Choked with Red Tape

11/04/2009 12:00 am EST

Focus: STOCKS

Jim Trippon

Editor-in-Chief, China Stock Digest

Jim Trippon of China Stock Digest sees lots of value in two lagging Chinese stocks whose issuers have run afoul of the bureaucracy.

Giant Interactive Group (NYSE: GA) continues to perform under pressure as new online gaming regulations put pressure on its bottom line. The company announced that after a preliminary review of its performance, it expects third quarter 2009 revenue to be between $39.8 million and $42.6 million. This is a big drop from the $53 million the company recorded for total revenue during the second quarter.

The company explains that revenue has been impacted by its voluntary cancellation during the third quarter of certain in-game monetization features (in compliance with recent virtual currency regulations issued by China’s Ministry of Culture). The Chinese government is extremely sensitive about the creation of alternate currencies and is not especially fond of computer game playing.

New games are in the works. Giant Interactive officially started the closed beta testing of its new game, ZT Online Green Edition, which aims to better serve non-pay users, according to Sina.com. The company has also reached an agreement to distribute its games in Russia.

As we have noted previously, Giant operates in a cash-rich business, and the firm has solid cash reserves to ride out rough periods. With a profit margin above 70% and huge cash reserves, GA is selling well below book value. And because of its enormous cash reserves, Giant Interactive is also able to pay a dividend of 2.18%, not something you’d ordinarily expect from this kind of company.

Giant Interactive is still a recommended buy at a purchase price of up to $8.50 a share. We have an estimated sell price of $17, and our stop loss price is currently $4. [Shares closed at $7.24 Tuesday—Editor.]

[Another pick,] Gushan Environmental Energy (NYSE: GU) has had yet another tough month on the stock market. A tax dispute with provincial authorities continues to put pressure on Gushan’s biodiesel production. As noted last month, Gushan Environmental Energy temporarily suspended production at its Fujian refinery due to a dispute with a local tax authority concerning consumption tax issues. Consumption tax rates were to be levied on diesel products, which took effect in January, but the company has stuck to its guns with the State Administration of Taxation of Fujian, saying that its biodiesel, which is produced from used cooking oil, vegetable oil, offal, and jatropha oil, should not be subject to consumption taxes.

Resolution of the Fujian tax dispute and the reopening of Shanghai Fujian will make an enormous difference to the future revenue and profit picture for Gushan, the largest biodiesel producer in China. The company is still 50% above our stop loss protector price and remains in the buy column. We expect to hear more at the firm’s annual general meeting in Hong Kong on November 18.

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