Panic Over U.S.-China Accounting Rift May Be Overblown
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Baidu (NASDAQ: BIDU) has been jumping around lately as if it were an unknown small cap with inexplicable financials targeted by a short-selling web site. It fell from a 52-week high of $154 last spring to a low of $86 in early December, then bounced back above $100, at least briefly, this week.
But stay tuned: Each day is a grand new adventure for one of the most widely-held Chinese firms in the U.S., valued by the market even in its current depressed state at about $35 billion and fabulously profitable all the while with operating margins in excess of 50 percent.
The issue, of course, is the long-awaited call to arms by the U.S. Securities and Exchange Commission, which has been wrangling for years, and to little effect, with Chinese regulators over the requirement in U.S. law that U.S. regulators be granted access to the audit documents of firms listed on U.S. stock exchanges. A series of fraud revelations surrounding small Chinese firms listed on U.S. exchanges through reverse mergers made this more than an academic exercise. One could argue that the SEC was several years too late getting around to it.
The shot across the Chinese bow came early in December when the SEC charged five big accounting firms with failing to made audit materials available. The targeted accounting firms included the Chinese affiliates of Deloitte , KPMG, Ernst & Young and PricewaterhouseCoopers, also known as the accounting profession's Big Four. This action threatened not only Chinese firms but also, possibly, North American-based multinationals that do business in China and have their Chinese operations audited by China-based accountants.
Chinese regulators insist that foreign governments have no business looking at the financial documents of Chinese companies, no matter where they're listed. It has consistently refused access to the U.S. Public Company Accounting Oversight Board (PCAOB), whose job, under the Sarbanes-Oxley Act, is to oversee the audits of public companies listed on U.S. exchanges on behalf of American investors.
This collision between American and Chinese government authorities has produced dire warnings that all Chinese accounting firms, including the affiliates of the Big Four, may be deregistered by the SEC for compliance failures. As a result, the doomsayers sayeth, all Chinese companies may be delisted from U.S. exchanges.
It is instructive to note, however, that the biggest and least exciting of these names, typically held institutionally, have sustained relatively mild damage as a result of the standoff among regulators. China Life and PetroChina both suffered dips on the news of the SEC action earlier this month, then recovered rapidly. China Life closed Wednesday just off its 52-week high.
Baidu and SINA have taken harder hits, which suggest they have other issues. In the case of SINA, there has been vast volatility as investors guess about when and how much it will be able to monetize Weibo, China's most popular microblog, often referred to as that country's version of Twitter. In the case of Baidu, there has been fretting over nascent competition in the search space from Qihoo 360 and the transition in search to mobile devices.
As a result, Baidu and SINA offer more of a Regulator Wars discount currently than do PetroChina or China Life. SINA remains a more daring bet inasmuch as nobody really knows just how profitable a social media platform like Weibo may turn out to be. Even in the U.S., the future profitability of Facebook and Twitter remains the subject of much and varied speculation.
But Baidu, with revenues likely to exceed $3.5 billion this year and likely to approach $5 billion in 2013, remains a rapidly-growing technology company in a growing economy with an enviable track record of monetizing its dominant position in search. Even with that growth slowing, as it must in percentage terms given Baidu's size, trading at a trailing price/earnings ratio of 23 and a forward estimated P/E of 12 offers a rather large margin of safety if you believe analyst estimates of its continuing growth curve, currently pegged at an average of nearly 40 percent a year over the next five years.
And Reuter's now reports that at least one member of the PCAOB seems less than apocalyptic than many media commentators about the likely outcome of the current skirmish among regulators. The news service quoted PCAOB member Lewis Ferguson saying the board gave Chinese regulators the outline of a plan for joint inspections last month and that the Chinese expressed interest in a meeting to talk about it in 2013.
"There is forward movement," Reuters quoted Ferguson as saying. "The number of issues ... has been narrowed significantly."
So for any investor who believes that China and the U.S. will ultimately find a way to avoid a financial cold war, it might be worthwhile to check in with any China stocks on your watch list to see if the fear surrounding the SEC's action has provided a particularly propitious time to invest. In the cases of both Baidu and SINA, the current discount is rather significant.
ultimatespinach owns BIDU and SINA. The Motley Fool owns shares of Baidu. Motley Fool newsletter services recommend Baidu and SINA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!