Adjusting Valuation Multiples and the China Price (Part 2)

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Last week we discussed the methodology for adjusting guideline public company valuation multiples for size, and we observed that the adjustment can be significant.  In last week’s example, the P/E multiple of an Ibbotson 3rd decile company as lowered from an unadjusted 14.9 to an adjusted 7.3.  We also noted that such an adjustment often needs to be considered when the company you are valuing would fall in the size range of the Ibbotson 10th decile.  So the question was whether we could find a source of 10th decile companies when the U.S. industry might have grown or consolidated far past that size.  From the land of the “China Price” that has created a manufacturing revolution and stocked the shelves of your local Wal-Mart with cheap merchandise, we now have a new Chinese product, the 10th decile guideline public company!


Yes, China is now producing publicly-traded companies with 10th decile market capitalizations.  Now to be clear, I am not talking about companies traded on local Chinese stock exchanges.  I am talking about companies listed on the NASDAQ, NYSE or OTC markets, companies with genuine audited U.S. GAAP financial statements.  Best of all, many of them are in industries like food products, distribution, chemicals, manufacturing and other industries in which many U.S. privately-held companies operate.  And many of these Chinese companies are steadily profitable, so they have useful P/E ratios.  Is this nirvana for valuation experts?


Certainly these U.S. listed Chinese companies provide another perspective on value.  Let’s take a look at a few examples.  NASDAQ listed China Natural Gas (ticker CHNG) is a distributor of natural gas and operates fueling stations.  The equity market capitalization is $160 million putting it clearly in the Ibbotson 10th decile.  CHNG’s P/E per Google is 7.4, a multiple which might be considered in the valuation of a small gas distributor.  In contrast, a U.S. gas distributor like Enterprise Products Partners (ticker EPD) has a $24 billion equity market capitalization, putting it in Ibbotson’s 1st decile.  With a P/E of 18.6, EPD is clearly a candidate for the multiple adjustment methodology described in Part 1 of this column last week.


Another resident of the 10th decile is American Oriental Bioengineering (Ticker AOB), a NYSE listed pharmaceutical company.  AOB’s P/E is 5.1.  Bristol Myers Squibb, a first decile company, has a P/E of 14.6. 


Sysco (ticker SYY), an American food distribution company, has a market cap of $17.7 billion, putting it in the 2nd decile.  SYY’s P/E is 15.33.  In contrast, Chinese food distributor China Organic Agriculture (ticker CNOA) has a market cap of $35 million and a P/E of 3.6.


Gulf Resources (ticker GFRE) is a NASDAQ listed producer of basic chemicals like bromine.  GFRE’s market capitalization of $325 million puts it in Ibbotson’s 9th decile, so a small adjustment could be considered to its P/E of 9.4 when valuing a 10th decile company.  The companies Google lists as competitors, Olin Corporation (ticker OLN) and Cabot Corporation (ticker CBT) have market capitalizations of $1.5 and $1.8 billion respectively, putting them in the 6th decile.  OLN’s P/E is 14.8 and CBT’s P/E is 36.4.


These are not rare examples.  There are scores, if not hundreds of U.S. listed, GAAP financial statement companies now trading on U.S. stock exchanges. 


So what do these U.S. listed Chinese companies offer the valuation expert?  First they provide valuation experts with a source of 10th decile guideline public company multiples that may not require significant adjustment.  Second, they provide an insight into the multiples common for companies in basic industries that might not have the managerial sophistication of a multibillion dollar U.S. corporation.  In that respect, these Chinese companies could be similar to certain small U.S. privately-held companies.  Finally, the differences in multiples illustrated in the examples above provide empirical evidence supporting the validity of the multiple adjustment methodology itself.  Perhaps that is the greatest benefit of investigating the “China Price”.


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