011, the Company hit back hard.
- First, SPU stated that it "believes that the article
contains many materially false and inaccurate claims" and
added that "it is important to alert the general public to
such fake reports and the false information contained
therein" (8-K filed with SEC June 3, 2011).
- Second, SPU released
that listed its actual cash balances at each of almost a
dozen banks. The filing provided information evidencing the
accuracy of its SEC filings, and it also
corrects/reconciles the mistaken calculations from the
SPU immediately sued
the analyst/fund that put out the short report.
- SPU hired 'heavy hitting' legal counsel and spent a
LOT on clearing their name.
- My view: SPU won its fight against the short
report/seller -SPU was right, they were wrong.
- Absaroka settled with SPU, and agreed to remove/retract
their short report entirely.
As a financial analyst, I deeply respect and admire the
work Absaroka did trying to uncover numerous Chinese
frauds, particularly RTOs. I acknowledge that they were
RIGHT about several OTHER companies, but they were WRONG
about SPU. I can understand how, given the multitude of
'guilty' companies, Absaroka would be inclined to believe
fraud was occurring -they were correct about most of
- SPU got some unexpected support: another analyst
immediately said the short report was wrong.
- Rick Pearson, who speaks Mandarin and focuses on
wrote an article
about SPU as a contributor for thestreet.com, which was
published one day after the short report. He noted that he
had "visited the company, its distributors and
- He stated that he was "puzzled why the firm would use
arguments that are so easily refutable" and noted that he
had "no position in SPU" when refuting the short
SPU's 'clean-slate' auditor is reassuring:
- After SPU was accused of fraudulent actions in June of
2011, the company began a search for a new auditor to provide
a totally fresh and clean assessment of the financials.
- The dismissed former auditor (BDO) did NOT
-importantly- note any concerns/issues. Put simply, BDO got
'dumped' -unlike most frauds where the auditor dumps the
- SPU elaborated in an 8-K: "During the Company's two
most recent fiscal years ended December 31, 2010 and 2009
and the subsequent periods through the effective date of
the dismissal of BDO, there were no disagreements on any
matter of accounting principles or practices, financial
statement disclosure or auditing scope of procedure, which
disagreement, if not resolved to the satisfaction of BDO,
would have caused BDO to make reference thereto in its
reports on the Company's consolidated financial statements
for such periods." The filing included a letter from BDO
agreeing about the financials.
- SPU's auditor was specifically hired to verify and audit
SPU's financials, and is the FOURTH auditor to determine that
SPU's books were clean.
- The current auditor does not have a local China
affiliate that they use to 'farm out' audit work: they
actually fly from the US to China to conduct their audit
work. This is very notable, because numerous Chinese frauds
have resulted from audit work being done by outside, local
accounting firms that do not have to comply with US audit
standards. This applies specifically to the 'big 4'
accounting firms, and others. As a result, SPU is
less-likely to have influenced/biased auditors, and their
auditors adhere to higher standards.
Investor-friendly US GAAP accounting:
- It's rare among its peers in that it reports in US GAAP,
which should help SPU's relative valuation. Most of the
Chinese juice/beverage companies are listed in Hong Kong,
with less-frequent financial reporting and less-robust
accounting standards and corporate governance.
- GAAP is expensive to satisfy (eg, Sarb-Ox costs) and
demonstrates a commitment to verifiable financial reporting
and transparency. Public company costs are a common reason to
- GAAP requires quarterly filings (greater frequency &
consistence), and avoids infrequent 'interim' filings.
- Net result: Required GAAP disclosures and frequency make
SPU easier to model and follow.
Cash flows support earnings
: Fraudulent companies are often associated with 'fake' earnings
with little to no cash flow to back it up, with sharp analysts
focusing on the cash flow statement and balance sheet to detect
evidence of 'fake' earnings that are either overly-inflated or
- Good cash conversion: In the case of SPU, CFO exceeded net
income over the last couple of years.
- Matching growth in cash balance: Thus far, SPU's cash flow
has been real -cash has steadily built since SPU's IPO back in
2010. As of 1Q13, SPU has grown its cash balance since IPO by
about ~$42Mn, which is almost identical to the sum of CFO less
capex over that period.
Management reassuringly owns ~50% of outstanding
- Just over 50% of SPU is owned by the Chairman of the Board
and the CEO, creating a strong incentive to avoid 'fraud' and
risk losing the substantial value of their investment.
- Management has been putting money BACK INTO the company: In
1Q13, the Chairman lent SPU a small sum to SPU for short-term
use (borrowed about $4Mn), and the interest rate he's charging
the company is below-market (not a way to bilk interest
payments from the company).
- In my opinion, it is highly unlikely that an investor
(the Chairman, a former banker) would invest additional
capital into a known fraud (e.g., the Chairman knows that SPU
is a fraud but risks more of his capital regardless of the
- Historically, management exploits frauds by EXTRACTING
money from the company, which is not the case with SPU.
- Historically, loans as a sign of fraud are more commonly
associated with Ponzi schemes like Madoff's funds where
frequent withdrawals require frequent additions.
- In summary, SPU passes the sniff test: the Chairman lent
money to SPU, and it's very unlikely he would have done so if
SPU (which he owns about 50% of) was a fraud.
I am long [[SPU]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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