CHIO's Planned Reverse Merger
posted by The Traveller on Sunday, November 14, 2010

China INSOnline (CHIO) is currently trading at $0.13, down 81.42% for the year and down 82.66% from its April 19 high at $0.75. The Trading China Tracker Score is 0 (Sell).

CHIO posted details about their proposed reverse merger with a Chinese biodiesel producer on Friday. Let's have a look into the details of the agreement and find out the likely direction of CHIO common stock should the merger close.

The merging company, Fujian Zhangzhou Dingneng Bio-technology Co. through Ding Neng Holdings (Ding Neng), began operations in 2006 and all of its revenue are, and in the near-term will continue to be, derived from the sale of biodiesel produced at Ding Neng's production facility in Zhangzhou City, Fujian province.

After the acquisition is completed, CHIO's existing stockholders are expected to own approximately 10.5% of the outstanding shares of the company, Ding Neng shareholders will own 85.0%, and 4.5% will be issued to Maxim Group LLP for services provided to complete the acquisition:

- Common stock outstanding pre-merger: 46 million
- Common stock outstanding post-merger: 438 million

CHIO intends to apply to Nasdaq to retain its listing upon completion of the acquisition. Nasdaq's approval will require that the post-acquisition entity will meet the initial listing requirements of the Nasdaq Capital Market, most importantly a minimum bid price of $4.00 per share. To achieve that, CHIO and Ding Neng have agreed to effect a reverse stock split at a ratio of not less than 1:20 and not more than 1:40, immediately prior to closing of the acquisition.

As CHIO is currently considered a public shell company, the merged entity will have to meet all of the rather strict requirements for an initial Nasdaq listing. At this point its seems unlikely, even with a 1:40 reverse split and "new CHIO" being able to meet the $4 bid rule, that the Nasdaq listing can be saved. Investors should be prepared to find new CHIO being quoted on the OTC Bulletin Board.

The agreement contains certain conditions to closing set by Ding Neng, the deal might still fall apart at this point. The Company must have been continuously listed on the Nasdaq Capital Market through the date of closing. The proposed name change to China Bio-Energy Corporation must have been approved by the company's board and shareholders, Nasdaq and FINRA. And, most importantly, no litigation, proceeding, investigation or inquiry will be pending or, to the company's knowledge, have been threatened.

Financials

Ding Neng Holdings' total revenue increased from $9.04 million in FY 2008 to $15.3 million in FY 2009 and $14.8 million in the first six months of 2010. Net income increased as well - from $1.22 million (2008) to $2.06 million (2009), and reaching already $3.24 million for the six months ended June 30, 2010.

It should be noted that reported net margins of 21.8% for 2010 are staggeringly high for a biodiesel business. Ding Neng reported net margins of 13.5% for both FY 2008 and 2009, which is more in line with competitors like China Clean Energy (CCGY). China Clean achieved net margins of 12.0% and 11.3% for the June quarters of 2010 and 2009, respectively. I couldn't find an explanation for the margin explosion at Ding Neng in the filing.

If we project Ding Neng's six months results on the full year 2010, using a sort of best-case scenario where the explosive growth rates (213% net income growth year-over-year) can be sustained for the second half of the year, we get to these estimates for FY 2010: Total revenue of $32 million (up 109%) and net income of $7 million (assumed net margin of 21.5%).

Please note that there are some discrepancies in this calculation. Ding Neng said that the annual aggregate capacity of their Zhangzhou biodiesel facility is approximately 40,000 tons. China Clean has reported a most recent average selling price of $682 per ton for biodiesel (up from $569 in 2009), and if we use this number we get to a maximum revenue potential for Ding Neng of $27.3 million per annum with their facility sold out and running at full capacity. Or $13.64 million for the first six months compared to the $14.83 million the company has already reported. Ding Neng must achieve much higher prices for their biodiesel than China Clean to make those numbers all work out.

Valuation

Ding Neng reported trailing twelve months earnings of $4.26 million and my best-case projection for FY 2010 net income is $7.00 million. Competitors like CCGY and China Integrated Energy (CBEH) are currently trading at 7 times earnings. Given that 2011 growth projections for Ding Neng are uncertain as the company is currently running at full capacity, has a short operating history, and growth based on margins that are about 80% above industry average (CBEH's net margin is also in the 12% range), I would set the fair value for "new CHIO" at the 5x earnings level.

This leads me to believe that a fair market capitalization for the post-acquisition entity should be in the $25 million to $35 million range. However, at CHIO's November 12 closing price of $0.13, and using the terms of the reverse merger agreement, the market capitalization of the new entity is currently $57 million, valuing the company with a P/E ratio of 13.4 and forward ratio of 8.2.

Personally, I would not touch the stock above a price per share of $0.05, and even then investors should be prepared for a delisting of CHIO from Nasdaq, as the proposed reverse stock split at a ratio of max. 1:40 won't be sufficient to maintain Nasdaq's required minimum bid price. It seems unlikely at this point that Ding Feng's conditions for closing will be met, and I would not be surprised if the deal will fall apart completely.

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1 Comments:

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