Is China Redstone Group Legitimate?

Take a dozen microcaps, and one of them will likely to turn out to be a fraud. For Chinese microcaps, the odds are probably double. That's why I spread my Chinese microcap stock positions over a basket of a dozen or more stocks (I trade them actively so the number tends to vary from 12-20).

Fraud allegations have been lodged over the past months regarding a few of the China stocks I own. Some believe that China MediaExpress Holdings (Nasdaq:CCME) doesn't have the business it claims. Others point out that recent transactions announced by Artificial Life (ALIF.OB) seem fishy.

But no China stock in my portfolio has come under more fire recently than China Redstone Group (CGPI.OB). It has lost over a quarter of its value in the past month, following accusations raised on GeoInvesting.

Specifically, GeoInvesting raised the following concerns (quoted directly from the GeoInvesting message board):

• A non-existent or improperly disclosed ownership structure between the non-PRC and PRC entities that questions CGPI claim to revenues.
• CGPI may not have disclosed the actual owner of cemetery license. (CGPI VIE/operating company, Foguang, does not have ownership interest in the actual company that owns the cemetery license).
• Misrepresentation of land use rights; appears that the developed cemetery plots are situated on a much smaller area of land than CGPI claims.
• Illegal lease of land where cemetery plots have been developed.
• Fines have been levied against cemetery operation in the past; right to operate cemeteries by actual company that held the license has been revoked.
• The real potential for increased competition exits with regards to cemetery operations.
• Tourism business plan may be less attractive than portrayed by CGPI due to the development of a nearby steel/iron manufacturing plant.

At least some of these questions seem to have been answered by China Redstone Group management. In a January 26 press release, CGPI describes its real estates and cemetery licenses. It also provides links to relevant documents — though they are in Chinese so I cannot make heads or tails of them.

Management also had a conference call on Friday, which is available for replay here. All China Redstone investors should listen. CGPI management, in my view, attempted to respond to each of GeoInvesting's points. That doesn't eliminate all concerns, but it is significant that the company is attempting to win back investor confidence. To that end, management said it would pursue an uplisting and also seek to upgrade to a major auditor. Both would be extremely positive steps.

The story is not over, but as it stands today I believe it's more likely than not that CGPI turns out to be a legitimate company. I remain long.

Update: CGPI's investor relations folks inform me that the materials from China Redstone's company update have been translated into English. Here they are:

• Land use permits
• CGPI corporate structure / photos
• operating approvals
• map of property
• local government policy
• Foguang cemetery license

DISCLOSURE: Long CGPI.OB. Also long ALIF.OB, though I have a sell order in. Took profits in CCME.