Monday, April 2, 2012

Skystar Bio-Pharmaceutical Company (SKBI), the Hidden Chinese Pharmaceutical

Not too long ago, roughly at the end of 2011, there was a breakout of a huge controversy surrounding dozens of chinese companies that accessed the US capital markets with reverse mergers, effectively getting an IPO through the backdoor. These companies we being critisized for misrepresenting their financial information, some cases falling into the downright fraud category.

According to the company's website, Skystar Bio-pharmaceutical Company ("Skystar") is one of China's leading manufacturers and distributors of vaccines and medicines for poultry, livestock and domestic pets. Skystar has over 173 products in its current product line and has over 50 more products in development. Skystar employs over 200 people in Production Facilities located in Hu Xian, Xi'an City, Shaanxi, Province, PRC.

Skystar has opened its GMP Certified Facility that increased production capabilities by 200%. The demand for veterinary medicines and vaccines in China far exceeds the supply and Skystar's plan is to capitalize on its new GMP Certified Facility to increase margins while increasing production to help meet the growing and overwhelming demand for its products.

Skystar has an experienced management team, a solid and diverse customer base, proven products, key R & D relationships to develop new products that are in high demand.

Skystar was incorporated on July 3, 1997 in the PRC as a limited liability company without shares. On December 31, 2003, Skystar was restructured from a limited liability company without shares to a joint stock company limited by shares. Skystar is a high-tech enterprise, which has grown to become one of China's leading manufacturers and distributors of bio-pharmaceutical and veterinary products. Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. was incorporated under the laws of the Cayman Islands on January 24, 2005. The Company is engaged in the research, development, production, marketing and sale of bio-pharmaceutical and veterinary products. All current operations of the Company are in the People's Republic of China ("China" or the "PRC"). Skystar does not conduct any substantive operations of its own and conducts its primary business operations through its variable interest entity ("VIE"), Xian Tianxing Bio-Pharmaceutical Co., Ltd. ("Xian Tianxin"). In 2005, Skystar executed a Share Exchange Agreement with the Cyber Group Network Corporation ("CGPN"), which is listed on the NASDAQ, and then Skystar was restructured into Skystar Bio-pharmaceutical Company ("Skystar" or the "Company") (Nasdaq: SKBI)
Time will tell if the company has really cooked it's books, but in the meantime, I adhere to a contrarian camp who thinks that Skystar has room for tremendous growth. Assuming a the current P/E ratio of 1.5, the current price assumes a decrease of Skystar's earnings of 1.02% annually over the next 5 years, giving us a 2017 price of 2.70$!! However, we know that the chinese firm has been growing earnings at about 38% a year over the past 6 years. Let's make another assumption and let's say that the highly puts some breaks on the growth of Skystar's earnings and that the company is only able to grow EPS at 10% per annum. We find ourselves with a 2017 price of 5.07$ per share.

For the long term investor who is knowledgeable of the pharmaceutical industry in regards to farm animals, this must be a great entry price, from a fundamental sandpoint, into a company that is operating in an growing industry as china industrializes further. With my limited knowledge of this particular industry, I used four different measurements and I came to the conclusion that the current price of Skystar's stock is overly pessimistic. The P/E method, which would be set at 7, gave me a 31.36$ price tag on shares of SKBI.

From another point of view, Skystar has managed to grow it's book value per share over the past 6 years at an incredible 70% per year. Assuming they can manage to keep that pace, we end up with a book value of nearly 23$ per share in 2017. At the current depressed Price/Book ratio of 1.6, we end up with a price per share of 38$.
We can also look at free cash flow per share, which I calculated to have grown about 7% per year over the same period, even if it has been swigging wildly as it can be seen on the above chart. Keeping Skystar's stock for 5 years and using a 10% discount rate, I ended up with a present value of 23.40$ per share for SKBI. Free cash flow per share would end up being about 2.40$ per share in 2017, If we use a reasonable Price/Free cash flow ratio of 7, justified by the fact that the market will gradually realize the value of chinese companies, we end up with a 2017 price per share of 31.36$ per share.

Assuming that my assumptions are not too flawed, it seems to me therefore that the market is being overly bearish on the long term prospects of Skystar. Investors with a long term view will be rewarded with above average returns by holding their positions in the company.

Disclosure: The author has a long position in SKBI.


  1. I'm a bit perplexed about how this investigation has turned out to be. For Chinese companies to always do business in the backdoor is already grossly inappropriate, what more is having to be dependent on a very important product that could spell life or death.

  2. I am not quite sure I understand; What product are you referring to exactly?