Last January I wrote about Ossen Innovation (OSN), a cheap stock but in the middle of a value destroying reverse merger. In this transaction valuable Chinese assets would be given away to the controlling shareholder. The other shareholders would get a small piece of a Chinese company (America-Asia Diabetes Research Foundation) with a going concern warning. I think that was more than a warning because from the balance at the time it seemed that company was almost bankrupt.
I also thought it was likely the transaction would complete ,for 2 reasons. First, the company has been very careful in following the necessary procedures. The transaction was also approved by a majority of the shareholders other than the controlling shareholder.
Amazingly the transaction did not complete. America-Asia Diabetes Research Foundation did not deliver shares necessary to complete the transaction. Hence the transaction was terminated. Now what?
Ossen Innovation, without reverse merger
As I wrote in January the old Ossen Innovation was cheap. Ossen Innovation manufactures plain surface prestressed steel, and also prestressed steel with rare earth and zinc coatings. This steel is used in the construction of infrastructure such as bridges and also in buildings. This is a Chinese company listed in the US.
That Ossen Innovation trades on a US exchange is just as illogical as if an American smallcap would trade in Hong Kong. Companies listed on an overseas exchange have higher fraud risks. In January I wrote the company has never been accused of fraud but this is not true. The company has not been accused of irregularities in the balance sheet and revenue recognition. However the company, or at least an affiliate, has been accused of providing fake test certificates for steel a road project in New Zealand. I do not know whether this is a reason for investors to mistrust the company. Other customers trust the company. According to this webpage President Trump has done business with the company. Also the Chinese government trusts the company. At least the Chinese government has a minority stake in one of the subsidiaries.
Details about the company can be found in the annual report over 2017. For example the only substantial shareholders are the chairman and his wife. The chairman, Mr. Liang Tang, owns 60% of the shares. His spouse and the CEO, Wei Hua, owns 3% of the shares. The company had a repurchase program for purchasing 500,000 shares from May 6, 2015 until May 1, 2017. Since May 1 2015 the company bought only 73,169 shares back. In 2017 the company did not buy back any shares. The company does not pay a dividend either.
Ossen Materials Research and Ossen Innovation are controlled by the same person so they are affiliated companies. Ossen Innovation used to procure supplies from Ossen Materials Research but does not do this any more. The 2 companies mutually guarantee loans of each other. Similarly Ossen Innovation guarantees loans of 2 other affiliated companies including a loan of $25.4 million to Zhejiang Pujiang. See also note 10 of the annual report.
Based on simple value metrics Ossen Innovation indeed appears very cheap. See the table below, based on the share price of May 15, 2018. The cash flow numbers, market cap, EBIT and Enterprise Value are in millions of dollars.
|
Share Price |
Market cap |
Enterprise Value |
EV/EBIT |
P/Tan B |
NCAV / MC |
|
2.49 |
50.1 |
88.6 |
11 |
0.49 |
2.13 |
|
EV/Revenue |
EBIT |
Cash flow from ops |
Free cash flow |
P/Ret Earn |
Liq Val / MC |
|
0.66 |
8.2 |
-3 |
-3 |
0.76 |
1.36 |
I have 2 remarks on this table. I mention retained earnings. The metric Price/Retained Earnings is similar to Price/Book only that it predicts returns much better.
Second, NCAV means net current asset value, or the book value of the current assets minus all liabilities. This is a proxy for the value of the company in a liquidation. For Ossen Innovation NCAV is $107 million. Companies with high values of NCAV/Market cap, also known as net-nets, have high returns, on average.
See also here for more explanation of retained earnings and NCAV.
A better proxy for the liquidation value is NCAV but then discounting inventory and prepayments with 50% and adding the value of any valuable assets like land. In this case inventory plus prepayments to suppliers are huge: $84.8 million. The book value of the land is $3.7 million. As a result my estimate of Liquidation Value/Market cap = 1.36, which is pretty good compared to other cheap stocks.
A red flag is the negative cash flow, combined with large debts. Much of the negative cash flow originates from increased prepayments partly offset by lower inventories. This could also mean the company expects a lot of new orders, or has a large backlog, and it has already sold a large part of its inventory. In practice I don’t think it is very difficult to run the company a bit more efficiently, in terms of its use of working capital. It is more likely than not working capital will be a source of free cash flow in 2018.
Is Ossen Innovation cheap or not?
It is hard to predict how Ossen Innovations operations will be doing in 2018. Compared to other stocks with US tickers the stock is very cheap, based on the metrics NCAV/Market cap, EV/Revenue and Market cap/Retained Earnings. Unfortunately it does not have much cash on the balance sheet and it owes pretty large debts. The long term debt of $7.7 million carries a high interest rate of 8%. The $13.9 million of short-term loans have an average interest rate of 6.41%, increasing from 6.1% in 2016.
I would describe the company as much financially distressed, if it was not profitable. Due to signs of distress, it is not especially cheap if you compare this to other net-nets without a US-ticker symbol. However compared to many other US-listed stocks Ossen Innovation is still cheap.
In any case I don’t think it is wise to short this net-net anymore now that the value destroying reverse merger has been canceled. Investors limiting themselves to US-listed stocks have with Ossen Innovation even a good long position, at least on a statistical basis.
In other words: there are less than 30 US-listed net-nets with NCAV/Market cap > 1.33. Some of them are likely outright frauds, but this one, I believe, is not. That said, corporate governance is certainly questionable. Because of signs of financial distress it is less attractive than many other US-listed net-nets but may likely still be a good investment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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