(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)
Last Monday, shares of Cleantech Solutions (NASDAQ:CLNT) were trading as low as $3.42. By Thursday the shares had more than tripled to a high of $10.85. The stock, which normally trades around 60,000 shares per day, traded an astonishing 22 million shares over the course of last week.
The timing of this surge was very fortuitous for Cleantech, coming shortly after the company filed an S3 registration statement for a planned equity offering. Cleantech hopes to raise up to $5 million.
Without the surge in price and volume, any such offering would have been utterly impossible for the company, which had previously been worth only $9 million in its entirety. For those who are interested, the details of this S3 are somewhat unusual, and will be explained in detail below.
The spark for this wild ride was a single press release from Cleantech which noted that Cleantech had become a "certified supplier" to both Sinopec and CNPC. Sinopec and CNPC are China's gargantuan oil companies which are responsible for many billions in equipment orders every year.
Yet by Friday, the stock had already retreated 30% from the high, to close at $7.68.
As I will show below, the market made an epic misjudgment in sending the share price higher. The result of this is that the share price will likely find itself right back in the $3-4 range in very short order. If Cleantech hopes to take advantage of this surge to raise its $5 million, it had better do so very quickly.
It is certainly the case that many who played this press release did not understand its meaning. It is also certainly the case that many day traders simply didn't care because they were only in the trade for a quick pop, which was virtually guaranteed.
Cleantech has repeatedly fallen below the $1.00 mark, making it subject to delisting from the NASDAQ. As a result, the company has conducted two reverse splits (a 1:3 and a 1:10). The result of these two reverse splits is that Cleantech now has only 2.67 million shares outstanding. When any spark of good news or hype comes out, the limited supply of shares virtually guarantees a sharp move upwards. In the past, day traders have caught on to this and have been quick to make a fast flip trade off of any positive headlines in Cleantech.
Cleantech's press release made reference to having "received the necessary third party certifications". What is not mentioned is that these certifications came from Beijing New Century Certification Co. (北京新世纪认证有限公司) (aka "BCC"). I have confirmed this both with Cleantech and with BCC.
BCC's website (in English and Chinese) can be found at www.bcc.com.cn. BCC has issued over 24,000 such certificates to various Chinese entities. For Cleantech, certification simply meant creating a sample product which conformed to the right size, shape and forging processing, and delivering it for inspection. Then they paid the appropriate fee and went through the appropriate documentation requirements and voila, they could call themselves a "certified supplier".
In short, such certifications do not mean all that much. This is especially true in China, where similar certifications are almost always obtained by companies for use as marketing tools. I have often visited various companies in China who have entire walls where similar designations from local governments and certifying bodies are prominently displayed for foreign visitors to gaze upon. Many of these companies have secured their wall full of designations while being engaged in virtually no commercial activity.
For those who wish to confirm certification of an entity, BCC includes a search box on the Chinese portion of its website, found here. Inside the box labeled "Certificate Number" (证书号), individuals can verify all details of certification. Many Chinese companies will post their certificates on their website, such that obtaining the certificate number is very straightforward. However, when I asked Cleantech for their number, they stated (somewhat paradoxically) that "from our laywer's view it's not that appropriate to send the certificate to any individual. We will issue this on our website for all the investers (sic) to see in the very near future".
So until that time arrives, we will just have to wait.
As noted above, the details of the recent S3 registration statement are worth focusing on. Within the Plan of Distribution, it is disclosed that:
we may enter into a continuous offering program equity distribution agreement with a broker-dealer, under which we may offer and sell shares of our common stock from time to time through a broker-dealer as our sales agent.
If we enter into such a program, sales of the shares of common stock, if any, will be made by means of ordinary brokers' transactions on such securities market or exchange on which our common stock is then traded, at market prices, block transactions and such other transactions as agreed upon by us and the broker-dealer.
Under the terms of such a program, we also may sell shares of common stock to the broker-dealer, as principal for its own account at a price agreed upon at the time of sale.
What this means is that "from time to time", Cleantech can simply sell shares to a broker, who then acts as a principal. The broker can then re-sell the shares to clients in the market. Ideally the broker could do this entire trade after receiving buy orders for Cleantech shares at a far higher price. This is far different than a standard offering where a company retains an investment bank to conduct a single, large offering. With the Cleantech style of offering, a company can make use of surges in price and volume to bleed shares into the market without any notice.
The S3 was dated as of April 24th, 2013. On that date, the last closing price had been $3.58 and the 5 day average volume was 84,000 shares. Assuming a 20% discount (due to size and illiquidity), a normal offering price would have been set at $2.86. Raising $5 million would therefore require 65% of all outstanding shares to be issued. It would also require a full month's worth of trading volume to be issued. In short, such a transaction would be essentially impossible.
But with the surge in price and volume, and with the ability to issue stock "from time to time" to broker dealers, such a trade would appear far more achievable for Cleantech. So again, the timing of the share price spike is very fortuitous indeed.
This is not the first dubious transaction for Cleantech.
The last time I wrote about Cleantech was in November of 2012. Author "Biotech Breakthroughs" had written a pump piece on the stock, boldly stating that the stock should be trading at $19.00, up more than 5x from its then-level of around $3.50. The stock immediately jumped by as much as 36% on huge volume.
Biotech Breakthroughs has written on precisely 3 Chinese small cap companies. In each case he predicted stratospheric share price rises on these tiny, illiquid Chinese stocks. And in each case the stock soared for a few days, but then retreated. I have personally visited each of these 3 companies in China, and in each case I felt I had more than adequate basis to suspect varying degrees of fraudulent activity. I have contacted Biotech Breakthroughs, but I have never received a response.
When I wrote about Cleantech, I noted that during my two day visit, I observed only a tiny handful of employees engaged in no meaningful productive activity. I also noted the extremely troubling history of its auditor, Sherb and Co. As I noted, with the exception of Cleantech, 100% of the clients which Sherb signed off on have either been delisted outright due to fraud or have traded down to the pennies once the market caught on. Were it not for the reverse splits, Cleantech would be trading in the pennies as well. A complete list of Sherb's Chinese audit clients (and their fates) can be found in my original article.
Despite the aggressive and direct nature of my article and a 30% drop in the stock, Cleantech issued no response to it. Instead, about 2 weeks later, Cleantech issued a very different press release noting that
Cleantech Solutions Management Purchase 157,966 Company Shares
As would be expected for a tiny float company, the share price again soared by nearly 50% on millions of shares of volume. What the market missed was the fact that this purchase was conducted solely by the Chairman and his wife. More importantly, the transaction was not an open market purchase, but instead was a new issue of shares by Cleantech to the Chairman and his wife at a price of just $3.88. This amounts to over 6% of the entire company being purchased in a private (off market) transaction by insiders. It is also important to note that this large insider transaction was conducted without shareholder approval.
The share price quickly hit a high of $5.50 on December 4th, but once it settled down, it retreated to the $3-4 range. The stock ended the year at $3.97.
During that time, Geoinvesting conducted its own visit to Cleantech and briefly took a positive view. They noted that, in contrast to my visit, Cleantech had upped its operations and there was enough activity for their firm to take a short-term long position.
Yet in April, Geoinvesting requested further follow-up from Cleantech including:
- Independent verification of cash accounts;
- Independent verification SAIC/SAT filings;
- Independent video coverage of manufacturing operations;
Geoinvesting notes that Cleantech could not comply with this request for independent verification.
Geo's April 26th report also cites a history of high CFO turnover, raises concern over the S3 and raises concern regarding auditor Sherb.
In contrast to their initial support, Geoinvesting ultimately came to the conclusion that
Given these developments, we cannot further validate CLNT's operations.
Geoinvesting states that it can no longer support a long position in shares of Cleantech.
So is Cleantech a fraud or not ?
Various market participants, such as Geoinvesting and myself, can only put forth their best efforts at conducting due diligence and do their best to arrive at the correct conclusion. However, none of us are the final arbiters as to the presence or absence of fraud.
However it is worth noting that the market as a whole certainly views Cleantech as a fraudulent company.
In the filings that it reports to the United States SEC, Cleantech claims that it earned a net income of nearly $6 million in 2012 on revenues of $56 million. Yet the market cap of the entire company (prior to the recent press release) stood at just $9 million. This means that Cleantech trades on a PE ratio of just 1.5x. In short, investors as a whole simply do not believe that the financial results (as reported to the SEC) are real.
There are numerous reasons why investors doubt the legitimacy of Cleantech's results. The wave of China frauds (including by numerous clients of Sherb and Co) which hit the US has resulted in suspicion falling upon all Chinese reverse mergers where results appear to be "too good to be true".
Shortly after my article in November, Cleantech's CFO, Wanfen Xu, resigned. In her place, the company appointed Adam Wasserman. Mr. Wasserman was the 3rd CFO to serve at Cleantech during a two year period (which is what gave rise to the CFO concern expressed by Geoinvesting). Mr. Wasserman had previously served as Cleantech's "vice president of financial reporting".
Mr. Wasserman's bio at Marketwatch shows that right now he is concurrently acting as a senior management figure for no less than 6 small US and Chinese companies including:
- CFO at Sanborn Resources
- CFO at Yew Bio-Pharm
- CFO at Oriental Dragon Corp
- CFO at Westergaard.com
- CFO CFO at Cleantech Solutions
- CEO at Oncall Inc.
Again, he currently is fulfilling all of those management duties at the same time. Typically each and every one of those roles would comprise a full time job for any one individual. So it is difficult to imagine how much attention Mr. Wasserman is devoting to Cleantech in China.
At the rather young age of 48, Mr. Wasserman's resume also includes a very, very extensive list of small companies for which he has acted as a senior management figure, including:
- CFO at Lotus Pharmaceutical (Chinese reverse merger)
- CFO at Gold Horse International (Chinese reverse merger)
- CFO at Pershing Gold Corp
- CFO at Bohai Pharmaceuticals (Chinese reverse merger)
- CFO at Staffing 360 Degrees
- CFO at CD International
- CFO at Transax International
- CFO at Relationserve Media
- CFO at Colmena Corp
- CFO at Explorations Group
- CFO at Genesis Pharmaceuticals
- CFO at Cenuco
- CFO at Options Media Group
- CFO S.E. Asia Trading Co.
- CFO Speedhaul Inc.
None of these are necessarily very lucrative roles. For example, at Cleantech Mr. Wasserman is only paid a base salary of $52,000. But when holding 5 or more simultaneous CFO roles, the compensation will no doubt add up.
As of its most recent 10K filing, Cleantech disclosed the following regarding its ineffective internal controls designed to prevent fraud:
Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer.
Based on that evaluation, Mr. Wu and Mr. Wasserman concluded that our disclosure controls and procedures were not effective as of December 31, 2012.
In the case of Cleantech, its financial statements themselves (as audited by Sherb) raise numerous red flags. As of the September quarter (prior to the Chairman's cash injection), Cleantech reported just $960,000 in cash. Yet it has a receivables balance of over $10 million. It has also reported "prepaid expenses" of $1.7 million.
So investors are left to wonder why a company with almost no cash on hand is advancing millions of dollars to both its customers (the receivables) as well as to its suppliers (prepaid expenses).
A company's cash balance is the easiest item within the financial statements to verify. As a result, investors are aware that companies who commit fraud are forever in need of accounts which let them state large and growing revenues, but which do not require them to prove the existence of cash. This is why Geoinvesting requested to verify the company's cash balance. Yet Cleantech refused this request.
Separately, Cleantech disclosed that:
Research and development costs are expensed as incurred.
The Company did not incur any research and development expense in 2012 and 2011.
This is a glaring red flag to any investor who wonders how Cleantech could possibly have entirely transformed its very high tech business 4 times in the past 3 years.
Cleantech went from being a high tech windmill component manufacturer, to a high tech solar component manufacturer, to that of a "high and low temperature dyeing and finishing machinery for the textile industry", and now (in just the past week) to suddenly being a supplier of precision components to China's largest oil companies.
Even if the company had been spending millions in R&D, each of these transitions would have been formidable accomplishments. And yet Cleantech has spent precisely nothing on R&D for the past 3 years.
The margins are yet another cause for suspicion. It is well known that Chinese manufacturers of solar and wind power components have nearly competed each other out of business. Many of these companies are now selling at gross margins which are close to (or even below) zero. Yet Cleantech continues to report massive gross margins of around 23%. A comparison with any of the other major Chinese suppliers would suggest that such a competitive feat is quite literally impossible. This is especially true for such a small company which operates without any meaningful economies of scale. Cleantech reported that 55.8% of its revenues came from forged rolled rings and components (including to the wind power industry) while 44.2% of its revenues came from dyeing and finishing equipment.
Cleantech Solutions has been repeatedly pumped as a "multi-bagger" stock by various parties over the past year. The ultra-low float of just 2.67 million shares means that any spark of news or hype can send the stock soaring within hours. Yet in each case the stock has quickly retreated back to the $3-4 range where it sits on low volume.
The latest "news" regarding Cleantech's certification by BCC was just the latest in the series on non-events for Cleantech. The fact that this explosive surge occurred immediately after the filing of an S3 registration statement to raise (a much needed) $5 million should speak for itself.
The market has been pricing this tiny cap Chinese reverse merger as a fraud for years.
While day traders are quick to play the "news driven" pop in the low float stock, it is clear that there are an abundance of red flags which will keep sensible longer term investors from owning the stock, even for just a few days.
Cleantech remains as a Chinese reverse merger with a very part-time, absentee US CFO and a set of entirely nonsensical financial statements.
In all likelihood this stock will fall right back to the $3-4 range within the next week or so, as it has done in the past. This represents a drop of around 50% from the last traded share price.