Last week, Noah Education (NED) shares plunged more than 40% on concerns that one of its products had to be removed from store shelves because it contained cancer-causing chemicals. I think the price drop was a gross overreaction to media reports exacerbated by thin holiday trading, lack of analyst coverage and inadequate management communication.
Noah Education debuted on the NYSE on Oct. 19. The company sells handheld digital learning devices (DLDs) and produces about 28,000 titles covering various academic subjects. The company priced 9.85 million shares at $14 a share.
The questions began with an article that appeared in the Shanghai Daily in which the writer wrote, "Two electronic products makers in China have made emergency recalls across the country to take their microwave ovens and electronic dictionaries off the shelves." At issue was Noah's NP800, a small handheld electronic dictionary. Hexavalent chromium (chromium VI) was found on the chrome electroplating of the NP800's internal speaker.
The company's 2008 fiscal first-quarter earnings conference call added to the confusion and led to investor panic. On the call, Executive Vice President Rick Chen stated that "Due to an oversight by our [original equipment manufacturer] , one of our products, NP800 DLD, was taken to the market without a simple warning sticker that is required on all the products sold in China that contain a certain element that is widely used in all types of electronic devices sold in China." One caller asked if there was a recall. Instead of answering with a definitive yes or no, management responded that product safety was very important. Another caller characterized it as a "sticker issue." While management repeated over and over that the "sticker issue" was minor, they provided insufficient detail to support that claim.
In investigating the limited news, I've learned more about the missing labeling requirements. Beginning on March 1, 2007, all electronic products sold in China that contain lead, mercury, cadmium, hexavalent chromium, polybrominated biphenyl and polybrominated diphenyl ether are required to carry the China RoHS label, a small circular sticker.
Here is an English translation of the law by the AeA China Restrictions on Hazardous Substances Steering Committee:
Article 1: These Methods are hereby developed to control and reduce pollution to the environment caused after disposal of electronic information products, promote production and sale of low-pollution electronic information products, and safeguard the environment and human health, according to the "Law of the People's Republic of China for the Promotion of Clean Production," the "Law of the People's Republic of China on the Prevention and Control of Environmental Pollution by Solid Wastes," and other statutes and administrative regulations.
Additional information about the China RoHS is available here.
Chromium VI is not prohibited from being used in products, but its use must be disclosed to consumers. The new labeling is part of an effort to help consumers dispose of and recycle products in an environmentally safe manner. The label is not to notify consumers of products that are dangerous to use.
NED operates both Chinese- and English-language Web sites. On the Chinese site, there are five articles addressing the chromium issue. Management is addressing this problem with Chinese consumers.
Because the English site has none of these articles, this information is unfortunately not reaching U.S. investors. Google can be used for a general translation.
I spoke with investor relations a few times, and on Monday, Nov. 26, the company has updated its FAQs section. The NP800 was not recalled. The company is voluntarily allowing customers to return the NP800, which is a minor product representing 5,000 of 229,000 products shipped in the first quarter. The company reiterated its revenue guidance on its recent conference call. All products were properly labeled except the NP800.
The NP800 was not removed because it posed a health or safety risk for consumers. Direct contact is not harmful. To be hazardous, the internal speaker would need to be removed, ground up and inhaled. Unfortunately, management's incomplete explanation on its conference call led to a panic in the stock.
Although this gaffe is a huge embarrassment to a nascent public company, it has been quickly rectified. On the conference call, management stated that they have taken steps to ensure that "it will never happen again." On Nov. 23, in an exclusive with the Beijing Evening News, the company disclosed that raw materials are being tested for all Noah models and that all products are in compliance with pollution control regulations.
Since its IPO, Noah Education has about $3.35 a share in cash. The company just reported first-quarter earnings of 20 cents a share and projected year-over-year revenue growth of 30%-32% to $96-$97 million. I expect to see analyst initiations with possible defenses with the quiet period ending. I think a buying opportunity exists in shares of Noah Education over what appears to be a simple "sticker issue."
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Noah Education to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
-------------------------------------------------------------------------------- At the time of publication, Uy was long Noah Education, although holdings can change at any time.
Hal Uy has been a full-time trader since 1997. He has been interviewed in Money, WSJ.com and in the book The After-Hours Trader. He has also served as a technical assistant on several trading books. He appreciates your feedback; click here to send him an email.
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