Variant View Research Responds to Advanced Battery Technologies
On 4/6/2011, ABAT issued a press release responding to our research report titled “Advanced Battery Technologies (ABAT): The Most Egregious Chinese RTO”
We present, side-by-side, excerpts from ABAT's response and statements from their official filings. ABAT’s response contains numerous false and misleading statements, which directly contradict its filings. We have provided links to these filings to make it convenient for the reader to verify our claims.
In our report, we noted that Chairman Fu now owns the company’s key subsidiary, which ABAT had previously claimed ownership of
We wrote:
If the filings are accurate, the Chairman transferred ownership of the company’s sole operating subsidiary to himself without explanation or compensation. If the filings are inaccurate, then the company is guilty of misrepresenting itself as previously owning 100% of HLJ ZQPT.
Excerpt from ABAT response on 4/6/2011:
[HLJ ZQPT] has been owned by 16 investors, including Chairman Fu, since … 2002. In 2004 the owners of Heilongjiang ZQPT transferred all of the benefits and obligations of ownership of Heilongjiang ZQPT to Harbin ZQPT, a subsidiary of ABAT. Under U.S. GAAP, the transfer of those benefits and obligations meant that the balance sheet and financial results of Heilongjiang ZQPT must be consolidated with those of ABAT as if it were a subsidiary. Thus, for accounting purposes, ABAT reported in its SEC filings from 2004 to 2009 that it "owned" Heilongjiang ZQPT.
[throughout this article, ellipses refer to an omitted clause, and emphasis has been added to excerpts by this author]
Excerpt from ABAT's FY 2004 10-K filing:
Mr. Fu also owns 30% of the outstanding stock of ZQ Power-Tech, and was responsible for structuring the transaction in which Advanced Battery Technologies acquired its 70% of ZQ Power-Tech.
Excerpt from ABAT's FY 2007 10-K filing:
Cashtech Investment Limited is also a holding company with only one subsidiary: Heilongjiang ZhongQiang Power-Tech Co., Ltd., a China limited liability company (“ZQ Power-Tech”). Prior to January 2006, Cashtech Investment Limited owned 70% of the capital stock of ZQ Power-Tech. In January 2006 our Chairman, Fu Zhiguo, transferred the remaining capital stock of ZQ Power Tech to Cashtech Investment Limited, so that it now owns 100% of ZQ Power-Tech.
In its prior filings, ABAT explicitly claimed ownership of "100% of ZQ Power-Tech [HLJ ZQPT]". They also explicitly claimed that the ownership of HLJ ZQPT was through "stock". They did not truthfully present HLJ ZQPT as a VIE, as other companies using VIE structures have done for years.
We reiterate that it is not a question of consolidation or accounting. Regardless of whether a company consolidates an entity or not, it cannot claim to own a entity that it does not own.
We interpret ABAT's response as an admission that it misled investors in its SEC filings from 2004 through 2008 regarding the true ownership of HLJ ZQPT.
In our report, we stated that ABAT misleads investors into thinking that it makes electric cars
Excerpt from ABAT's Response, 4/6/2011:
No person reading our SEC filings or looking at our website in good faith could draw the conclusion that ABAT manufactures electric cars.
Excerpts from ABAT's 10-K filing:
Since 2002, Wuxi ZQ has been engaged in the design, development, manufacture and marketing of electric- and hybrid-powered two wheel vehicles, as well as electric-powered agricultural transport vehicles and sport utility e-vehicles.
…
[Wuxi ZQ] is engaged in the business of manufacturing and distributing electric vehicles
The company regularly refers to its business as an "electric vehicle" business in its press releases and filings. This is highly likely to mislead Western investors whose idea of an electric vehicle is a Tesla, not a bicycle with a small electric motor attached.
However, even if we were generous enough to say that it is legitimate to refer to bicycles as 'electric vehicles', there are numerous explicit references to cars and sport utility vehicles in the company's website and filings.
Partial screenshot of ABAT's website, taken on 3/30/2011:
The company’s website, ZQPT.COM, explicitly stated "electric cars".
Note that the company changed the text on 4/6/2011 to read "electric vehicle." However, the company did a poor job of scrubbing its site for references to electric cars. As of the morning of 4/6/2011, this page still has a claim that Wuxi is producing 'the electric four-wheel car series'. Another page still has an "electric cars" button.
As of 4/6/2011, the old image of “Electric cars” can be found in the Google cache or in a Google image search. A screenshot of the old website is also available in my initiation report on ABAT dated 3/28/2011.
The site contains no images of SUVs or agricultural vehicles. We don’t believe that the company is selling any real sport utility vehicles for $3,400 or less, as it claims in its 10-K.
In our report, we stated that ABAT overpaid for Wuxi Angell by spending $22 million on the acquisition.
Excerpt from ABAT's Response, 4/6/2011:
The purchase price paid by ABAT for Wuxi ZQ was $12.87 million (cf: ABAT 2009 10-K, Note 3 to the Financial Statements), not $22 million.
Excerpt from ABAT’s 8-K/A filing:
In exchange for the equity in Wuxi Angell, ABAT agreed to pay US$3,640,000 and 70 million Chinese Renminbi (approx. $10,248,902) in cash. In addition, Advanced Battery Technologies, Inc. issued three million shares of its common stock to the sellers.
| Units (mn) | USD per unit | USD (mm) | |
| USD payment | 3.64 | 1.00 | 3.64 |
| RMB payment | 70.00 | 0.15 | 10.20 |
| ABAT Shares | 3.00 | 2.64 | 7.92 |
| Total | 21.76 |
Excerpt from ABAT's FY 2009 10-K filing (footnote 3):
We looked at the 2009 10-K which ABAT references. Strangely, Footnote 3 claims that the total purchase price is $9.87 million, not $12.87 million as it now claims. ABAT seems very confused about the purchase price it paid for the Wuxi acquisition. Of these three prices that ABAT has claimed at various times, at least two must be fictional.
In our report, we stated that the purported acquisition of Shenzhen ZQ in early 2011 was most likely a sham transaction because of Chairman Fu's connection to Shenzhen ZQ.
Excerpt from ABAT's Response, 4/6/2011
Until we acquired it in January 2011, the registered owner of the registered equity of Shenzhen ZQ was Wang Changhe. He is the person to whom the purchase price for Shenzhen ZQ was paid.
The Variant View report notes that our Chairman, Fu Zhiguo, is identified as an officer and legal representative of Shenzhen ZQ in that company's government registration. That is correct. In order to register the acquisition of Shenzhen ZQ by Harbin ZQPT with the provincial government, Mr. Wang, the seller, gave Mr. Fu a power of attorney to represent the company before the government. This was solely an administrative convenience, as the purchase of Chinese companies cannot be completed without government registration performed in person.
The Shenzhen AIC registration filing which ABAT says we are “correct” about is dated 2008. This was definitely not an "administrative convenience" to facilitate a 2011 transaction.
More information about the Shenzhen ZQ transaction can be found in our follow-up report here. Essentially, Shenzhen ZQ, which the company now claims to have purchased in 2011, was actually purchased in 2008.
Excerpt from Defendant ABAT's court filing, dated 12/7/2009:
Plaintiff’s Employment Contract was executed contemporaneously with [ABAT's] acquisition of Huang’s father’s company, Shenzhen Shengxi Science and Technology Co., Ltd.(“Shenzhen SST”), by ABAT’s Chief Executive Officer, Fu. See Compl., ¶ 7 & Ex. A. Curiously, the Complaint refers to Shenzhen SST as “Luke Battery Corp.,” Compl., ¶ 6 & Ex. A — a name appearing nowhere in the Acquisition Agreement. The company was then renamed Shenzhen Zhongqiang Energy Science and Technology Co. Ltd., a name sometimes rendered in English as “Shenzhen ABAT” or “SABAT.” Fu Decl., ¶ 10.
The names in the US court filing match the names in the 2008 Shenzhen AIC filing. As the court filings show, ABAT had purchased this company from a Mr. Huang for $1 million in 2008, not from Mr. Wang for $20 million in 2011.
The announcement of a second acquisition for the same company that ABAT already owned seems to be a device for the Chairman to funnel $20 millon of shareholder funds into his own pocket.
In our report, we stated that ABAT’s $4.8 million loan from Chairman Fu appeared to be fabricated because it did not appear on the balance sheet
Excerpt from ABAT's Response, 4/6/2011:
Variant View's other point is that the loan does not appear on the balance sheet in the 2005 10-K. To which we respond: "Of course it doesn't. It was satisfied in January of that year."
ABAT implies that the loan was taken off the balance sheet in 2005 when it was repaid. Unfortunately for ABAT, the purported $4.8 million loan does not appear on their 2004 10-K balance sheets either. (Our report initially included the 2004 10-K balance sheets also, but they were inadvertently deleted during editing.)
Excerpt from ABAT’s FY 2004 10-K balance sheet:
None of the footnotes indicated in the liabilities section make any reference to the purported loan.
We reiterate our belief that this purported loan never existed in the first place. We don’t believe that Chairman Fu would lend money to the company without a written contract and without properly disclosing it in the balance sheets.
The company claims that a loan contract was signed in January 2005 “acknowledging” a loan that was made many years prior, and that the loan was repaid in January 2005. We simply don’t find this claim credible, in light of the lack of balance sheet disclosure. This was not a small loan that could have been overlooked. $4.8 million is greater than the total liabilities disclosed by the company at year end 2004. It remains far more likely that the agreement was fabricated.
In our report, we noted that John Leo was the promoter of both ABAT and the CYXI fraud.
Excerpt from ABAT's Response, 4/6/2011:
The RTO occurred in 2004. John Leo had no relationship with ABAT after February 2005 other than as a relatively small shareholder.
Excerpt from ABAT's Correspondence with SEC Staff, 9/11/2006:
Excerpt from ABAT's Correspondence with SEC Staff, 11/14/2006:
[T]he value of the shares was properly accounted for as a prepaid expense, to be amortized over the expected duration of Mr. Leo’s relationship with the Company.
ABAT was claiming to the SEC in late 2006 that it expected a 10-year relationship with John Leo. Now, it is claiming that their relationship ended in February 2005. At least one of these two claims must be false.
In our report, we estimated that Chairman Fu has sold approximately 28 million shares of ABAT since 2004.
Excerpt from ABAT's Response, 4/6/2011:
Chairman Fu has never owned more than the 9,149,730 shares (options included) he currently owns.
Excerpts from ABAT's FY 2005 10-K filing:
In consideration of Mr. Fu's transfer of the interest in ZQ Power-Tech, the Company issued 11,780,594 shares of common stock to Mr. Fu.
…
In consideration of Mr. Fu's transfer of the patent to ZQ Power-Tech, Advanced Battery issued 4,400,000 shares of common stock to Mr. Fu.
Excerpt from ABAT’s FY 2004 10-K filing:
Conclusion
We interpret ABAT's response on the subsidiary ownership question as an admission that it misled investors in its SEC filings from 2004 through 2008 by falsely representing its VIE entity as a wholly-owned subsidiary.
The company’s responses continue to mislead investors with statements that can be easily disproven by checking them against the company's prior filings with securities regulators and the US federal court system.
Shocking Allegations Behind Advanced Battery’s $20 Million Acquisition
In our previous report explaining why we are short Advanced Battery Technologies, we claimed that “ABAT spent $20 million to acquire a company linked to the Chairman without disclosing the relationship.” Further research confirms that the truth is even more nefarious than we initially believed. The target company was not only related, but was in fact a company that ABAT had already acquired in 2008 for $1 million. The announcement of a new acquisition appears to be a fabrication allowing Chairman Fu to funnel $20 million of shareholder funds out of the company into his own pocket. We also learned of disturbing allegations by the CEO of the company acquired in 2008. That individual alleged that ABAT's Chairman threatened his life in retaliation for a lawsuit over $600,000 worth of ABAT shares.
Background
In January 2011, the company claimed that it acquired Shenzhen Zhongqiang New Energy Science & Technology Co., Ltd. (“Shenzhen ZQ”) (深圳市中强新能源科技有限公司) for 135 million RMB (about $20 million).
We thought it was strange that the company acquired an entity with the “ZhongQiang” branding, since ABAT’s existing subsidiaries are also branded ZhongQiang. ZhongQiang roughly translates to “Strong”, so it is not a common part of company names.
Shenzhen ZQ’s Government Registration
This Shenzhen government registration, dated September 10, 2008, shows that Shenzhen ZQ changed its Legal Representative and Executive (Managing) Director from Huang Youlin (黄友林) to Fu Zhiguo (付治国).
Sui-yang Huang vs. Advanced Battery Technologies, Inc.
In an unusual “coincidence”, ABAT had acquired a Shenzhen battery company in 2008. We don’t know about this acquisition from ABAT’s SEC filings; we couldn’t find any that disclosed this purchase. We know about the acquisition because the acquired company’s CEO, Huang Suiyang (黄穗阳), who became ABAT’s Chief Technology Officer, sued ABAT in US federal court over a payment dispute related to the acquisition.
Huang Suiyang, in his court filings, claims to be a US citizen; to have a home in San Francisco; to pay US income taxes; and to have worked at the National Renewable Energy Laboratory (a prestigious US government lab). According to ABAT (back when they were still on good terms):
Dr. Suiyang Huang is one of the most well respected minds in the Chinese battery industry. He holds a Ph.D from the Universite de Bordeaux, and has over thirty papers published throughout the world. Dr. Huang personally owns 7 U.S and 20 Chinese patents. [emphasis added]
Source: ABAT press release, dated 9/4/2008
Two key questions:
(1) what is Huang Suiyang’s connection to Huang Youlin (former executive of the Shenzhen ZQ entity)?
(2) What is the connection between the Huang Suiyang’s battery company and Shenzhen ZQ?
Shenzhen Zhongqiang Was the Company ABAT Acquired in 2008
The answer to question (2): ABAT acquired the Huangs’ company for $1 million and renamed it Shenzhen ZQ in 2008; two years before they told the public that they acquired it for $20 million. We believe that this connection was overlooked because the court regularly refers to Shenzhen ZQ as “Shenzhen ABAT” or “SABAT”. However, as a motion filed by ABAT’s own attorneys makes clear, SABAT is simply an “English rendition” of the company’s real name, Shenzhen Zhongqiang Energy Science and Technology Co. Ltd.
Plaintiff’s Employment Contract was executed contemporaneously with the acquisition of Huang’s father’s company, Shenzhen Shengxi Science and Technology Co., Ltd. (“Shenzhen SST”), by ABAT’s Chief Executive Officer, Fu. See Compl., ¶ 7 & Ex. A. Curiously, the Complaint refers to Shenzhen SST as “Luke Battery Corp.,” Compl., ¶ 6 & Ex. A — a name appearing nowhere in the Acquisition Agreement. The company was then renamed Shenzhen Zhongqiang Energy Science and Technology Co. Ltd., a name sometimes rendered in English as “Shenzhen ABAT” or “SABAT.” Fu Decl., ¶ 10. [emphasis added]
Source: Defendant ABAT’s Court Filing, dated 12/7/2009, originally retrieved from Pacer, Southern District of New York, case no. 1:09-cv-08297-HB, document no. 12
Note that both the former name of the company (Shenzhen Shengxi Science and Technology Co., Ltd.) and the new name of the company (Shenzhen Zhongqiang Energy Science and Technology Co. Ltd.) match the names on the registration filing we referenced above.
We sourced the court filings from Pacer. Pacer is a US government website that is accessible to the public, but they charge 8 cents per page to download documents. We encourage readers to download these documents themselves from Pacer, but for your convenience, we have also uploaded copies to Scribd.
Huang Suiyang and Huang Youlin are Related
We believe that Huang Youlin is Huang Suiyang’s father and the original sole shareholder of the Huangs’ company before it was acquired by ABAT.
Huang [Suiyang] was the founder and CEO of a company called Luke Battery Corporation (“LBC”),1 and his father financed its formation and was its sole shareholder. On August 30, 2008, Huang, acting as an agent for his father, entered into an acquisition agreement with ABAT Chairman and CEO Zhiguo Fu (“Fu”) to sell LBC to ABAT for one million dollars.
Source: Judge Baer’s opinion, dated 3/26/2010, retrieved from Justia.com, also available on Pacer
Evidence that Huang Suiyang and Huang Youlin are connected can be found in asimple Google Search, which reveals that the Huangs are co-authors on numerous academic papers and that Suiyang was listed as inventor on patents owned by Youlin. One example can be found here.
Death Threats
We found Dr. Huang and his complaint very credible, and we think that shareholders should beware of what kind of people they are dealing with when it comes to Chairman Fu and ABAT management.
Huang, in a court filing, alleged that he received death threats on the day after he filed his initial complaint (September 30, 2009) as well as the day after he amended his complaint (November 17, 2009).
Coincidence? We think not.
Huang presented the following exhibits as evidence:
[Profanities redacted]
Source: Plaintiff Huang’s court filing, dated 1/21/2010, originally retrieved from Pacer, Southern District of New York, case no. 1:09-cv-08297-HB, document no. 16
Ultimately, the judge decided that this case belonged in a Chinese court rather than a US court for technical reasons, but he made no judgment about the allegations raised in the complaint. If they are true, perhaps ABAT should change its name to Assault and Battery Technologies.
Conclusion
We are extremely confident that the purported 2011 acquisition of Shenzhen ZQ is a fabrication allowing Chairman Fu to funnel $20 million of shareholders’ money into his own pockets. However, we believe that the ABAT case is not just a question of accounting misstatements or disclosure failures. If Huang Suiyang’s allegations are true, ABAT is a criminal enterprise masquerading as a public company, not a real business.
Advanced Battery Technologies (ABAT): The Most Egregious Chinese RTO
I am short Advanced Battery Technologies (ABAT) for the following reasons:
- The Chairman appears to have transferred ownership of ABAT’s key subsidiary to himself without explanation or compensation
- ABAT leads investors to think that it makes cutting-edge electric cars, when in fact it produces cheap scooters and bicycles
- ABAT claims unrealistic margins in what it admits is a commodity space
- ABAT claims to have increased revenue from $4.2 million to $97.1 million from 2005 to 2010 while DECREASING its employee count
- ABAT claims distribution relationships which appear to be fake
- ABAT is a serial issuer of equity at low prices
- ABAT spent $20 million to acquire a company linked to the Chairman without disclosing the relationship
- ABAT spent $22 million or 7x sales to acquire a failing and possibly related company
- ABAT issued 11 million shares to the Chairman and other individuals to repay a “loan” which appears to be entirely fabricated
- Despite a parade of auditors and multiple restatements, ABAT still has material weaknesses
- ABAT’s RTO promoter, John Leo, is behind a number of suspicious Chinese reverse mergers, most notably CYXI
- No fundamental institutions are significant shareholders
In short, I think that the financial statements and management of ABAT cannot be trusted and therefore the stock is worth zero.
BACKGROUND
Advanced Battery Technologies (ABAT) is a $250 million market cap company listed on the Nasdaq. The company originally went public through a reverse merger transaction with a shell company called Buy It Cheap.com in 2004. The company claims to have increased its revenues from $11 thousand to $97 million from 2003 to 2010.
ABAT owns Cashtech Investment Limited (“Cashtech”), a BVI corporation which owns two Chinese entities, Harbin ZhongQiang Power-Tech Co. Ltd. (“Harbin ZQ”), and Wuxi ZhongQiang Autocycle Co. Ltd. (“Wuxi ZQ”), as well as a 49% interest in a Texas corporation named Beyond E-tech, Inc (“BET”).
Harbin ZQ is a non-operating shell that has a contractual arrangement to receive all of the "benefits and responsibilities" of an operating entity called Heilongjiang ZhongQiang Power-Tech Co., Ltd. (“HLJ ZQPT”).
According to the 10-K:
- HLJ ZQPT “is engaged in the business of manufacturing and distributing polymer lithium-ion batteries”
- Wuxi ZQ “is engaged in the business of manufacturing and distributing electric vehicles”
- Beyond E-tech “distributes cellular telephones in the United States”
THE SHORT CASE
The Chairman appears to have transferred ownership of ABAT’s key subsidiary to himself without explanation or compensation
In the 2007 10-K and 2008 10-K, HLJ ZQPT is described as the 100%-owned subsidiary of Cashtech:
Cashtech Investment Limited is also a holding company with only one subsidiary: Heilongjiang ZhongQiang Power-Tech Co., Ltd., a China limited liability company (“ZQ Power-Tech”). Prior to January 2006, Cashtech Investment Limited owned 70% of the capital stock of ZQ Power-Tech. In January 2006 our Chairman, Fu Zhiguo, transferred the remaining capital stock of ZQ Power Tech to Cashtech Investment Limited, so that it now owns 100% of ZQ Power-Tech.
Yet, in the 2009 10-K, we suddenly learn that HLJ ZQPT is actually owned by Chairman Fu again, without any explanation of how he reacquired ownership:
HLJ ZQPT is owned by our Chairman, Mr. Fu and other individuals but controlled by Harbin ZQPT through a series of contractual arrangements that transferred all of the benefits and all of the responsibilities for the operations of HLJ ZQPT to Harbin ZQPT.
The filing fails to mention that this structure is different than the previously disclosed structure.
I searched every SEC filing by the company between the 2008 10-K and the 2009 10-K. As late as the 10-Q filed on August 11, 2009, the company continued to claim ownership of HLJ ZQPT without ever mentioning Harbin ZQ.
The first mention of Harbin ZQ is in an S-3 filing dated August 17, 2009. However, this filing contains no disclosure of the VIE arrangement or Chairman Fu’s ownership.
The only other mention is in the 10-Q filing dated November 9, 2009. Here, we are finally told of the VIE arrangement, but the filing fails to mention that the VIE structure is different than the previously disclosed structure, nor are we told that Chairman Fu owns Heilongjiang ZQPT.
The 10-Q does say that they are now consolidating the results of both Harbin ZQ and HLJ ZQPT, and they refer to the change of accounting standards under topic ASC 810, consolidation. Specifically, they are referring to SFAS 166 and 167 (June 2009).
SFAS 166 requires additional information about financial assets and securitizations, as well as eliminating the concept of a Qualifying SPE. SFAS 166 primarily affects banks and other financial institutions, not manufacturing businesses like ABAT.
SFAS 167 changes the assessment process for what entities must be consolidated. It also expands certain disclosures, specifically, separation of certain VIE assets and liabilities on the balance sheet, disclosure of certain risks, restrictions, and assumptions made during the consolidation process.
However, what SFAS 166 and 167 DO NOT DO is affect in any way how companies represent their ownership of subsidiaries or VIEs. In other words, I’m pretty sure that if ABAT did not own HLJ ZQPT, then representations to the contrary would be considered securities fraud, either prior to or after SFAS 166/167.
If the filings are accurate, the Chairman transferred ownership of the company’s sole operating subsidiary to himself without explanation or compensation. If the filings are inaccurate, then the company is guilty of misrepresenting itself as previously owning 100% of HLJ ZQPT, when in fact it did not (and remember, the company issued millions of shares to Fu supposedly in exchange for his holdings of HLJ ZQPT).
Either way, this is the most egregious action by any Chinese RTO management that I have witnessed, and that’s quite a tough competition to win.
ABAT leads investors to think that it makes cutting-edge electric cars, when in fact it produces cheap scooters and bicycles
ABAT represents that its subsidiary Wuxi ZQ “is engaged in the business of manufacturing and distributing electric vehicles”. On its website, under “products”, the company lists “electric cars” as one of its product categories.
The 10-K also states:
Since 2002, Wuxi ZQ has been engaged in the design, development, manufacture and marketing of electric- and hybrid-powered two wheel vehicles, as well as electric-powered agricultural transport vehicles and sport utility e-vehicles . [emphasis added]
This sounds exciting: electric SUVs! An unsuspecting investor might place ABAT into the same category as high tech companies like Tesla Motors or BYD.
Yet the 10-K continues: “The prices of Wuxi ZQ vehicles range from $427 to $3,471, with an average selling price of $574.” Let’s assume that the e-SUVs are at the high end of that range, $3,471. This would be an astoundingly cheap price and I am shocked that the company has not yet taken the world by storm with a three thousand dollar electric SUV.
The company website, despite having many photos of its products, shows not one single electric car, SUV, or agricultural vehicle. The photos are of cheap electric scooters and bicycles.
To emphasize this point, one does not normally think of Amazon.com as a place where one would purchase vehicles, electric or not. And yet, Amazon sells exactly the same type of cheap scooters and bicycles that ABAT makes, offered by many different companies (clearly it is a commodity product).
ABAT claims unrealistic margins in what it admits is a commodity business
ABAT’s 10-K states:
The technology utilized in producing polymer lithium-ion batteries is widely available throughout the world , and is utilized by many competitors, both great and small. ZQ Power-Tech’s patents give it some competitive advantage with respect to certain products. However, the key to competitive success will be ZQ Power Tech’s ability to deliver high quality products in a cost-efficient manner. This, in turn, will depend on the quality and efficiency of the assembly lines that we have been developing at our plant in Harbin. [emphasis added]
In other words, the company admits that LiPoly batteries are a commodity. This should come as no surprise: LiPoly batteries have been available in consumer electronics since 1996. An examination of ABAT’s patent portfolio does not reveal any IP that would give it any substantial advantage.
Evidence that ABAT has no special technology is found in its R&D expenditures:
| ($'000) | R&D | Revenue | R&D %Rev |
| 2004 | $65 | $1,191 | 5.46% |
| 2005 | $143 | $4,222 | 3.39% |
| 2006 | $185 | $16,329 | 1.13% |
| 2007 | $383 | $31,897 | 1.20% |
| 2008 | $4 | $45,172 | 0.01% |
| 2009 | $348 | $63,561 | 0.55% |
| 2010 | $204 | $97,128 | 0.21% |
Note: The company claimed a 2005 R&D expense of $32 in the 2005 10-K, but changed this number without explanation to $143 in the 2006 10-K. In the table, I gave them the benefit of the doubt and used $143, but I think that $32 is more likely to be the correct figure.
2010 R&D expense was 0.2% of its claimed revenues. So one would not expect ABAT to have significant technology to enable better margins than its competitors. Yet, looking at its public comps (I am being generous with the word “comp”), no one is even in ABAT’s ballpark:
| Gross Margin | Op Margin | Net Margin | R&D % | R&D $m | |
| ABAT'10 | 52.7% | 38.9% | 37.8% | 0.2% | $0.2 |
| ABAT'09 | 44.6% | 28.5% | 34.3% | 0.6% | $0.3 |
| Wuxi'08 | 9.4% | -25.9% | -39.9% | 4.4% | $0.4 |
| VLNC | 12.7% | -113.4% | -146.5% | 27.5% | $4.4 |
| AONE | -17.9% | -153.4% | -156.7% | 62.4% | $60.7 |
| ENS | 22.9% | 7.0% | 3.9% | undisclosed | undisclosed |
| TSLA | 25.9% | -125.9% | -132.8% | 79.3% | $37.6 |
| BYDDY | 21.6% | 11.9% | 9.4% | 3.2% | $195.6 |
This doesn’t make much sense: ABAT manufactures commodity products with expensive ingredients. The rest of the industry is having trouble turning a profit. Yet, ABAT claims margins that would make Google jealous.
Now, before you say that ABAT has a lower cost structure because it is in China, of course this cannot be the explanation because its competitors also manufacture in China or other low cost countries, and regardless, ABAT has a number of domestic competitors who should have compressed industry margins. Manufacturing in China is a notoriously low margin business.
The main difference between ABAT in 2009 and 2010 is the addition of Wuxi. Since consolidated margins improved significantly YoY, Wuxi’s implied post-acquisition gross margin was about 60% and op/net margins about 40%. These are absolutely ridiculous claims given that Wuxi had pre-acquisition gross, op, and net margins of 9.4%, -25.9%, and -39.9%.
ABAT claims to have increased revenue from $4.2 million to $97.1 million from 2005 to 2010 while DECREASING its employee count
| ($'000) | Revenue | SG&A | Employees | Rev/Emp | SG&A/Emp |
| 2004 | $1,191 | $2,811 | 362 | $3.29 | $7.77 |
| 2005 | $4,222 | $1,221 | 1,261 | $3.35 | $0.97 |
| 2006 | $16,329 | $1,604 | 1,264 | $12.92 | $1.27 |
| 2007 | $31,897 | $3,283 | 1,262 | $25.27 | $2.60 |
| 2008 | $45,172 | $3,263 | 909 | $49.69 | $3.59 |
| 2009 | $63,561 | $9,890 | 854 | $74.43 | $11.58 |
| 2010 | $97,128 | $7,842 | 1,176 | $82.59 | $6.67 |
Also note that the 2009 and 2010 employee counts include employees of Wuxi ZQ. It is amazing that the consolidated employee count decreased even as ABAT acquired a new subsidiary that accounts for almost all of its 100% revenue growth from 2008 to 2010.
Fraud is a more likely possibility than employee efficiency growing 25x over 5 years in a commodity manufacturing business.
ABAT claims distribution relationships which appear to be fake
ABAT claims in its 10-K report, “In May 2010 Wuxi ZQ signed an agreement with All-Power America to serve as the first U.S.-based distributor for Wuxi ZQ since the May 2009 acquisition.” All-Power’s website does not even mention electric scooters or bicycles.
I spoke with an employee of All-Power America who has access to a list of APA’s suppliers. This person told me that although one of APA’s subsidiaries sells electric scooters, Wuxi ZQ is not one of that subsidiary’s suppliers. The person I spoke with had never even heard of Wuxi ZhongQiang Autocycle Co.
I also questioned a manager at Kuralkan, the sole manufacturer, distributor and exporter of Kanuni motorcycles since 1995, which Wuxi claims a relationship with. This manager stated, “We do not know this company [Wuxi ZQ].” He also confirmed to me that Kuralkan is the only manufacturer of Kanuni motorcycles. (“Kanuni” is the name of the Kuralkan boss’s son).
Another purported distributor, “Eco Style Di in Italy” has a nonsensical name, as the word di is Italian for of. I tried looking up “Eco Style” instead, and that company does not appear to have any business related to distributing scooters or bicycles.
Other purported Wuxi distributors seem to not exist at all. A Google search for the following names did not have any search results besides ABAT filings:
How likely is it that in 2011 a legitimate company would not have a website or any search results at all? What are the odds of a “coincidence” involving several of Wuxi’s purported distributors having no websites or search results?
ABAT is a serial issuer of equity at low prices
- In August 2008, the company issued 5 million common shares and warrants to purchase an additional 2.6 million shares.
- In June 2009, the company issued preferred stock that converts into 4.3 million common shares and warrants to purchase an additional 3.5 million shares.
- In December 2010, the company issued 7.5 million common shares and warrants to purchase an additional 3.7 million shares.
In addition to the equity sales, the company also issued, in aggregate, at least 30 million shares for acquisitions and a suspicious “loan repayment” (at least 26 million of these shares went to Chairman Fu and friends).
If the financial statements are believed, then these issuances were done at unreasonably low P/E multiples at times when the company had significant net cash balances. The only possible explanations are that (1) the financial results are inflated, (2) the counterparties are related and getting a sweetheart deal, or (3) the management is incredibly stupid.
In my opinion, issuing shares at absurdly low prices to fund opaque transactions is one of the most serious red flags that a public company can have.
ABAT spent $20 million to acquire a company linked to the Chairman without disclosing the relationship
In January 2011, the company acquired Shenzhen Zhongqiang New Energy Science & Technology Co., Ltd. (“Shenzhen ZQ”) for 135 million RMB (about $20 million).
The first red flag is that the company has spent a significant sum on an acquisition, but gives investors very little information about the target company. Not a single financial metric was disclosed until two months post-acquisition, even now we know very little. In legitimate acquisitions, management is quick to trumpet the good qualities and results of the business being acquired.
Even the target’s name, Shenzhen ZQ, is suspiciously similar to the company’s existing subsidiaries (Harbin ZQ and Wuxi ZQ). But we can dig deeper than that. From Shenzhen ZQ’s government registration, we learn that Fu Zhiguo was previously Executive Managing Director and Legal Representative of Shenzhen ZQ.
Yet in ABAT’s announcement of the acquisition, and its 10-K, the company does not mention this relationship at all.
I think it is quite likely that the Shenzhen ZQ acquisition is a sham transaction that enabled the Chairman to funnel $20 million of proceeds from the December equity raise into his own pockets.
China Integrated Energy (CBEH) was recently accused of a similar scheme to funnel out cash through an acquisition. That stock fell from $6 to $3.75 in less than a week.
ABAT spent $22 million or 7x sales to acquire a failing and possibly related company
In 2009, ABAT paid $3.64 million, 70 million RMB, and 3 million common shares to acquire Wuxi Angell (later renamed Wuxi ZQ), the producer of electric scooters and bicycles. Previously, ABAT had advanced Wuxi $3.81 million. Note that the purchase agreement does not mention the advance, and the consideration amounts do not appear to include it. So the total acquisition cost may be over $25 million.
Wuxi had a book value of $9.6 million at March 2009; a net loss of $3.7 million in 2008, and a net loss of $1.1 million in 2007. Its gross profit actually declined by 35% from 2007 to 2008. Revenue was rapidly contracting: 2009 Q1 revenue was $0.75 million, or down 63% year over year.
Working capital position was negative $15 million. Cashflow from operations in the first quarter was negative $4.1 million. Wuxi had been sued five times and brought to arbitration over bad debts. The company lost all six cases and had not repaid any of the debts at year-end 2008.
The situation was so dire that the auditor issued a going concern warning and Wuxi had to take a $3.8 million “advance” from ABAT a few months prior to the acquisition. ABAT should have been purchasing Wuxi in bankruptcy court, not at over 2x a questionable book value.
The pro-forma statement of operations (page F-40) is very enlightening.
| ($'000) | ABAT | Wuxi Angell | Intercompany Eliminations | PF Combined | Wuxi Net Contribution |
| 2008 Rev | 45,172 | 9,332 | 6,079 | 48,425 | 3,253 |
In other words, after eliminating the battery revenue that ABAT was previously getting from Wuxi, ABAT was paying 7x FY08 revenue for a business that was about to go bust. If we estimate SAAR from the 2009 Q1 revenue number, and use the same intercompany elimination percentage, we get an absurd price of 18x sales.
Subsequent revenue growth numbers seem impossible. As a standalone company, Wuxi generated an estimated $1 million revenue in the first four months of 2009. Yet, ABAT claimed $20 million of “electric vehicle” revenue in 2009, which means that average monthly sales grew by 9.5x from the first four months of the year to the last eight months of the year. Meanwhile, the combined companies had fewer employees at year-end 2009 than legacy ABAT alone at year-end 2008.
ABAT claims that Wuxi’s shareholders are not related parties to ABAT, but it also says that one of the owners, Bao Jin, was a major shareholder of ABAT, with one million shares. Chairman Fu agreed to buy his ABAT shares “in order to facilitate the purchase of Wuxi Angell.” The majority owner of Wuxi was a Chinese entity whose shareholding is opaque. Also, Wuxi was audited by Bagell Josephs Levine, the same firm that was auditing ABAT at the time. Despite ABAT’s claim of non-relatedness, it is hard to believe that these individuals were not friendly, especially since ABAT clearly overpaid for Wuxi.
ABAT spent $1.5 million on another suspicious transaction
Quoting the 10-K:
In December 2008 Advanced Battery Technologies purchased a 49% equity interest in Beyond E-Tech, Inc. (BET), a corporation located in Texas that distributes cellular telephones manufactured in China to its order by Flying Technology Development Co. and Lenovo China. The purchase price for the shares was $1.5 million cash.
A search of Beyond E-Tech shows that BET-branded phones exist, but as the 10-K reveals, these are simply white label devices purchased from ODMs. It looks like BET sent some samples to review websites to get reviewed, but besides that, there is virtually zero mentioned about the company online, and I cannot find any reputable merchants selling their product. Does this business still exist? Was it ever a “real” company?
To dig deeper, I looked up Beyond E-Tech, Inc. on the State of Texas Comptroller’s website.
We see that the entity was created only two months prior to ABAT’s equity purchase, with the registered agent listed as: Lisheng Zhang, 3005 West Loop South Suite 100, Houston, TX 77027.
It turns out that 3005 West Loop South Suite 100 is actually the retail address of “Impression Bridal”.
Just to be sure, I called Impression Bridal and the friendly clerk informed me there was no Lisheng Zhang associated with that location.
A registered agent is a designated person who must be available during all business hours to receive service of process, otherwise, the company can automatically lose its corporate status and protection. This is important enough that every legitimate corporation is going to have legitimate registered agent information. (One can pay an “agent service” $70/yr to handle this)
Based on the above evidence, I wonder whether this is another sham transaction intended to funnel cash out of the company.
ABAT issued 11 million common shares to Chairman Fu and two other individuals to repay a “loan” which appears to be fabricated
In the company’s 2006 10-K, filed April of 2007, ABAT disclosed for the first time [see correction] that it had entered into a contract in January 2005 with Chairman Fu and two other individuals. This purported contract “acknowledged” [ABAT’s wording] that these three individuals had loaned $4.8 million to ABAT and that this contract “provided” that ABAT would issue 11.2 million shares to satisfy $3.3 million of the loan ($0.33 per share). At the time that the disclosure was made, the stock was trading at $0.60 per share.
Strangely, this contract had never been disclosed prior [see correction]; in fact, no long-term liabilities whatsoever are listed in the 2005 10-K balance sheet. The 10-K does list $4.1 million of “Short Term Bank and Other Borrowings”, but Note 8 to the financial statements clearly describes that these borrowings are bank loans, car loans, and other non related party loans. There was no disclosure in the 2005 10-K under related party transactions. This so-called “contract” appears to be entirely fabricated.
Why did the company describe the transaction as a “loan”? The individuals transferred money to ABAT. ABAT was required to issue shares to these individuals. This is not a loan, it is an equity sale. In fact, the SEC requires that unregistered equity sales be disclosed in a timely manner.
Even if the transaction is exactly as ABAT described it, ABAT appears to have violated securities law by failing to disclose it timely. However, I don’t believe that cash was ever transferred to ABAT. I doubt that Chairman Fu would lend money to the company without recording a liability in the financial statements.
Management has done many other related party transactions
The 2004 10-K risk factors include this gem:
RELATED PARTY TRANSACTIONS MAY OCCUR ON TERMS THAT ARE NOT FAVORABLE TO ADVANCED BATTERY TECHNOLOGIES.
What an understatement.
In addition to the egregious transactions described above, here is a brief list of “piggy bank” transactions:
2004-2005: The company sold goods to related parties. At the end of 2005, the company had a large account receivable from one of these parties. I believe this was, in effect, a kind of interest-free loan.
January 2006: Fu sells 30% of HLJ ZQPT to ABAT for 11 million shares. The company admits that Fu structured the transaction and the Board did not get a fairness opinion.
…It is likely that Mr. Fu will engage in other transactions with Advanced Battery Technologies and/or ZQ Power-Tech, including transfers of all or part of his interest in ZQ Power-Tech to Advanced Battery Technologies. It is unlikely that the Board of Directors will obtain independent confirmation that the terms of such related party transactions are fair.
January 2006: Fu sells a patent on “a nano material lithium ion battery and its production process” to the company for 4.4 million shares
2006: The company made interest-free, unsecured loans of $884,929 to companies owned by Chairman Fu.
Q1 2009: ABAT made an interest-free loan of $19,355 to a company where Fu sits on the board of directors
July 2009: The company agrees to lease a house from the Chairman for $4,000 per month.
Chairman Fu has sold an estimated 28 million shares since 2004
During the same time period, the company’s diluted share count tripled. The number of shares sold by Fu is greater than the shares outstanding at the time the company obtained its listing.
| s/o | Fu % | Fu shares | Shs rcvd | Change | |
| 2004 | 24.2 | 43.8% | 10.6 | ||
| 2005 | 41.0 | 19.5% | 8.0 | (2.6) | |
| 2006 | 50.6 | 15.8% | 8.0 | 15.4 | - |
| 2007 | 49.4 | 15.8% | 7.8 | 11.2 | (15.6) |
| 2008 | 54.2 | 14.4% | 7.8 | (11.2) | |
| 2009 | 58.0 | 15.7% | 9.1 | 1.3 | |
| 2010 | 76.5 | 11.9% | 9.1 | - | |
| Net Sales | (28.1) |
This is an estimate that understates sales to the extent of options received, and overstates sales to the extent that any shares received in the related-party transactions went to other individuals. However, I believe it to be roughly correct.
The addition of 1.3 million shares in 2009 is explained by a 1 million share purchase that was part of the Wuxi transaction, and the balance (I believe) by options.
Despite a parade of auditors and multiple restatements, ABAT still has material weaknesses
Prior to 2006, ABAT was audited by PKF CPA in Hong Kong. HLJ ZQPT was audited by Rosenberg Rich Baker Berman & Company. For the fiscal years 2006-2008, ABAT was audited by Bagell, Josephs, Levine & Co (which later merged with Friedman). ABAT’s 2009’s audit was done by Friedman and 2010 audit by EFP Rotenberg. Auditor changes are a red flag, as they may be a sign of “opinion shopping.”
Another red flag: both Friedman and EFP Rotenberg identified material weaknesses.
Quoting EFP:
(a) a lack of expertise in identifying and addressing complex accounting issues under U.S. Generally Accepted Accounting Principles among the personnel in the Company’s accounting department, which has resulted in errors in accounting that necessitated a restatement of the financial statements for 2008 and 2009 and (b) inadequate review by management personnel of the Company’s reports prior to filing, which resulted in errors in prior filings that necessitated the filing of amendments to the 2009 Annual Report and the Quarterly Reports through the quarter ended September 30, 2010. [emphasis added]
Translation: Management does not understand GAAP and failed to read its own filings.
Not exactly confidence-inspiring.
ABAT’s RTO promoter, John Leo, is behind a number of suspicious Chinese reverse mergers, most notably CYXI
ABAT’s reverse merger was the brainchild of John C. Leo, who was also ABAT’s first public-company CFO. John Leo has been involved in a number of shady Chinese reverse mergers, most notably, China Yingxia (CYXI).
CYXI now trades on the Pink Sheets for $0.01 and two CYXI executives were sentenced to death in China for fraud. They made the mistake of defrauding Chinese investors prior to defrauding Americans.
How many $250 million companies cannot even get their own name right?
The “Exact name of registrant” in ABAT’s SEC filings is Advanced Battery Technologies, Inc., but the company's website alternately calls the company:
- United States Advanced Battery Technologies, Inc.;
- United States Advanced Battery Technology, Inc.;
- United States Advanced Battery Technology Company;
- USA Advanced Battery Technology, Inc.;
- U.S. ABAT Group (China) Co., Ltd.; or
- ABAT Group
(depending on which page you are on). None of these latter six names is listed in the company’s 10-K, and yet the company’s real name is nowhere on its website! If you were running a legitimate company with over $100 million in the bank, wouldn’t you be sure to get the name of your company right?
A more disconcerting question: is there an undisclosed “ABAT Group” Chinese entity holding assets that belong to shareholders?
Virtually zero fundamental institutional ownership
Looking at the list of top holders at 12/31, out of the top nine, seven are major index product providers, one is a “social” fund which appears to be a closet indexer, and one is a quantitative fund. None of these funds is likely to have done any due diligence on this company. There are no fundamental institutions with a significant shareholding. Another multi-hundred million market cap company with this characteristic was China MediaExpress (CCME). We all know how that turned out.
Conclusion
ABAT is the most egregious Chinese RTO I have seen. If the ownership status of HLJ ZQPT alone is not enough of a red flag, ABAT has a self-dealing management, falsely represented business description, serial equity issuances to acquire related or poor businesses, ludicrous profitability claims, customers that cannot be verified, multiple audit problems, the list goes on and on. This company has the dubious honor of achieving every major red flag that one looks for in a Chinese RTO fraud.
If CBEH is any guide, the market is eager to punish companies that do suspicious acquisitions funded by dilution. I would not want to be on the long side of this one.
Disclosure: At the time of publication, Variant View Research and its affiliates are “short” ABAT through its common stock and options. We intend to profit from our short positions by covering, hedging, or otherwise unwinding them at lower stock prices. We reserve the right to add to or reduce our “short” positions at any time, and we do not intend to disclose these transactions, either before or after they are made.
Correction 4/7/2011:
In our original article, we stated that a $4.8 million loan had not been disclosed prior to the 2006 10-K. As we stated in the article, our reason for believing this was that the disclosure was not explicitly listed under the 2005 10-K, footnote 17, "Related Party Transactions" or in the 2005 balance sheets. Our research had also shown that there was no explicit disclosure in the 2004 10-K, under footnote 19, "Related Party Transactions", or in the 2004 balance sheets. However, the company did in fact disclose the transaction in other sections of its 10-K filings. We regret and apologize for our error.
China MediaExpress (CCME): The Most Polarizing Stock in the World
Longs have called it "The Best Stock in the World". Shorts have accused it of being a brazen fraud that has overstated its revenue by many multiples. There have been accusations of forgery, fraud, and market manipulation coming from both sides. A quick look at the comments on the web reveal personal attacks, and people publishing the home addresses and photos of short sellers. This has become a dangerous and dirty game. One thing everyone can agree on is that CCME is one of the most polarizing stocks in the world.
Why is this stock so polarizing?
Reason #1: whoever is right stands to make a lot of money--the stock is either grossly undervalued or overvalued, depending on whom you believe. People are taking oversized positions in the name. Both sides are "interested parties." I would advise all to not take anyone's word for anything here. People will lie to you to make money at your expense. Neither shorts nor longs have a monopoly on bad behavior, but clearly either the shorts or the longs must be correct. So the fact that someone has "bad" people on their side does not make them wrong.
Reason #2: most investors are depending on others for due diligence. The reason for this is the language and distance barriers. Most US market participants lack fluency in Chinese and/or the ability to do proper due diligence in mainland China. The result is that most investors cannot evaluate the other side's arguments on their merits. This creates a situation where a many smart people will end up being wrong, because they may be depending on the advice, interpretations, and translations of others. Also, since they cannot interpret a Chinese language document that is presented, they instead attack the presenter. Personal attacks, which have been rampant in this discussion, have a tendency to snowball.
Reason #3: the volume and tenor of discussion are unusual. CCME is one of the most heavily trafficked names on popular stock websites. And the tone of these discussions has been 'echo chamber'-like. Similar to the situation in the political "blogosphere", investors are grouping together with others who are on their side. Dissenters are ostracized. The result is confirmation bias.
I am short CCME. I see a very high probability that revenues are overstated. The reason for this is that there are simply too many red flags and inconsistencies in the company's story. Any one or two of these red flags could be explained away. However, I cannot explain them all with a consistent story.
In making the short case, I am intentionally including only information that can be easily checked by an English speaker. I exclude some of the strongest short arguments, which require Chinese fluency to evaluate. However, even based solely on my list of "English" red flags, I don't trust the management of this company or their numbers.
Following is a list of suspicious statements and actions by management:
COMPANY RESPONSE TO SHORTS
The CEO's letter does not respond to the primary claim of the shorts--that their customers' media buyers do not know who they are. Muddy Waters implied that CCME's customer relationships do not exist. If the company is legitimate, they should come out and state that the customers are real, and publish letters from major customers to that effect. The company's silence is a "dog that did not bark".
The CEO claims that FMCN, VISN, and AMCN are not aware of CCME because these companies are each in a different "industry group" from the others. Of course this is absurd for many reasons. One reason easily verified through filings, is that these companies all list each other as competitors, except that no one lists CCME, while CCME lists everyone else. Another reason is that CCME claims margins which should be the envy of every media company in China. Other companies should be desperately trying to reproduce CCME's success, and certainly should know of the company’s existence.
The CEO's letter claims that Eading Group is an Apple distributor (wholesaler). Actually, Eading appears to be an authorized reseller (retailer) based on the photos on their website. The difference is material. If it is a retailer then no margin is left for CCME. Also, a wholesale agreement implies volume, a retail agreement implies nothing. I don't think this is a case of "careless translation" because the rest of the letter is very well translated. In the press release about SWITOW, the company is clearly implying something bigger than working with a retailer, although it was toned down slightly in the CEO letter.
The CEO implies that there may be some investor misperceptions due to translation uncertainty ("however you want to translate…") Interesting that the company strongly implies, but does not directly say, that the shorts made translation errors. If that were the case, wouldn't it be easier just to say so? I would paraphrase the CEO's response as "even if we mistranslated, it doesn't matter, just look at our earnings". Is it believable that a company claiming $170 million in the bank and $50 million quarterly cashflow cannot or will not hire a proper translator, and prefers to "unintentionally" mislead investors?
The lack of a scheduled conference call to discuss the short allegations is troubling. The company should immediately schedule a conference call, and it should not be a scripted PR affair, but an open call where they take all questions. (If they wish to duck a specific question for trade secrecy reasons, that is fine, but it should be on record that they refused to answer.)
CASH BALANCE AND DELOITTE
The interest rate CCME is earning on its cash is much lower than outdoor advertising comps (FMCN, VISN). If anything, CCME should be earning more because they have such a strong balance sheet. CCME is earning less than 0.3% annualized vs 1.3%-1.5% annualized for comps. Interest rates in China are highly regulated and the rate for a demand deposit account (equivalent of a checking account) is 0.35%. Much higher rates can be obtained by committing money for short time periods (equivalent of CDs). I estimated the interest rate as interest income divided by (BOP cash&STI + EOP cash&STI) / 2. For CCME I analyzed Q2 and Q3. Q1 was excluded because of the capital transactions.
It does not make sense that the company would throw away 1% per year--over $1 million--by depositing over $100 million into the rough equivalent of a checking account. But even if they were doing this, they should be STILL earning more interest than what appears on their income statements.
Deloitte's presence does not prove anything. They have only been auditor for 1 year, were crammed in at year end '09, and quarterlies are unaudited. And Deloitte has made mistakes before. The big 4 auditors including Deloitte were caught up in the S-Chip scandals in 2009 (see FibreChem and Ferrochina). In some cases, company cash balances were created through temporary borrowings to deceive auditors or were illegally and secretly promised as collateral for personal loans. See Satyam for another case where large cash balances audited by a big 4 firm turned out to be fictional.
The longs like to point out that the CFO has 8 years of experience with PwC. However, this could be construed as a negative. If I wanted to execute a sophisticated accounting fraud, what better person to hire than someone who is intimately familiar with audit processes and has personal connections within the auditor community?
SPAC
The company chose to go public through a SPAC. They could have gotten a much higher valuation via a normal IPO. The company would claim that the IPO market was closed when they wanted to go public. However there was no rush to be listed since they had no capital needs, due to their cash balance and strong cashflow. They could have simply waited for the IPO market to reopen. If any shareholders needed liquidity, they could have participated in the private placement with Starr.
SPACs are particularly attractive to frauds for raising money quietly. The reason is that the warrants require investors to pay cash to the company upon exercise. The company can thus avoid the scrutiny that normally accompanies stock issuance, since the warrants are already outstanding. The earn-out terms created an additional "obscured" share issuance. These are not accidents, the company made an active decision to use this structure and deal terms. Also, the obscured nature of these share issuances was observable in market dynamics as the shareholders voting on the SPAC transaction were special situation players primarily concerned about perception, not long-term investors focused on per-share economics.
This SPAC that had an unusual provision that allowed shareholders to get their money back without voting against the acquisition. There is only one logical reason for such a provision--to ensure transaction approval even if the majority of shareholders think it is a bad deal. In fact, the majority did not want to be a part of this, and asked for their money back.
The earn-out is extremely large (15 million shares), on very aggressive growth targets. This creates a very strong incentive for the management to inflate the numbers. Was there ever any doubt that they would "make" these earnings targets? Perverse incentives routinely lead to accounting misconduct even in markets like the US where legal protections and investor oversight are much stronger than they are in China.
INSIDER TRANSACTIONS
One of the promoters, Ou Wen Lin, filed form 144 with the SEC that he was planning to sell 1,060,000 shares. After the stock tanked, the company issued a press release basically claiming that this was a typo or similar mistake, and that the correct number was 60,000 shares. One month later, Lin sold 1,000,000 shares through his vehicle Thousand Space Holdings. The company had no legitimate incentive and clear disincentives to issue this press release. Lin sold at a very low valuation and the company tried to cover it up.
It does not make sense that the company would sell shares to Starr at such a low valuation. Taking into account the deep ITM warrants, they sold equity to Starr at a very low single-digit P/E at a time when the company had NO legitimate need for capital.
On Dec 9, 2010, the CFO purchased 100,000 shares at $15 according to a filing. However, the insider vehicle Bright Elite Management also sold 100,000 shares at $15 on the same date according to a different filing. This was not a normal insider purchase, but a deceptive investor relations stunt.
On Sep 16, 2010, the company authorized a $30 million buyback and issued a press release. However, as far as I know, no shares have been repurchased. The failure to follow through is highly suspicious given the balance sheet and valuation.
We do not know Starr’s true motivation or whether they have hedged their investment. However, a few points: (1) Chinese private equity does not have a great track record in PIPE deals. A much more prestigious firm, Carlyle, was recently left holding the bag with a $40 mn investment in China Forestry, and may have made a mistake investing in CAGC. (2) To my knowledge, Starr is not a particularly prestigious investor. For many of the longs, their involvement in CCME is the first they have heard about Starr. (3) PE firms routinely “sponsor” their portfolio companies to get the story out to the institutional community so that they can realize a return on their investment. I view it as a negative that they haven’t done so here. (4) Starr negotiated a fairly onerous “put option” that triggers if certain net income targets are not met. This greatly reduces the validation value of the transaction and also contributes to the “perverse incentives” pointed out above.
GOVERNMENT EXCLUSIVITY DEAL
The company claims some kind of government exclusivity for inter-city buses. The exact nature of this deal has always been kept vague by CCME. (There is a very long statement in the 10-K which, strangely, does not actually clarify the deal.) The description has even changed over time. There is no reason to be vague about the exclusivity deal if it is real. Trade secrecy is a non-issue in this case. This is the public company analogue of someone saying, "I know a guy". I conclude that the deal is not what they imply it is.
The latest wording is "designation as the exclusive inter-city bus TV media by China's Ministry of Transport". However, this is confusing, because CCME claims lower than 100% marketshare. Their 10-K says: "[CCME] competes directly with existing smaller advertising network operators who place their network on inter-city buses that travel primarily between villages or on highways in China". You're not exclusive if others are doing the same thing as you.
BUSINESS ECONOMICS & ACCOUNTING ISSUES
Margins are significantly higher than public comps. 2009 gross margin% was 65.6% vs 49.4% for VISN, the strongest comp. EBIT margin% was 59% vs 22.4% for VISN. It does not make any sense that such a strong business would have any difficulty going public or obtaining financing on good terms.
The company has less than 100% marketshare. Since other companies have some ability to compete, I would have expected the excess margins to be competed away. Their product is essentially a commodity.
The company claims higher margin on airport shuttles versus inter-city buses. This does not make sense if the abnormal margins are a result of the government exclusivity deal, because the deal is for inter-city buses and not airport shuttles. Superior demographics may lead to higher revenues but not margins.
The advertising business is sensitive to the macro economy. All of CCME's public comps suffered gross profit declines in 2009. Yet CCME claims it grew GP by 65% in 2009.
For the period from 2008 (year-end) to 2010 (Q3 or run rate for revenues):
Display network equipment, gross of depreciation, grew 39%
Bus count grew 53%
Revenues grew 227%
I define “equipment efficiency ratio” as revenue $ per equipment $. This ratio grew by 135% over this period. However, ad rates grew only 16% (to Q2’10). Ad minutes grew by 33% due to the addition of embedded ads. This leaves a gap of ~80% unaccounted for. It does not make a significant difference if we substitute bus count for equipment $.
The company claims their CPMs are ~3% of comparable media. (1) Why should it be so low? Market exclusivity should give them pricing power. A "97% off sale" seems unnecessary. (2) Achieving CPM parity would imply a 33x gain even with flat bus count and utilization. 33x 2010E revenue would be $7 billion. Since costs presumably would not rise much, op margin would be nearly 100%. Does this scenario sound plausible? Baidu has TTM revenue of $1.2 billion.
The company implies to investors a >$7 billion market opportunity, and yet they concede industry low revenue share to bus operators and pay zero for their content. How does this make any sense?
The concession contracts have annual escalators of 10-30% per year, 15% is typical. These are very generous terms. (1) This is not consistent with the market power they should have as the exclusive provider (2) Margins will collapse when current contracts expire. The straight-line accounting will reset a higher rate. (3) This looks like CCME is desperate to put up growth numbers.
MISCELLANEOUS
Even if the numbers are real, the shareholders are still screwed. They do not have legal ownership of the operating company, rather, there is a "contractual agreement" with the opco, which is controlled by the CEO, who can expropriate value at any time without legal consequence. (See S-chips scandal for examples.) This might be an acceptable cost of doing business in China if management is trustworthy, but in this case they are not.
Outside of Starr, quant funds, and index or closet index funds, there is virtually zero institutional ownership. Nor is there reputable sell-side coverage or buyout interest. This is completely unexpected for one of the largest advertising companies in China, especially one that claims such attractive economics and growth relative to share price. It is one thing to say that a couple organizations (Deloitte, Starr) are making a mistake. But how could ALMOST EVERY SINGLE INSTITUTION have missed this investment opportunity? Given the two choices, the second is much less likely.
Context is extremely relevant. Corruption is widespread in Chinese business and government, making it easy to get key parties (customers, partners, bankers, even auditors) to assist in a fraud. This is exacerbated by the prevalence of organized crime and incentives created by very low incomes. One only needs to go back to the S-Chips scandal in 2009 to see how widespread and sophisticated securities fraud is in China and the disadvantage at which foreign investors stand relative to Chinese stock promoters. Munger's "lollapalooza" effect is present here. From management's perspective, you have a combination of envy (your peers are getting rich, many illegitimately), and incentive bias (huge payoff, little consequence for defrauding foreign investors). Even if a manager started out honest in this environment, it would be quite difficult for him to remain honest.
There are also numerous red flags based on what longs have stated that they were told by the CFO or IR. However, since I did not hear these statements first hand, I will not repeat them. You can easily find them online.
CONCLUSION
N.N. Taleb, author of The Black Swan, tells an interesting story. A coin is flipped 50 times, and it lands heads 50 times in a row. The mathematician is asked what the probability is that the coin will land heads on the next flip. He answers, "50%". He argues that a coin's historical results do not affect future probabilities. The trader is asked the same question and he answers "100%". The trader has been around, and he realizes that the coin is rigged.
There is an old saying on Wall Street: "there are no coincidences". It is unlikely that the preponderance of red flags here is simply a coincidence. Even if it turns out that CCME is not a massive fraud, I think it would be a terrible idea to trust management.
Disclaimer: We are short CCME through the stock and options, and we may change our position at any time without disclosure. This does not constitute investment advice.
American Power Corp (AMPW.OB): Smoke and Mirrors
Quick Stats
| Ticker | AMPW |
| Share Price | $1.57 |
| Market Cap | $142 million |
| $ traded/day | $1.1 million |
| Borrow Cost | -9.4% |
| Borrow Difficulty | Hard |
| Est. Short Interest (Dec 2010) | 47,500 |
| Days to Cover | 0.2 |
Summary
American Power Corp (AMPW:OTCBB) is a $142 million market cap exploration-stage coal company that uses smoke-and-mirror agreements to obscure its lack of real assets or capital. It’s another stock promotion that I believe will go to zero sooner or later. The promoter and majority shareholder of AMPW, Johannes Petersen, also promotes another penny stock, (SILA:OTCBB) which has declined from $1.40 to $0.22.
What does AMPW own?
I estimate a current cash balance of $600k minus promotional expenses over the past quarter. A property in Montana is being held in escrow until the company delivers $1.2 mn in cash and certain documents (reserve estimate and mining feasibility study) to the sellers.
The Property Scheme
The company signed the following agreements in April 2010:
•$700k to acquire 40% of a “coal property” in Montana, with a call option on the remaining 60% struck at $1.25mn.
•$700k to acquire 40% of a “mineral rights property” in Montana, with a call option on the remaining 60% struck at $1.25mn.
Deal issues:
•It’s a seller-financed deal. The company only invested $200k total up-front. If these properties have any value, why is the seller giving away a huge option to the buyers? Would you give 20x leverage to a company with no real assets at a 5% interest rate with an interest waiver for the first two years?
•The company has invested $800k so far over the past 9 months (call it a time-weighted 4.5 month investment period.) The notion that these assets are worth $142mn today, is simply not credible.
•SILA has similar option arrangements to purchase properties
My opinion:
The property is worthless.
The Capital Scheme
On Sep 10, 2010, AMPW entered two agreements with a Marshall Islands corporation named Black Sands Holdings, Inc. (BSH).
•AMPW issued BSH ~417k shares to settle an obligation of ~$208.5k
•BSH granted a “put” option to AMPW to issue Units (1 Unit = 1 share + 1 warrant) to BSH for up to $10 million, priced on a 10-day VWAP formula. Exercise is limited to $1 million per 3 months.
I think the implication (what we are supposed to believe) is that the settlement priced stock at a generous level to BSH and BSH in return issued this put option to AMPW as a “fair trade”.
Deal issues:
•Both agreements are ridiculously favorable to AMPW: There was roughly zero asset value in AMPW prior to Sep 10, and who writes a put struck at VWAP with a penny stock promoter on the other side?
•The value of a long-term, $10 million option is not in the same ballpark as the $200k obligation
•Why are the two agreements separate? I'm not sure the option contract is even legally binding, as there is no consideration due to BSH
•SILA has a similar “put option” agreement with another mysterious offshore entity
My opinion:
BSH is likely to be owned by the promoters or their affiliates.
Note: On Oct 5, 2010, AMPW issued ~600k Units to BSH for $500k, outside of the option agreement.
Promotional actions/statements:
The most recent press releases from the company are:
•2/1/11--Company has retained a small investment bank to explore strategic alternatives
•1/4/11--Paid research report put out by Cohen Independent Research Group (their disclaimers state that they receive compensation… I love the asterisk next to “Independent Research” on their website)
•12/13/10—“American Power Corp. Well Financed to Advance Pace Coal Project”—announcing the BSH put option deal, which they call a “financing” with a “European institutional investor”
•12/7/10—“American Power Corp. Pace Project Update”—Company announces that it has retained Mission Engineering of Billings, Montana to prepare a permit application. The CEO makes some non-sequitur comments about Western Coal and Riversdale being taken out at $3bn+ each.
I’d also recommend checking out the company’s website, www.americanpowerco.com/. It’s extremely flashy, appeals to patriotism with a huge American flag, and even plays up an emerging market angle (“Powering Asia”) by citing trade statistics.
Management
Johannes Petersen, the CFO, owned 52.6% of the stock at Sep. 30 (market value ~$72mn today).
Other public company associations:
•CEO, Century Petroleum (CYPE:PINK-$0.01)
•CEO, Paloma Resources (PLO-H:Venture-$0.15, C$1.2mn mkt cap)
•CEO, Gold American Mining Corp (SILA:OTCBB-$0.22)
•Former CFO, American Sierra Gold Corp (AMNP:OTCBB-$0.04, $2.7mn mkt cap)
•Former CEO, Dragon Gold Resources (sold as a shell for an RTO in 2007)
(source: http://investing.businessweek.com/research/stocks/people/person.asp?personId=20523461&ticker=AMNP:US)
Alvaro Valencia, the CEO, went to the same college in Peru as Petersen and owned 0.2% of the stock at Sep. 30.
Conclusion
I believe this stock is worthless. Short selling may be difficult due to borrow issues and the skill of the promoters. Nevertheless, the longs should beware.
Disclaimer: We are short AMPW and may change our position at any time without disclosure. Please read the full disclaimer
Willow Creek Enterprises (WLOCD.OB): A Classic Stock Promotion?
| Symbol | WLOCD |
| Share Price | $0.72 |
| Market Cap | $193 million |
| $ traded/day | $1.25 million |
| Borrow Cost | -6.5% |
| Borrow Difficulty | Moderate |
| Short Interest (Est.) | 350,000 |
| Days to Cover | 0.15 |
Willow Creek Enterprises (WLOCD:OTCBB) is a $193 million market cap exploration stage mining company with no discernible asset value and a promotional management. I believe the stock is worth zero.
[Note: Yahoo! Finance currently shows a market cap of $48 million, but this is incorrect. WLOCD had 67.2 million shares outstanding at December 9, 2010 and just issued a 4:1 forward split, which must not have hit Yahoo's database yet.]
What exactly does WLOCD own?
In August 2007 the company paid $6,000 (six thousand) for a mineral claim in British Columbia. In October 2010, the company purchased 20-year rights to explore the Dolly Varden Property in Nevada. It paid $10k up front and owes an additional $10k annually. On November 17, 2010, the Company acquired 7-year exploration rights for the Hercules Property in Nevada. WLOCD owes $290k over the term of the lease and must provide $3.5 million in work commitments. The payment schedule is $20k up front, $10k monthly for four months, and then annual payments.
As of the most recent financials on Aug. 31, 2010, the company had $0 (zero) in cash and current liabilities of $66k.
The most recent press releases from the company are:
- 1/13/11 – The company announces a 4:1 stock split effective on 1/14.
- 1/4/11 – “Willow Creek Samples Positive Quantities of Copper, Silver and Gold on Dolly Varden”. Literally, the company found 16 rocks, some with “anomalous quantities” of metal. This vague press release does not mention the name of a third party engineering firm, probably because is no such firm, or if there is one it is not of high quality.
- 12/29/10 – “Willow Creek Outlines Preliminary Exploration Programs for Early 2011” I saw only one sentence that actually discusses the company’s plans: “Early 2011 exploration program to include: trenching, sampling, ground geophysics, mapping and further targeting; then, advancing the exploration program in the early spring.”
- 12/15/10 – The company raises $250k in equity by selling shares and warrants to an entity incorporated in Belize. There was no press release, though the company did file an 8-K (though they don’t always seem to file 8-Ks for the press releases…)
How much does the company intend to spend on the exploration program? According to the 10-K filed Dec 2010, they plan to spend $35,000 for exploration over the next 12 months. That’s right: the company tells us that it will spend $35k exploring claims that the stock market values at $193mn.
In the extremely unlikely possibility that there is a material amount of precious metal on these claims (about as likely as the CEO going to the 7-11 and buying a winning lottery ticket), the cost of building an actual mine is significant. Since the company has only ~$200k cash (from the Belizeans), shareholders would face significant dilution.
WLOCD has invested a total of $46,000 in its various rights and claims—less than the amount it currently owes to creditors. Most of this money was invested in the past 3 months. If these assets are really worth $193 million today, these investments rank amongst the greatest in history.
Management
The Multi-tasker
So who exactly is responsible for this magical 4000-bagger in 3 months? The CEO, President, CFO, Secretary, and Treasurer positions at WLOCD are all held by a “Mr. Terry Fields, LL.B., BSc.”
A quick search also revealed that Mr. Fields is also CEO or president of the following public companies:
- Uniontown Energy (UTOGD-OTCBB, $1.65)
- Formcap Corp (FRMC-Pink, $0.02)
- Daulton Capital Corp (DUCP-OTCBB, $0.19)
- Spirit Exploration (SPXP-Pink, $0.01)
- First Pursuit Ventures Ltd (FPV-Venture, C$0.16)
- Malwin Ventures (MLWN-Pink, $0.23)
And associated or formerly associated with the following companies:
- Yankee Hat Minerals (KHT-Venture, C$0.07)
- GoEnergy (GOEE-Pink, $0.55)
- Liberty Silver (LBSV-OTCBB, $0.43)
- Meadow Bay Capital (MAY-Venture, C$0.18)
(source: investing.businessweek.com/research/stoc...)
So in addition to being one of the world’s greatest investors, Mr. Fields is also able to run 6 companies at once. That’s quite an impressive feat. How much does such a talented executive cost?
According to the 10-K, Mr. Fields received 2 million unrestricted, pre-split shares when he became CEO in August, and another 5 million pre-split shares from a Mr. Sidney Swick on October 21, 2010. That’s a cool $18.7mn total at market today.
The Insurance Broker
Who is Sidney Swick? According to the 10-K, Mr. Swick was the majority shareholder of WLOCD at August 31, 2010 with a holding of 105 million shares, and
“On October 22, 2010, the Company and Mr. Swick agreed to retire a total of 100,000,000 restricted common shares owned by Mr. Swick.”
There is no stated reason why Mr. Swick would agree to cancel $80 million worth of shares (The stock was trading at $0.80 at the time).
Here is a profile of Swick (source: investing.businessweek.com/research/stoc...)
“Age: 36
...
Sidney Swick served as the Chief Executive Officer of Willow Creek Enterprises Inc. until August 9, 2010 and served as its President, Chief Financial Officer, Secretary, Treasurer and Principal Accounting Officer from January 16, 2007 to August 9, 2010. Mr. Swick has been employed as an insurance broker since 2004 specializing in group benefits for small and medium sized businesses in Edmonton Alberta and surrounding area. He served in the telecom industry at Bell Canada until 2004. Mr. Swick served as a Director of Willow Creek Enterprises Inc. from January 16, 2007 to August 9, 2010.” [emphasis added]
So who else is associated with this company? There are only two directors on the board at WLOCD. One is Terry Fields, and the other is a Mr. Larry Eastland.
The Promoter
From the 10-K:
“Since 1980, Mr. Eastland has been Chairman of the Board of Directors of LEA Capital Advisors, Inc., an international business and investment advisory group specializing in taking private companies public with various offices worldwide”.
And this is what the State of California thinks of Mr. Eastland and company:
“the California Corporations Commissioner is of the opinion that Larry Eastland, Justin Eastland, and LEA Capital Advisors, Inc. have effected transactions in securities as a broker-dealer without having first applied for and secured from the Commissioner a certificate authorizing them to act in that capacity, in violation of Corporations Code section 25210. Pursuant to section 25532 of the Corporate Securities Law of 1968, Larry Eastland, Justin Eastland, and LEA Capital Advisors, Inc. are hereby ordered to desist and refrain from effecting any transaction in, or inducing or attempting to induce the purchase or sale of, any security in this state, unless and until they have applied for and secured from the Commissioner a certificate, then in effect, authorizing them to act in that capacity, unless exempted under the provisions of Chapter 1 (commencing with Section 25200) of this part.” [emphasis added]
(source: www.corp.ca.gov/ENF/pdf/2010/LEACapital_...)
Conclusion
I believe that the buyers of this stock are retail victims of a classic stock promotion. Even for a penny stock, this is such a blatant promote that I suspect that many of the buyers are knowing participants in a greater fool game. When the downside comes it will be violent.
Disclaimer: We are short WLOCD at the time of publication and may change our position at any time without disclosure. This is not an investment recommendation. Please read the full disclaimer.