Investors Herded Back Into Lone Star Technologies

By Dr. Duru written for One-Twenty

August 16, 2006


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I love it when a stock soars soon after I write about it. If only I could be so smart to anticipate the move!

This time, it was Lone Star (LSS) - one of the few steel companies I follow relatively closely. The move was a bit strange. Tuesday morning, LSS announced an important joint venture with one of China's largest steel companies, Hunan Valin Steel Tube & Wire Co., Ltd. LSS held a conference call and provided a nifty presentation and lots of details on the transaction, including operational and strategic information. A good thing too. Because I struggled to figure out why it took the market a whole day to really care, and I read everything. On a big rally day, LSS managed only a 0.57% gain on the news. So, excuse me for not even digging into the details of this deal yesterday. Even if I had read it yesterday, I probably would have been just as blase as the rest of the market acted.

But suddenly, today, on another big rally day in the market, LSS soared for an 8% gain! Wow! So what happened? It appears at least one analyst gushed over the prospects of this deal, and investors and traders were all too happy to fall in line. The Jeffries analyst is looking forward to some major earnings accretion and boosted the price target from $50 to $62, 41% above Tuesday's close. Now why the herd, myself included, could not figure this out on its own, I cannot tell you. But I am a bit wary. The deal will not close until early 2007 and is subject to the infamous Chinese bureaucratic system for deal approval (LSS is buying into Chinese production assets). Finally, while LSS was generous in providing financial details on this deal, as far as I can tell, all the money they are sure to make is from an expansion of North American sales. They get a favorable share of sales earned here. We are to assume that the expanded product line also has the potential to increase sales to customers worldwide, but we are given no details on how that portion of the profit-sharing will work out. We are also teased with the prospects of "participation in the Chinese oilfield tubular markets." But again, no specifics on what this means. As far as I am concerned, Valin will not be giving up any markets or money it is already making on its own domestic turf.

Despite my wariness, I do believe in the promise of this deal. But it will take some time to see the proof and evidence of the benefits. Perhaps LSS was motivated to do something "exciting," given Tenaris is buying out one of its main competitors, Maverick Tube (MVK). Regardless, I suspect analyst support and boosterism will keep the stock aloft until the real money materializes - barring any intervening bad news of course. As I mentioned before, the stock is incredibly cheap from a valuation perspective - that alone could support a buy of a quality company. Add in a potential increase in profits and the beginnings of renewed investor interest, and you get a decent story again. I will be looking for a slightly lower re-entry point (see disclaimer here).

Be careful out there!

DrDuru, 2006