Ferrochina Acquisition - A Powerhouse Emerges.

Foreword: This post is dedicated to my good friend Donmihaihai.

Ferrochina released a statement today (see here) announcing that it had acquired full control of its associate, Superb Team Ltd, which owns Changshu Everbright Material Technology Co. Ltd and Chnagshu Changgang Steel Plate Co. Ltd.

Everbright and Changgang are involved in the manufacturing of high-end thin gauge
galvanised steel coils and supplying to the consumer electronics, home appliances,
computer, automobile and building material industries.

From a current 35.45% (25.02% on a fully diluted basis) stake which it acquired last year, FerroChina said today it has entered into a conditional sale and purchase agreement to purchase the remaining 64.55% (74.98% on a fully diluted basis) of Superb Team for approximately S$568 million.

This proposed acquisition will transform Ferrochina into a top-tier global galvanised steel processor, with a FY2006 combined revenue of a whopping $1.6 billion and an EBITDA of $158 million. It will also certainly place Ferrochina on the radar screen of global fund managers.

Ferrochina's CEO, Mr. She Chun Tai, has declared that the target is now for Ferrochina to become the world's largest galvanised steel processor by achieving a production capacity of 5 million tonnes of galvanised steel.

How much of a difference will this make?

Currently, Ferrochina's revenue and profit estimates based on 2QFY2007 results stand at $746.6m and $139m respectively. This acquisition (if it goes through) will immediately double its revenue and profit.

Based on its last traded price of $1.77, it currently trades at 12x PE. However, even a doubling of earnings would reduce its PE Ratio to 6x, which is still a slight premium to the steel industry standard historical 3x - 5x PE.

Hence, despite the good news, Ferrochina still remains slightly overvalued at the moment, i.e. despite its vast future potential, buying its stock at this point still represents significant downside risk.

The Impact of the Acquisition

The impact of this acquisition will not be limited to Ferrochina's share price alone. The acquisition now creates a true blue powerhouse SGX-listed china company - a company with the potential to become the largest in the world.

Actually, there have been quite a few companies which have listed on SGX in recent times, that are relatively prominent market leaders in China in their own right. Companies like Synear Foods, China Hongxing Sports, possibly even China Fishery and Yangzijiang Shipbuilding, all come to mind.

Unfortunately, we cannot declare based on that fact that the quality of china companies seeking SGX listings have improved. Out of every 10 China IPOs, maybe up to 7 or 8 of them are still small cap companies with very volatile earnings.

Nevertheless, the good news is that local investors wanting to get a share of China 's booming economy via SGX listed stocks need not place their bets on these small and volatile companies any longer, not when these "powerhouse" china companies are now available and provide more consistent and potential earnings growth, which will invariably lead to greater share price performance.

Personally, when it comes to China stocks, I am now only going to invest in these "powerhouse" companies. But at the right price of course.