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The Most Unexpected Data Coming Out of Beijing

Here’s a shocker for you, straight from Beijing…

No, I’m not talking about how China’s manufacturing growth unexpectedly cooled in March.

Fears over a slowdown in the world’s second-largest economy are so yesterday’s news.

Especially after we learned roughly two weeks ago that China’s GDP growth rate slid from 7.9% in the fourth quarter of 2012 to 7.7% in the first quarter of 2013. (That’s great by U.S. standards, but stinks for China. It’s actually the slowest rate in over a decade.)

Instead, I’m talking about the fact that China just turned its army loose on the United States. That is, an army of financial attorneys.

Because online retailer, LightInTheBox (Proposed Ticker: LITB), officially filed plans with the SEC to go public.

What’s the big deal?

For one thing, it’s the first Chinese company to file for an IPO on a U.S. exchange in 2013.

More importantly – and I bet you didn’t know this – China-based IPOs have been on a bit of a tear lately.

Consider: Social network operator, YY (YY), which debuted in November 2012, is up 55%. Then there’s online discount retailer, Vipshop (VIPS), which IPO’d in February 2012. It’s up by an even more impressive 341%.

Granted, those are the only two Chinese companies that IPO’d in the United States in the last year or so. But it doesn’t matter. As investors, it only takes one timely investment to meaningfully increase our bottom line. Plus, as the investing adage goes, three makes a trend.

So is LightInTheBox the next Chinese IPO destined for stock market riches? And, more significantly, is it about to signal the start of a trend? Let’s find out…

From Boom to Bust… to Boom?

While no investor lays claim to their very own printing press, back in 2010, they had the next best thing – Chinese IPOs.

A total of 41 China-based companies debuted on U.S. markets that year. In total, they raised almost $4 billion, which accounted for nearly a third of all IPO volume in the United States.

And, like clockwork, many of these Chinese IPOs handed switched-on investors triple-digit gains…

  • Camelot Information Systems (CIS), a provider of financial industry IT services, jumped 117% higher.
  • Youku.com (YOKU), a leading television and online video portal, soared 174%.
  • And HiSoft Tech, a provider of outsourced IT and R&D services – and now known as Pactera Technology International Ltd. (PACT) – jumped 256%.

Of course, the boom eventually busted. (Don’t they all?)

Fraud allegations, accounting irregularities and slowing growth in China quickly sapped investor demand for new Chinese IPOs.

Investor confidence in the previous IPOs weakened, as well.

In fact, the three standout performers above are down 73%, 94% and 84%, respectively, from their peaks. (Ouch!)

This is perhaps the most telling indication of a reversal, though… In 2011, the value of Chinese companies that withdrew from the U.S. market actually exceeded the amount raised by Chinese companies going public!

Like clothing, though, the stock market is cyclical. What goes out of fashion eventually comes back in.

So it’s only a matter of time before Chinese IPOs start listing more frequently on U.S. exchanges again. Especially considering that the U.S. IPO market “is the deepest, most prestigious capital market,” according to Kevin Pollack, Managing Director at Paragon Capital.

Moreover, successful IPOs naturally encourage more activity. Or, as Pollack says, “A long line of companies want to do IPOs here. Having one successful IPO bodes well for the other companies.”

Not to mention that the bust years should have weeded out the lower-quality companies ­- leaving the more compelling opportunities for investors.

With that in mind, let’s find out if LightInTheBox does, indeed, boast high-quality fundamentals – and, in turn, deserves a spot on our coveted “Hot IPO” watch list.

Worth Our Attention, But Not Our Investment Dollars

Longtime Wall Street Daily readers know that I run every IPO, no matter its home country, through a pretty stringent gauntlet. (You can get up to speed here.)

And when I put LightInTheBox through the paces, it doesn’t exactly emerge unscathed…

On the plus side, the company isn’t an unproven startup. It’s been around since late 2007. The $200 million in sales the company booked last year demonstrates its viability, too.

And it’s growing impressively – with plenty more room to run.

Sales increased at least 70% over the last three years. Yet it’s still only scratching the surface of the $521-billion global online retail market, which is expected to expand by 17.7% over the next three years, according to Euromonitor.

On the negative side, though, the company’s debt load is on the rise – up 114% in the last year, to almost $37 million.

More significantly, the company is unprofitable.

That’s particularly troubling, especially since the company has done an admirable job of earning repeat business.

Returning customers now account for roughly 25% of total sales.

But what good is customer loyalty if it doesn’t translate into profits?

It goes without saying that, without profits, the company’s share price is ultimately doomed. And I can’t say that profitability is definitely in the company’s future, either, since LightInTheBox doesn’t benefit from any meaningful or sustainable competitive advantages.

Management wants us to believe otherwise. In the prospectus, they play up their ability to source products cheaply, largely because of the company’s location in China. But the problem is, China is becoming less and less of a source for low-cost goods. So that advantage is fleeting, at best.

The company also boasts about its “proprietary technology platform that integrates every aspect of our business operations, including global marketing, online shopping platforms, supply chain management, fulfillment, logistics and customer service.”

Yet it doesn’t own a single patent. So how proprietary and unique could its technology really be?

Bottom line: LightInTheBox’s IPO promises to be anything but a slam dunk. In fact, underwriters would be well served to price the deal at a compelling valuation to increase the odds of aftermarket success.

Nevertheless, I’ll be carefully monitoring its trading debut. Because a successful launch would signal the formation of a verifiable trend for Chinese IPOs. Something that should lead to more fundamentally sound Chinese companies joining the U.S. market – ones that will ultimately be worthy of our investment dollars.

And since so few investors are paying attention to the latest developments, the potential profits should be that much higher.

Ahead of the tape,

Louis Basenese