One Chinese investment to resist

China’s seemingly unstoppable momentum certainly gets investors’ pulses racing, but, says Tom Bulford, not every company operating in China is worth a punt – and one especially is worth avoiding.

Here is a story about China told to me by Philip Connor. Philip was in Harbin, a Chinese city up near the border with Russia. He was in a taxi and asked to be taken to the City Hall. Expecting it to be slap in the middle of town, he was surprised when the taxi left the city and began to pass through bumpy country roads.

'Are you sure we are on the right road?' he asked the driver. 'Yes,' came the reply. 'Look.' And there looming up in the distance was a vast and gleaming building, the Chinese equivalent of a French chateau. Once inside this edifice, he ventured to enquire why it was built ten miles outside the city. 'Because,' came the reply, 'the city will come to us in just a few years' time the city will have grown and spread all around us.'

This is just the type of tale that illustrates the unstoppable momentum of the Chinese giant and sets investors' pulses racing. It whets the appetite of financiers, too, including Connor, who has teamed up with two other experienced hands, Roger Bendelac and Taso Carayannis, to form the emerging markets advisory and investment company Geo Genesis (OFEX:GEOP).

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Geo Genesis was listed on Plus Markets on April 8th at a price of 35p. Today the share price is 59p, putting a value of about £13m on the stake of these three directors, and £40m on the group as a whole.

I was interested to meet Connor and Bendelac, and to read Geo Genesis's prospectus which waxes lyrical about the possibilities of China and other emerging markets. Geo Genesis has three offices in China where it concentrates its efforts on the Magic Triangle' - the name given to the area between Beijing, Shanghai and the coastal city of Dalian.

A massive 41% of China's GDP is produced by the 320 million people who live here in the provinces of Jiangsu, Shandong and Hebei. Jiangsu is host to no fewer than two million private businesses, while Shandong and Hebei are rich both in gold production and in agricultural output, notably apples and radishes.

Geo Genesis is keen to play a part in this region both through making investments and also by providing advice to Chinese business people who are gradually understanding that there is more to financial management than simply watching the cash coming into or leaving their bank accounts, and realising the possibilities offered by such Western practices as asset depreciation, the assumption of debt and the issuing of equity capital.

Geo Genesis has ambitious plans, and hopes shortly to bring its first Chinese company to AIM in the shape of Changda International, a fertiliser company that is cashing in on the agriculture boom.

Geo Genesis arranged a $3.5 million private placing for Changda and expects the AIM listing to deliver a handsome profit to those who participated including itself. Geo Genesis is also looking to raise up to $500 million to invest into China through funds that will be independent of the advisory business. These funds could be listed on AIM, and give outside investors the chance to participate in the funding of rapidly growing Chinese businesses at a relatively early stage.

£40m valuation hard to justify

But for all the possibilities of the Chinese economy, and even if one believes that its companies will adopt Western ways, the £40 million valuation of Geo Genesis is hard to justify. The starting position is this.

Geo Genesis made a net loss of $76,000 on revenues of $59,000 in its latest accounting period. Having not raised any new money on its Plus Markets debut its balance sheet had net assets of just $361,000, along with 1.2 million shares in Changda and another 250,000 in marina developer Global Sealand Development.

It also has a few relationships with Chinese companies from which it expects to extract some advisory fees, and a strategic partnership with China's sixth largest bank. It has about twenty staff, and I don't suppose that the bill for wages and office accommodation in China is especially high.

The remuneration of the directors, though, is quite high. Chairman Marc Koplik is paid $60,000 for two days' work per month equivalent to an annual salary of about $600,000. The other two non-executive directors snaffle a further $60,000 between them, also for two days per month, while the three executive directors are paid $180,000 per year, plus up to $75,000 of expenses and 10% of the 'company's consolidated profit in the first year.' They also have 'the right to be allocated between 45 and 60 per cent of any founders' shares of the Company's transactional clients.'

This could be a nice little earner for these three. But why would outside investors accept a valuation of £40 million for whatever is left in it for them? Geo Genesis's presentation tells us that it has 'strong management with an excellent record of generating shareholder value' - but nowhere is this claim substantiated by any evidence.

There is talk of a 'large network of global strategic partnerships', and a vague intention to get involved in other emerging markets with all the start-up costs that might be involved. Geo Genesis is hoping to create some value from advisory fees; from making early stage investments that can multiply in value on a successful IPO or trade sale; and from charging the standard '2% plus 20%' performance-related fee on the funds under its management. If it achieves all this, it might one day be worth £40m. But not today.

This article is taken from Tom Bulford's free daily email, 'Penny Sleuth'.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

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