Description

Wowjoint Holdings Ltd. ("Wowjoint" or the "Company") is a China-based designer and manufacturer of specialized heavy-duty lifting equipment.  The Company was purchased by a SPAC (China Fundamental Acquisition Corporation), whose shareholders approved the purchase in February 2010.  If you're not interested in taking China risk then read no further.  If you are, however, Wowjoint gives you the opportunity to purchase a business that is growing its top line in the mid-teens (20%+ on a trailing basis), with expanding operating margins, leading market positions, and fat returns on invested capital for 4-5x EPS.

The Company has both shares (ticker: WJHCF) and warrants (ticker: WJHWF) outstanding.  The warrants ($5.00 strike) are more interesting, as there are a number of near-term catalysts that could move the stock (and, by extension, the warrants) and, in addition, there is little free float in the shares.  Although trading volume in both shares and warrants is currently extremely spotty, due to the limited free float in the shares and the OTC status of both shares and warrants, there are a reasonable volume of warrants that can be shaken loose with a few phone calls.  In addition, although the relevant market makers typically only post 500 shares at a time on the offer, there are often tens of thousands behind what is actually posted.  The Company made its application to the NASDAQ Global Market in early March and, assuming approval, an uplisting (and associated improved liquidity) may occur shortly.

The Company's products include a range of customized infrastructure construction equipment, which are typically used in the construction of railways, highways, bridges, and viaducts.  The products include launching carriers, launching gantries, tyre trolleys, marine hoists and special carriers.  A picture is worth a thousand words, and with that in mind I would suggest you visit the Company's website to see some pictures and videos of their products in action (http://www.wowjoint.com/eweb/index.jsp).  The Company is a top-3 provider in each of its primary product areas.

There is a fair amount of reasoned debate currently regarding whether the Chinese economy is entering bubble territory.  I don't have any unique insight into this; however, with respect to an investment in Wowjoint it is worth pointing out that nearly all the bears on China point first and foremost to the property market as evidence of a bubble.  Wowjoint does not address this market.  Basic transportation infrastructure, Wowjoint's end market, will likely continue to be a sustainable growth driver in the years ahead.  Undoubtedly, there are specific infrastructure projects in China that are/were ill-advised, but a rational assessment of China's land area, population, and aggregate transportation infrastructure (roads, rail) paints an optimistic picture for continued healthy investment levels.  Roughly $1 trillion of spending on rail and highways is expected over the coming decade.

Pro forma for redemption of dissenting votes from the SPAC, Wowjoint has roughly 8mm shares outstanding.  Additionally, there are 7.3mm warrants.  Of the 8mm common shares, 5.7mm are held by the current operating management, 1mm by the SPAC sponsors, and the balance (1.3mm) float freely.  Management guidance for fiscal 2010 (year ending Jun 30 2010) is for $50-55mm of revenue and $11.5-$12.5mm net income.  This implies EBITDA margins in the mid-20s, roughly in line with what was reported for the 2009 fiscal year.  So, on a primary basis, 2010E earnings are $1.50/shr (4x PE multiple).  Pro forma for closure of the SPAC transaction, the Company had roughly $7mm of cash.  Assuming all warrants are exercised, the Company would have 15.3mm shares outstanding and $44mm cash ($2.85/shr).  Thus, on an as-exercised basis, EPS would be $0.78/shr (5x PE multiple ex-cash).

Wowjoint is moving aggressively to establish a US presence.  It recently appointed a new CFO (Chinese national), who was previously an investment banker with Deutsche Bank in Hong Kong.  In addition, an internal US-based IR professional has been added (Amy Kong), whose background is impressive vis-à-vis her peers (former public market equity manager).  The Company has also recently added a US-based external IR firm (Hayden), and is in the process of recruiting a US-based salesperson.  It is worth noting, in addition, that Wowjoint has sold product into a number of foreign markets including Germany, Italy, Russia, and UAE.  Just last month it closed its first US deal.  Senior management is clearly building a team to aggressively raise the Company's public market profile.  I believe that these efforts, in conjunction with the pending uplisting, and the increasingly international flavor of the Company's customer base, should help lead to a rerating.

Given the illiquidity of the underlying common, the warrants' intrinsic value is something of a moving target.  Bid-offer spreads on the common routinely exceed $1/shr.  That said, since closure of the deal the warrants have traded anywhere from a $1.00 discount to intrinsic value to the current $0.50 premium to intrinsic value (based on last trade for the common).  Note, however, that at the current bid for the stock ($6.06/shr) the warrants trade at a $0.70 premium to intrinsic, while at the current offer ($7.65/shr) they trade at a $0.90 discount!

What are the warrants worth?  As the Company's public profile improves and it achieves an uplisting, I could see it trade to a mid-high digit multiple of current year EPS.  On an as-converted (i.e. fully-diluted) basis, and adding back the implied $2.85/shr in cash, this would yield a share price of $8.30-$10.00/shr for the equity.  This, in turn, would imply intrinsic value for the warrants of $3.30-$5.00/shr, or upside of 90-190%.  While the warrants could certainly trade at a discount to intrinsic value, I think there is a strong likelihood that if the share price cooperates management will call the warrants relatively quickly, which should immediately collapse any discount.

With respect to risks, there are a few.  Any China-based business is obviously subject to myriad risks, including illegal appropriation of intellectual property, a murky legal system, and aggressive and/or fraudulent accounting.  At some level, you are either comfortable investing in the country or you are not.  However, I will make a few random comments that may give incremental comfort.  First, the current operating management, who received 5.7mm shares in the parent company in exchange for their business, have locked up 2/3 of their shares for four years.  This scale and length of lockup is relatively unusual for US-listed Chinese small caps and indicates a reasonable degree of confidence in the business' prospects and integrity.  Second, if you care to dig up the underlying Company's local financials (filed with regional tax authorities), you'll find a relatively high degree of correlation with what has been reported per the audited SEC financials.  In most of the problematic US-listed Chinese companies, restatements and/or frauds have typically been present in those companies where local financial are of an entirely different order of magnitude from what is filed locally.  This is not the case with Wowjoint.  Lastly, the Company does have multiple patents protecting its products although, admittedly, enforceability in China is always an issue.

My primary knock against the Company is the choppy historical performance in operating cash flow.  Offsetting this risk, to some extent, is a customer base of large construction companies that present only modest credit risk.

Catalyst

Aggressive IR effort from new team (CFO, internal US-based IR professional, external IR firm)

Uplisting

Announcement of additional US (and other non-Chinese) contracts

Warrant conversion