Stockhouse Ticker Trax is equity specific research (Canadian listed and market cap < $300 million) published every Monday to paid subscribers. Our free Friday column may feature companies previously featured to paid subscribers (with a minimum one month delay) or discuss topics of interest to the general investment community and relevant to overall portfolio management.
I. Mistake to paint all Chinese Pubco’s the same shade of grey
II. Great firewall and the Gmail mystery
III. Challenges ahead for China
I. A mistake to paint all small Chinese Pubco’s the same shade of grey
Note that both CHO and GMN discussed below are followed in the paid Ticker Trax newsletter (link at the bottom of these weekend reports).
I last visited China in 2007 and 2009 so when China Health Labs (TSX: V.CHO, Stock Forum; 52 cents) invited me on an analyst tour, I took advantage of the opportunity. I had been following this company for a couple months (since 45 cents) and while I felt the growth potential was significant, lurking in the back of my mind was this deeply rooted avoidance of Chinese stocks I had been witnessing since Q2 2011.
China Health Labs was a good benchmark study for us because they had a strong business model in the giant Chinese healthcare industry. This was an opportunity to inspect facilities, talk with management and clients, and gauge the overall Chinese economy. CHO paid my return airfare ($1400) and hotels/meals in the Beijing region for the week (about $700). I paid my own expenses after leaving and travelled to Shanghai and Hong Kong.
In two or three weeks I will report here my insight into China Health Labs (CHO) and also Gobimin (TSX: V.GMN, Stock Forum; 71 cents), which has a very nice gold project in Western China that the market currently values at about $5 per ounce – again because few pay attention to (or trust) Chinese companies.
For the past several years large Chinese companies listed on North America stock exchanges have done very well (Baidu for example is up 1400% since Jan 09). Unfortunately, though, in 2011 a handful of high-profile Chinese companies destroyed investor confidence by reporting fraudulent contracts or financial statements that were far from compliant with North American accounting standards.
In Canada it was Sino Forestwho did the most damage. In April 2011, they were at $24 per share but were halted in August at $4.81 and now may never trade again. It’s a long story but investors lost a small fortune. Once the media was done with them, few wanted anything to do with Chinese companies – in particular the micro cap and small cap companies.
While the damage done by Sino and a few others in the United States was extensive, it has resulted in some very positive changes. Now these Chinese public companies realize it is imperative they bring their accounting up to Western Standards, establish stronger audit committees, and hire North American educated internal / external auditors and controllers.
When looking at these public companies, see if you recognize who they use for audit engagements (simply Google them) and check their board of directors. You want people from outside China who cannot risk having their reputation destroyed. Few board members will jeopardize their career for the sake of sitting on a board. If you see key people leave or the company changing audit firms, find out why. If you don’t like the answer or suspect something out of the ordinary, sell the stock.
II. The Great Firewall and the Gmail mystery
If you have not been to China, the main cities are no different than any other major city around the world. With the exception that half the city appears new. Most everything is becoming expensive and traffic is very congested. I saw very few signs of the military or police in Beijing, Shanghai, Hong Kong, or parts of rural China. The people were very free to do what they liked and free enterprise was strongly encouraged as this is one country where small business is booming.
If you view China as this oppressed Communist country, I would think again. If I didn’t know they had such strong control over “freedom of speech,” I would say this was one giant country of capitalism. Business is thriving everywhere you go. The major cities in particular are one giant economic machine humming along very nicely.
Then reality set in.
After the first five days in Beijing I viewed China as nothing even close to a communist country. But sadly reality set in one night from the hotel. In Canada if I send an email copy to myself using Gmail, it arrives in my inbox within a fraction of a second. This happens anywhere in North America and I am sure it is the same in most countries.
Not in China. There is a delay of almost five minutes. Where your email goes during this period of time is a giant mystery. No doubt there are algorithms running throughout the country’s servers that look for certain keywords but it is disturbing to know this happens with your email. It makes you wonder what else they are looking for. It wasn’t just my hotel where this occurred as I tried (with the same result) from a couple different locations.
I Almost succeeded in blocking Stockhouse from 1.3 billion people in China
This one was the most shocking events of my trip. From my hotel in Beijing I needed to post some information and a link to our monthly TTrax gold valuation table. I visit the Bullboards of the gold companies we cover in the study and post a link to the report. This took about one hour.
When I was finished I logged off my browser jumped in the shower and within half an hour went back to Stockhouse.com – strange it didn’t work this time. I thought the Internet was down so tried several other websites – they worked fine. Tried Stockhouse several times over the next few hours and the website was completely blocked.
About this time I thought Marcus (Stockhouse CEO) would want to kill me forblocking Stockhouse in China. That would not be cool. The next day I tried from a corporate office and luckily it worked fine. I never did try the next day from the hotel as I was checking out.
The strange part of this entire episode, during that hour I was posting to a message board in another country, something or someone recognized that activity and wasted no time in blocking the activity and the website – simply because it contained a public message board. You can imagine the Internet traffic in a country the size of China and yet it recognized something so simple (and innocent) as this.
The Gmail episode bothered me but this was outright disturbing. Prior to this I thought China had changed dramatically and was moving in the right direction. Now I am not so sure.
III. Challenge ahead for China
Outside media talks about the fears of an economic slowdown in China and it definitely would have an impact on what is happening around the world. However, they are still building everywhere you go and the Chinese consumer is very happily spending money.
The primary risk is that they have 600 million people living in rural China (50 million in poverty) and while expanding to the rural areas will fuel further growth, will it happen quick enough? There is huge divergence between the haves and the have-nots and when you have several hundred million poor or living in poverty (and 300 million in the mid to upper class category), you always run the risk of social uprising on a grand scale.
It is because of that risk that the government must be very cautious with how the Internet is used within the country. As a writer and analyst I am a HUGE believer in freedom of speech and human rights. But at the same time, you have to see China to fully appreciate what is happening there.
While they are definitely moving in the right direction, I cannot imagine how difficult it must be for the government to manage this growth and the divergence between the rural and urban areas. And trying to do so while still having a cheap labor force that can compete on a global scale and drive competitive exports.
Everything is becoming so expensive in the Chinese cities that the cheap labor will not be cheap for much longer. If China loses that competitive edge it will have a definite impact on their economy (fortunately their home-grown economy is massive).
I suspect one of the biggest challenges faced by the government is managing that imbalance between the giant working class and the emerging wealth of the middle and upper class.
Relevant quotes
1) The political and ideological background of the Internet censorship is considered to be one of Deng Xiaoping's favorite sayings in the early 1980s: "If you open the window for fresh air, you have to expect some flies to blow in." The saying is related to a period of the economic reform of China that became known as the "socialist market economy."
2) Internet censorship in the PRC encourages self-censorship through the perception that users are being watched. The enforcement (or threat of enforcement) of censorship creates a chilling effect where individuals and businesses willingly censor their own communications to avoid legal and economic repercussions. ISPs and other service providers are legally liable for customers' conduct.
The tremendous benefits of China are unfortunately over-shadowed by this (excerpt from Wikipedia):
Amnesty International notes that China “has the largest recorded number of imprisoned journalists and cyber-dissidents in the world.” The offences of which they are accused include communicating with groups abroad, signing online petitions, and calling for reform and an end to corruption. The escalation of the government's effort to neutralize critical online opinion comes after a series of large anti-Japanese, anti-pollution, anti-corruption protests, and ethnic riots, many of which were organized or publicized using instant messaging services, chat rooms, and text messages. The size of the Internet police is rumored at more than 30,000.
Disclosure: Danny Deadlock owns 25,000 shares of China Health Labs (TSX: T.CHO) and 25,000 shares of Gobimin (TSX: T.GMN).