Wednesday, August 26, 2009

Reward vs Risk

Orsus Xelent (ORS) is a Chinese cell phone maker that trades for $22 million on the AMEX. The company has a ton of risks:

  • Almost all of its sales are to one distributor. Having one customer is always a risk, though this risk is somewhat tempered by the fact that many consumers purchase Orsus' phones.
  • As a foreign-owned entity in China, its taxes are about to double.
  • The company prides itself on being innovative and meeting end-user needs, yet its R&D budget was about $11,000 in the latest quarter.
  • It has guaranteed a $17 million bank loan to one of its suppliers.
In many cases, these risks would be enough to turn a value investor away from a company like this. But as Mohnish Pabrai notes, value investing is about investing in companies with upside potentials larger than the downside risks. Clearly, there is some risk with Orsus Xelent, so what possible upside is there that can trump these risks? The answer is the company's low price on several levels.

First of all, Orsus trades for a P/E of around 2! Companies normally trade at such levels if earnings are expected to fall drastically. For Orsus, however, earnings and revenue this year are expected to be even higher than they were last year, as the company continues to supply more and more of rural China with mobile phones.

The company also trades for about half of its liquid assets. While those assets do include a ridiculously large sum due from its main distributor, that number has come down in the last quarter. Furthermore, the company has taken out a 3rd party insurance policy on the overdue receivables, which should provide some protection. The distributor is also guaranteeing a portion of Orsus' outstanding loan, whatever that's worth.

Orsus can hardly be considered a risk-free stock. Nevertheless, despite a huge number of risks, the upside potential of this company was too high for this value investor to ignore. This penny stock trades at a massive discount to its earnings and to its assets. Time will tell if that discount is justified.

Disclosure: Author has a long position in shares of ORS

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.

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