The Street recently sat down with Marco Ku, CFO of China Marine Food Group, (CMFO) to discuss the controversy on CMFO's acquisition of Hi-Power energy drink.
What is Hi-Power? What is in it?
Hi-Power is an algae extract. It is colorless, has no smell and no taste. We put other things into it into a can with the algae to make the Hi-Power.
What were the total revenues and net income so far by quarter for Hi-Power?
In 2009, sales were $7.5 million for two quarters, about $4.5 million in the third quarter and $3 million in the fourth quarter. The reason for this drop in Q4 was that Q3 is the summer -- the peak selling time. Q1 2010 revenue was $2.7 million, Q2 is currently more than $7 million (latest update from sales team). The rest of 2010 will be about $10 million; the net margin is 20-25% for these products.
Explain Hi-Power to me in terms of total number of cans sold?
In 2010, we should sell approximately 60 million cans. That's 34 cents for the wholesale price per can.
How many retailers?
10,000 retail points. 10,000 retail points with 60,000,000 cans sold means 6,000 cans per retail point. So that's 16.5 cans per day per retail point. That that is approximately 1.5 cans per hour.
Let's look at the economics of the business on a per can basis so it can be explained to a third grader. COGS of the can?
Packaging material is 60-70% of the total cost. Raw material and packaging cost per can is 20 cents. Sales and marketing cost per can is 7 cents.
What about fees paid to bottlers per can?
About RMB 0.2 per can. We provide them with can, extract, flavor and packaging box. They do the bottling according to our formula and then pack into boxes. Net Profit margin per can is 7 cents. The gross profit is 40%, the bottom line is 20%. In between the SG&A will be 20%, most of it will come from sales and marketing.
Why were your SAIC documents different from your SEC documents?
CMFO used an agent, paid a fee and got the business license done. In the process, the agent doesn't care whether you earn how much or whether you lose money. They just care whether your company is in operation. The agent firm doesn't ask us for audited reports. We pay the fee and get the license back.
Let's walk through the allegations from the acquisition: So it only cost 8,776 for the algae-based drink know-how?
Why $414 for PP&E? What comprised that $414? I would like to add that Coke, while a somewhat different business model, has 9.5 billion in PP&E so the Sales:PP&E ratio is approximately 3:1.
The $414 could be a single computer or a printer, Hi-Power doesn't need any equipment. We only need a few computers for Hi-Power, some of the people bring their own. Most employees go out to the distributors and points of sale all the time, they seldom go to the office. They don't really need those fixed assets like bottling plants, distribution centers, huge office space, trucks and vending machines.
Coke will need different things because they are a different business. We just need office equipment and computers.
Is it basically a sales and distribution company? With a third-party bottler and third-party manufacturer
Yes. We have the formula, trademark and brand name, and use the OEM to do the beverage and what you have to do is select distributors to use so that your product can be spread to multiple retail points.
Why is their only 11,000 in inventory? What was it made up of? Coke inventory is 2.3 billion with sales of 31 billion so the ratio is 15:1 in terms of sales:inventory.
The 11,000 is for raw materials. We use just in time methodology for our supply chain. We just purchase the raw materials including cans, extract and packaging materials and send them to the third-party bottler. We only buy when we receive purchase orders. So we then send raw materials to the OEM facility. When production starts, the raw materials will be used up. After production, we do not have really any inventory
So you purchased Hi-Power for about 30 times book value? For reference Coke is at about 5 times BV now. Book value is not that meaningful in this acquisition as we're not buying its assets but all about intangibles like formula, brand, distribution network and people.
Our projected EPS in 2010 makes the forward PE ratio about 8 times. If you use 2009 numbers then yes it would be 30 times book value.
Zack Buckley is general partner for Buckley Capital Partners Hedge Fund and manages his blog at Uncoveringalpha.com. He developed his investing methodology by synthesizing the ideas from the best investors of all time: Warren Buffett, Peter Lynch, Seth Klarman and Benjamin Graham. Using a value approach, he researched thousands of companies in order to pursue the most undervalued companies, which led primarily to companies in China. Buckley will be spending three months this year in China visiting companies that are exciting investment opportunities. Follow him on his blog, Uncoveringalpha.com, as he travels across China touring factories and interviewing management.