Eternal Technologies (ETLT.OB)

I received an email earlier today from a reader suggesting a micro-cap value company, Eternal Technologies, Inc. (ETLT.OB). Operating in China and incorporated in Nevada, the company offers embryo-transfer services, large-scale improvement of livestock quality, and the development of agricultural and medical  products. If you know exactly what any of that means, shoot me an email. I’d love to know.

But all joking aside, the company seems compelling due to its attractive valuation.  Its price to tangible book value, coupled with boatloads of marketable securities and cash on hand, give the company around a 40-50% discount to realizable asset value. All the while, the company has virtually no debt, a profitable income statement, and is cash flow positive. It also expects much of the same in the coming year(s).  So with all that going for the stock, it’s a no-brainer, right?Tech

Not so quick. Before getting too giddy about the opportunity, I wanted to share my email response to the suggestion. Forgive me again for allowing my cynical side to run amuck, but I believe their are several risk factors in the company that are tempering my greedy side. Here goes:

“I’ve checked out ETLT before and went back to take another look. The cash in the bank is tempting, but I’m a bit    hesitant to buy any shares. I see the company as having several material risks offsetting its net asset value.

First, the company is a Chinese operation with ‘government backing.’ Truth be told, I have no idea what that means, and, for that matter, I don’t know if I like the Chinese government backing anything I have my money in right now. I know little to nothing about China, and I believe investors face substantial risks investing there, and should be prepared to heavily discount any investments there.

Second, the company may have that cash stash, and you may be right that their acquisitions are good. But I just don’t have the ability to say one way or another. And generally speaking, when I can’t tell for sure that an acquistion is good, I assume it’s bad. That said, I’d love to see [more of] your research on this.

Third, the business is inherently complex, and given the high tech area in which it operates, I have no special knowledge that can give me an edge. Tell me that management planned to distribute what they have in the bank or allow it to earn returns in a much simpler business then that’s a different story. I have no idea what they plan to do with the assets, and because they’re investing in (other) high tech businesses, I’m especially afraid that whatever they do, it’ll be stupid.

Fourth, be careful not to fall into the trap of looking at the total asset value and not the diluted per share values. The company has been issuing equity at a rapid pace, and has 2.5 million shares worth of in-the-money options waiting to be exercised. Running a quick calculation reveals a ‘true’ per share value of about $1.11 in book, not $1.30.

And last but not least, I always worry about these very small operations having materially significant deficiencies in accounting and control procedures. Though their auditors (whom I’ve never heard of) issued a clean opinion, they also reported at least two material deficiencies [in the past few years, including 2005]. And, on a completely different note, their somewhat sketchy website doesn’t ease my worries. I’m not saying they’re fraudulent, but you never know what ugly practices lurk behind the scenes.

Again, I’d love to see or hear more research. If my aforementioned fears could be eased, I’d be very interested in purchasing shares…”

I’ve seen a fair bit of bullishness on the stock on message boards, other posts, etc. The enthusiasm is understandable. Give any investor a profitable and growing company trading for less than liquid assets, and they well should be excited. But I believe ETLT is a different can of worms, with a set of unique risk factors that must be taken into account and fully realized before any investment is made.

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