Fushi Copperweld Looks Risky

 | Dec 05, 2012 | 5:30 PM EST
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Shares of Fushi Copperweld (FSIN) are up 20% year to date, having been up only slightly for the year when Muddy Waters Research labeled the company a fraud risk in April. That had sent the stock down substantially. Muddy Waters has had success in the past identifying fraudulent Chinese companies and tends to draw a significant reaction in the market when it releases a report. The stock has since more than recovered, with a state-owned lender providing enough capital to execute a transaction that will acquire all Fushi Copperweld shares for $9.50 apiece, a small premium to Wednesday's closing price of $9.29. According to its most recent 10-Q, a vote on the transaction (which is technically a merger) will occur Dec. 11. The board has recommended that the transaction be approved.

The producer of wires and cables with copper coatings has seen business stagnate. In the third quarter, revenue was down slightly from the same period in 2011, continuing a trend from the first half of the year. In addition, operating expenses were up substantially, and so the company's earnings slipped 14%. Some of this was probably due to weaker Chinese growth (about 80% of Fushi's sales are to Chinese customers). Cash flow from operations plummeted in the first nine months of 2012: $16 million vs. $40 million in the first nine months of last year. Fushi reported a total of $218 million in cash and cash equivalents on its balance sheet.

That compares very well with the company's market capitalization of about $360 million. If we look at Fushi's enterprise value in relation to its reported EBITDA, we get an EV/EBITDA multiple of 2.8x. Even if the company's numbers haven't been doing particularly well recently, that represents a very low valuation. Of course, we can't really evaluate any fraud concerns, and we'd note that the most recent data shows that about 10% of the outstanding shares are held short.

Still, any shortfall in the reported numbers would become China's problem as investors would receive a small premium on the current price. That's another point that we can't really evaluate -- if anything, the biggest risk to a deal may be current investors who are convinced that Fushi is operating a legitimate business and so would be eager to keep the company publicly traded. Certainly if the company could somehow convince the markets that this is the case, we'd expect the stock to trade considerably higher than 3x trailing EBITDA.

We calculate that investors could get a 2.4% unlevered return if they were able to buy the stock at $9.28 and the deal closes at a price of $9.50. We're not sure when a transaction would actually close; if it took place six months from today, just to give an example, the annual return (again, unlevered) would be 4.86%. While the deal may well be less risky than other merger-arbitrage situations, we don't think that return is high enough to recommend participating.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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