Checking in on China Templeton Trade

 | Apr 03, 2012 | 12:05 PM EDT  | Comments
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hogs

In late February, I created a basket of Chinese small-cap stocks that I thought would be ripe for a Templeton-type stock trade.

For the uninitiated, this trade is named after Sir John Templeton, one of the greatest investors of the twentieth century. Back in 1939, when Europe was mired in a political and economic crisis (sound familiar?) and the stock market was in disarray, Templeton bought shares in 104 companies trading below $1 a share. Some of those companies were bankrupt at the time Templeton invested in them. In the end, the winners outperformed the losers and Templeton nearly quadrupled his money.

I thought a similar approach could be applied to Chinese small-cap stocks today. Many of these businesses look absurdly cheap on the surface, but the reality is that many of them have turned out to be fraudulent enterprises at worst or in many cases, businesses with opaque financial statements. Just last week, Sino-Forest (SNOFF), after many months of accusations that its assets were not legitimate, filed for bankruptcy. Sino-Forest became famous after hedge fund manager John Paulson was forced to sell his massive stake many months ago at a huge loss.

Here's where the Templeton China Trade Portfolio stacks up so far after about a month of activity.

So far the trade has been a dud. A month is clearly not a significant time period. I've always said that if this trade is going to work it will take time. Templeton held his 1939 trade for nearly four years. And to be fair, he owned 104 stocks. This 10-stock portfolio is merely a slice of the hundreds of available Chinese businesses. But my guess is that given the overall disdain for Chinese small caps today, even a 100 stock portfolio would likely have produced subpar results.

It's hard to compare these results to a benchmark index and have a fair comparison. Needless to say the results thus far have likely underperformed many possible comparisons given the overall positive start the global markets have had in 2012. Interestingly enough, one of the best performers in the portfolio was Zhongpin (HOGS), which also happens to be largest company by market cap in the group at $412 million. Zhongpin is also covered by the Value Line Investment Survey, another indication that this company has a higher level of transparency. Zhongpin sells meat and food in China. The stock symbol gives it away: pork. In addition, the company sells fruits and vegetables to restaurants, schools, hotels and grocery stores. The company operates more than 3,000 retail stores.

This week investment firm Prestige Trade Investments raised its ownership in HOGS to 8.5% from 6%. This comes after an even more interesting development. Last week Zhongpin announced that its chairman is offering to take the company private for $13.50 a share in cash. The chairman already owns 17% of the company. With shares trading at $11, the market clearly has doubts about this deal. To be sure, the chairman expressly stated he does not have the capital needed to buy out the company and that he would seek to raise capital to finance the deal.

In any event, this story is one to follow. The interest could cause HOGS to be the first big winner in the portfolio. Alone, this company could pose a nice arbitrage opportunity especially with an interested chairman and an investment group that clearly believes in the story.

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