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Cleantech Solutions (CLNT) is a tiny $12.0 million market cap company which describes its business as the manufacture of forged and fabricated products for end use primarily by manufacturers of windmills in China. The share price has nearly doubled in just the past week.

The share price history of Cleantech is very confusing to some people given that it has now done two reverse stock splits, first doing a 1:3 reverse split, then subsequently doing a 1:10 reverse split. As a result, although the share price appears to have traded as high as $144.00 in the past, the reality is that this stock has never traded above a real price of roughly $8.00 in its entire history. When looking back at the share price history, it is important to note that a past price of $30.00 really means that the stock was trading for just $1.00 at that time.

Only briefly did it spike above $5.00 back in 2008, but since then it has traded almost entirely at $5.00 or below. Again, a historical price graph may give the reader a different impression due to the reverse splits but this stock has simply never traded in the double digits, much less the triple digits. Ever.

In early 2011 this was once again (following a reverse split) up to $4.50 per share, but was steadily trending down. It ultimately bottomed out once again at just 25 cents earlier in 2012. The reverse split conducted in March of 2012 caused the stock price to be once again restated as $2.50 and it had stayed between $2.50 and $2.80 until just a few days ago.

The stock jumped substantially on the date of Cleantech's earnings release due to stronger than expected reported sales as noted in its unaudited financials. The obvious weak point, however, was that the company is now down to just $960,000 in cash, which is only enough for it to survive at all for about two more months given its rate of cash consumption.

Last year, I had the interesting opportunity of visiting Cleantech Solutions in Wuxi, Jiangsu Province, China. This was only a few hours by plane from Beijing, where I live in China, so it was certainly not an inconvenient trip to make. I had been contacted by a shareholder who was a firm believer in the company and had felt that at a price of $3-4 it was deeply undervalued. It should be noted that my visit was prior to the company's 1:10 reverse split, so in today's terms, that would have been viewed as a price of $30-40.

Without the reverse split, the nominal price for Cleantech today would obviously be at 1/10th of where it is today, so $0.45 relative to the $3-4 at the time of my visit. As a result, based on my past history with the company and the stock, I view Cleantech currently as a $0.45 stock not a $4.57 stock. Basically, I continue to simply look at the overall value of the company rather than just the nominal stock price.

I showed up at Cleantech on a Tuesday, prepared for a full day tour of the facilities and interview with management. Management had been informed about my visit some weeks before and I was told that they planned on putting on quite a show of how their business was booming. However, the entire tour of the facilities took less than 30 minutes because the operations were conducted in a single, small open air warehouse.

The part that was intended to be so visually impressive was the ESR ("electro-slag re-melted") production facilities and this was also said to be the key driver of CLNT's huge future revenue potential. However, apparently the ESR line takes time to heat up and start production, and it wasn't running at all on the day I visited.

Instead what I saw was quite literally fewer than 10 employees (in total) engaged in very low-end metal stamping of forged rings which are used in windmills.

Including all members of management who were present, Cleantech had less than 15 people on site on the day of my visit, which struck me as notable given that its SEC filings had stated it employed several hundred people. I distinctly wondered, "where are all of the employees?"

Ordinarily, I would try to be more understanding of the variation between daily production output in a factory. However, at the time, Cleantech had made it known that it was operating at absolute full capacity, meaning that production should have been going full bore from dawn to dusk every single day of the year. In addition, I had been promised that I would be shown the state of the company at its absolute best.

Rather than give up entirely due to my disappointment, I decided to tell management that this was clearly far from impressive and I came back the next day. When I came back the next day, the situation was absolutely identical with no ESR line running and again just a handful of employees engaged mostly in moving (rather than production of) a small number of large low-end metal rings.

For some reason, management couldn't really give me much of an explanation for why these two particular days were so empty and devoid of any activity, and it was notable that they did not in any way suggest that other days were in any way more active. I was given a very clear understanding that I was seeing a very normal day of operations at Cleantech. Management also didn't have any answer when I asked about the whereabouts of the several hundred other employees who should be present. Instead, management just encouraged me about the company's very strong prospects going forward and assured me that future profits were going to be exceptionally strong.

Another development I was told was very positive was the then-recent appointment of Cleantech's new CFO, Fernando Liu. But as it turns out, I was told that despite being CFO, Mr. Liu wasn't even living in China. They did however let me know that Mr. Liu had visited Cleantech on multiple occasions. In any event, it was unfortunate that I did not get the chance to ask him directly about my concerns regarding lack of production or the lack of any employees at the company.

As it turns out, Mr. Liu ended up resigning as CFO and as soon as Cleantech passed its annual audit (which claimed a lofty $55 million in revenues), he sold all of his shares in CLNT at prices as low as $1.58. He made these transactions quickly in a period of just a few weeks, even though business seemed to be booming (according to the SEC filings) and even though the share price was now touching all-time lows for its entire history as a company.

I took the view that if this was the most compelling display of activity and commitment that management could muster for a 2-day visit of a potential investor, then there was no way I could possibly invest in this company. I left disgruntled at having wasted 2 days of my time to view a company that clearly was engaged in no business whatsoever.

It turns out that I was correct in my assumption. Over the course of time, Cleantech dwindled down from that share price of $3-4 to just 25 cents during early 2012. At this time the company did the 1:10 reverse split, taking the share price back up to a nominal level of $2.50. Even following the recent run-up in the stock over the past few days, had I bought in at $3.00 at the time of my visit, I would now be selling at the equivalent of just $0.45 due to the impact of the reverse split, i.e. already a decline of 85% even at the recently higher price.

From the start, one major issue for me was Cleantech's choice of auditor, Sherb & Co. This was all the more concerning given that Cleantech has had to disclose that "management identified significant deficiencies" in internal controls for preventing fraud, and that these weaknesses have been present and unchanged several years without any correction to them.

During my visit to Cleantech, I had been assured that the company would be upgrading to a Big 4 auditor "imminently," yet this still hasn't happened, and there is no sign that it is in the works going forward.

Sherb has been the auditor of record for some of the most notorious Chinese reverse merger frauds which were later exposed and delisted by the SEC and the stock exchanges. (Links to delisting notices are included below).

There are two important points worth noting:

First, with the exception of Cleantech (and only Cleantech), all of Sherb's Chinese audit clients now trade for just pennies even though many of them were one-time high fliers trading at well over $10.00. As we can see, were it not for the reverse split, Cleantech would also be trading at just $0.45 rather than at $4.57.

Second, it is very odd that many of these companies continue to put out extremely positive press releases and filings. Quite surprisingly, the positive stream of bullish new continues even after their delisting. In many cases, the companies which are only $5-15 million in market cap report cash balances in excess of $50 million. The only explanation for such a discrepancy is that the market simply does not believe that the cash is really there. In fact, if the cash were actually there, management could simply use a small portion of the cash balance to buy up the entire company and immediately pocket tens of millions of dollars for themselves. But notably, this just doesn't seem to happen with any of these companies.

Chinese audit clients of Sherb & Co.

Ticker

Company

Price

Auditor

Status

CLNT

Cleantech Solutions

$4.57

Sherb & Co.

Still trading and listed !

CEAI

China Education

$0.45

Sherb & Co.

Delisted due to fraud

CHNG

China Natural Gas

$0.60

Sherb & Co.

Delisted due to fraud

CHLO

China Logistics Group

$0.01

Sherb & Co.

No audit committee

QING

Qingdao Footwear

$0.01

Sherb & Co.

Mgmt resignation due to fraud

CDII

Cd Intl

$0.12

Sherb & Co.

Delisted due to fraud

CPHB

China Pharmahub

No longer trading

Sherb & Co.

Ceased all filings

SDTC

Sentaida Tire Co

$0.01

Sherb & Co.

Never listed past OTC

SUWN

Sunwin Stevia

$0.20

Sherb & Co.

Never listed past OTC

SHZ

Shen Zhou Mining

$0.26

Sherb & Co.

Down 99% from $10.00 in 2011

OINK

Tianli Agritech

$0.83

Sherb & Co.

Down 90% from $8.00 in 2011

FRXT

Fuer International Inc.

No longer trading

Sherb & Co.

Never listed past OTC

In the case of China Education Alliance (OTCQX:CEAI), Sherb had even put out a statement noting that Sherb had "performed enhanced procedures on the cash balance," causing the shares to rocket back up to $3.50 before the company was ultimately delisted. The huge run-up in the stock followed by a subsequent delisting left many investors wondering what exactly was meant by the phrase "enhanced procedures" which Sherb used to verify the cash balance.

At the time, CEAI had just reported that it had generated over $35 million in revenues in just the previous 9 months, so even at $3.50, the stock looked very cheap as long as the audited results were in fact real. However I had also just visited CEAI some weeks before and toured all of their facilities in Harbin for an entire week. What I found was that in all of their facilities combined, CEAI had no more than 300 students in total. The obvious conclusion was that there was no way that CEAI could be generating even just 1/10th of the revenues that it was reporting to the SEC.

Not surprisingly, China Education Alliance was subsequently delisted to the pink sheets due to findings of fraud even after the assurances provided by Sherb. However, just last week the company yet again announced stellar results and reported a cash balance of over $65 million, in comparison to the $4 million market cap for the entire company. The stock still trades, but only a few thousand dollars per day and the price is just $0.45 on the pink sheets.

Similar to CEAI, Cleantech has spent most of 2012 trading just $30-50k per day, until days such as yesterday where it suddenly traded over $4 million in a single day. In fact, despite the fact that there are only 2.6 million shares outstanding for the entire company, nearly 1 million traded on just Tuesday alone.

Conclusions:

I have been living, working and traveling in China for over 20 years. I speak Mandarin quite well, and I also spent many years as an investment banker on Wall St. I have visited over 100 Chinese companies during just the past few years and I have seen some very good companies and some companies which are engaged in egregious fraud.

In this case, I realize that I have the distinct advantage that I actually had the opportunity to visit Cleantech in person and was shown the best side that the company had to offer. I am not simply assuming that the opportunity looks too good to be true, instead I have confirmed it in person.

Even when business was supposed to be booming at its peak, Cleantech operations consisted of a single open air warehouse with less than a dozen employees engaged in making a small number of simple, low-end metal rings.

But even for those who haven't had the chance to visit Cleantech in person, the continued use of an auditor with a uniquely troubling history of signing off on fraudulent financials as well as the continued lack of internal controls at Cleantech should be enough cause for any sensible investor to seriously question the publicly released numbers.

Now that Cleantech is back above $4.50, how low can this stock go once again? Each time the stock falls back below $0.50, the company simply conducts another reverse split to get the cosmetic price up high enough to keep it from looking like yet another penny stock. And each time the stock briefly rallies back to a notional level of $3-5. Afterwards, it quickly drops back down to $0.50 again, which is where I expect it will find itself within a very short period of time.

Following the huge run-up on Tuesday, I shorted Cleantech in the aftermarket at a price of $4.68. If the stock rises more, I will gladly short more. And in fact if the stock falls, I will also be shorting more.

The author can be reached at comments@pearsoninvestment.com

Source: A Troubling Visit To Cleantech Solutions

Additional disclosure: The author has lived, traveled and worked in China for over 20 years and has an extensive financial background as an investment banker on Wall St. The author also speaks Mandarin.