Harbin Electric (NASDAQ:HRBN)

This morning, Harbin Electric announced  

that its Board of Directors has received a proposal letter from its Chairman and Chief Executive Officer, Mr. Tianfu Yang and Baring Private Equity Asia Group Limited for Mr. Yang and an investment fund advised by Baring to acquire all of the outstanding shares of Common Stock of Harbin not currently owned by Mr. Yang and his affiliates in a going private transaction for $24.00 per share in cash, subject to certain conditions.

This is a very interesting development.  Private buy out transactions and merger activity have been a key missing element in the ChinaHybrid space.  If completed, this transaction is important in that it could help bring some legitimacy to a space where reputable and significant value players may finally be eying up quality companies. This could lead to a short-term pop, that had already been set in motion, for deeply discounted ChinaHybrids, as investors speculate if third party transactions are on the horizon. 

Our challenge is to sift through the reverse takeover firms (RTO) to find the ones that have been improperly punished.

Added to the GeoBargain list on November 10, 2009 @ $21.00

Catalyst: Strong 2010 estimates; Low valuation; Reduced debt.

Peak performance: Reached a high of $26.00 on March 10, 2010 

Current Price: $18.00

Current road block: 2011 EPS growth is forecast to grow only 6.8% to $2.99; Issued 2010 Revenue guidance, but no income guidance; Filed an S-3 which could signify an imminent capital raise; Still has $58.2 million in debt (although, debt to equity is still under 20%), most of which is short-term.

According to estimates, HRBN has two more quarter of above average EPS growth remaining. Adjusted EPS growth for the 2010 June and September quarters are forecast to grow 75.0% and 118.2%, respectively. EPS growth for the 2010 fourth quarter is expected to come in at only 12.9%. However, HRBN was able to quickly deploy its last capital raise quickly by paying down debt and completing accretive acquisitions. Thus, in the case of HRBN a capital raise may be welcomed by investors if used for purposes other than general working capital needs.

"A major factor in the Company’s liquidity and capital resource planning is its generation of operating cash flow, which is strongly dependent on the demand for our products. This is supplemented by our financing activities in the capital markets including potentially debt and equity, which support major acquisitions and capital investments for business growth."

Note: HRBN’s debt level may be a reason why the company has not achieved major a P/E expansion.

As far as liquidity goes the company has $77.8 million in cash and its annualized cash flow from operations is tracking at $69.4 million. We would strongly NOT favor a capital raise at current valuations, but with its debt position and need to maintain EPS growth, we can understand why an accretive raise my be necessary.

Our intent over the short-term is to build a check list to assess the risk position of firms in the ChinaHybrid space. For the time being this will consist of the following: (this list is likely to grow substantially)

- Is the company's auditor ranked in the top 100?
- Is the auditor located in the U.S.A? If located in China the PCAOB (Public Company Oversight Board) may be denied access to investigate the practices of the auditing firm. Short sellers have been using this information as a tool to validate their opinions.
- Are the company's internal controls satisfactory?
- Are their any outstanding legal issues?
- Do the company's top ten customers represent less than 10% of revenues?
- Operating cash flow divided by current liabilities is greater than one. The higher the better.
- Cash divided by current liabilities. This is an the most conservative liquidity ratio. The higher the better
- Is the company buying back stock?
- Chinese filings match respective SEC filings.(In process)

Short term and risk adverse investors should be aware of the quality issues currently present in the ChinaHybrid Space, questioning the validity of what seem like solid fundamental stories. It is beginning to get ugly so be cautious and understand that more pain may have to be endured, as ChinaHybrids are easy prey for short investors. The broad brush that is being applied to theses stocks appears unfair, but we can’t ignore the psychological impact this can have on investors’ portfolio decisions. If history is our guide, fear will eventually create an immense opportunity to invest in the companies that prove they can meet quality litmus tests enact shareholder friendly moves. Credibility can also be restored if independent legal/SEC opinions validate accounting practices currently in question.

We have yet to verify if the Chinese filings for ChinaHybrid stocks we monitor match respective SEC filings. We are in the process of completing this task. Conservative investors may want to limit exposure or buy put options on stocks, that have this availability, as insurance against long positions, until we publish our findings. Odds are we will identify some promising companies that will fail this litmus test.

Please note: On July 6, 2010, the GeoTeam® removed all Chinese stocks that were on GeoBargains and GeoSpecial lists to respective Radar lists as we complete our "quality assessment."

***Very Important GeoTeam® note. We have yet to verify if the Chinese filings for ChinaHybrid stocks we monitor match respective SEC filings. We are in the process of completing this task. Although we are not totally convinced that SAIC filings are an accurate represenation of financial statements the issue is impacting stock prices. Conservative investors may want to limit exposure or buy put options on stocks, that have this availability, as insurance against long positions, until we publish our findings. Odds are we will identify some promising companies that will fail this litmus test.

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