We all make mistakes, but the most important thing is that we realize and correct our mistakes and learn our lessons from them.
I need to confess to my readers one mistake I made last May when I published articles claiming that China MediaExpress (OTCPK:CCME) was a hidden gem of China (here, here and here). Today I completely changed my opinion of this company: In my opinion, it is no longer a hidden gem, but rather a hidden lie.
Being a follower of Warren Buffett, I liked China MediaExperess’ market position and growth potential. I carefully examined its history and figured that the management of the blank check company that merged with China MediaExpress may have helped us find good value. I also examined its operating metrics, and felt that all the trends were consistent historically. At that time, I was aware of the existence of many Chinese frauds, but determined that if China MediaExpress were a fraud, it would have to be a perfect fraud. And now, I believe that I might be just perfect right there – it might be just a fraud, no matter how perfect it is.
I will discuss many aspects of this company and answer many of your questions as to why my attitude turned 180 degrees. Some investigations are still going on, so my readers will have to bear with me as I unfold a truer China MediaExpress.
Today I am going to discuss two areas in which I believe management intentionally misled the investors.
1. China MediaExpress Does Not Have an Exclusive License from Ministry of Transport as It Claimed
China MediaExpress wanted its investors to believe that it has “exclusive license from the Chinese Ministry of Transport to install nationwide TV system on buses” as found in “Investment Highlights” section in its corporate profile (also in its website, see the screenshot below), and that “CME’s five-year agreement with China’s Ministry of Transport creates a barrier for other competitors”, as found in the “Growth Opportunities” section of the same document.
click to enlarge images
The truth is that there is no license involved, but instead what was signed was a cooperation agreement. The other party is not the Ministry of Transport either, but rather an affiliate of the ministry who does not appear to have any administrative power. This cooperation agreement does not give the company a license and is not a barrier for its competitors.
To come to this conclusion, we first need to understand that there is a standard named “Layout key for official document of administration” and coded “GB/T 9704-1999” that every government organizations have to follow to issue official document. Baidu wiki has an entry and the google translation can be found here. A complete copy in Chinese can be found here in Baidu Wenku. Code 8.1.5 command that every document have a reference number, which is composed of the posting authority, year and serial number. I found three examples of official documents from Ministry of Transport (here, here and here), each of which denotes on the top the Ministry of Transport, year and serial number of the document. Each of them also contains a short paragraph describing the approval process of the document, date of effectiveness, signed by the head of the ministry and properly dated.
Now let us look at the "official document" provided by China MediaExpress on their website. Though the Chinese document is printed on the letter paper of the Ministry of Transport, which is not difficult to obtain by the way, the document identified the issuer being Transportation Television and Audio-Video Center (“TTAVC”), an entity affiliated with the Ministry of Transport.
Compared to other official documents, this TTAVC document does not include a reference number and is without description of how it became administratively effective, and thus this document does not possess any administrative power.
A search of China MediaExpress’ SEC filings reveals that the company did not initially describe the document as “exclusive license”, but rather a “cooperation agreement”. Later the company started misleading its investors to believe that the document is something it is not.
The original description of this document can be found in its June 2009 filing when TMI was merging Chna MediaExpress.
Slide 16 is shown here:
Rather than phrases like "Exclusive License", the slide describes the document as “cooperation agreement”, and the party it worked with was TTAVC. Note that no penalty for breaching exclusivity was mentioned in this slide (which will miraculously appear in a later slide), and in November 2007, it is TTAVC - not Ministry of Transport - that issued a notice to municipalities, provinces and transportation enterprises in China facilitating - not demanding - the implementation of the system contemplated under the agreement.
A news article published on China Communications News dated November 8, 2007 also revealed that China Communications News signed a “cooperation agreement“ with Fuzhou Fenzhong (The sole operating entity of CCME) to develop on-bus TV system, and TTAVC, which belong to the China Communication News, is in charge of business. Since this news article was produced at the time the “exclusive license” was supposedly granted and the newspaper has a close tie with involved parties, the description here should be accurate.
Before I go on further discussing how I believe the company moved on to mislead the investors about the nature of the deal, let us examine the nature of TTAVC.
First, TTAVC has a website: www.jtbtv.com, which indicate that it is a media firm that belongs to the Ministry of Transport. I encourage interested readers to use Google Translate to explore the content by themselves. Its business description does not indicate that it has administrative power.
Second, the website also indicate that the same organization has a second enterprise identity, Beijing Zhongjiao Video Culture Development LLC, incorporated in April 2007. A search in Beijing Enterprise Credit website finds the result here (original and Google translation). Of course an enterprise should not own any administrative power, which is also manifested by its business description.
All the evidences above indicate that this is a cooperation agreement with a business, not an exclusive license from the government;
But China MediaExpress appeared wanting to mislead the investors. Let’s look at its most recent presentation. Page 27 is shown below.
- The subject who issues the notice now is no longer TTAVC, an affiliate of Ministry of Transport, but changed to the Ministry of Transport. The action is vaguely mentioned as “granted a document”, not strong words like “issued an administrative decree”.
- Compared to the TMI merge presentation this slide added a claim that TTAVC will have to compensate RMB 40 million to CCME if the grant is no longer exclusive. I surmise that such an addition is put here only trying to offer a hint for the value of this agreement, which actually had little value to begin with because TTAVC does not control the express bus resources and does not have any administrative power.
- The slide claims that China MediaExpress “is the only outdoor media company to be acknowledged by the Chinese government”. The word ‘acknowledge’ is another vague term here which does not stand for any legally binding concept but serves to mislead the US investors into believing that it has a competitive barrier created by government decrees.
The misleading culminated in its profile description, in which the company described itself having an "exclusive license" to set up on-bus broadcasting system with Ministry of Transport.
Many US investors were concerned if the company would be able to renew their license with the government. Such a worry is overstated since there was no exclusive license to begin with. TTAVC would be rather happy to accept some payment from the company and produce another such document which does not have any administrative power.
Not only can we find proof that there is no exclusive license by checking the validity of the document, we can also find the existence of legally running competitors, such as Fuzhou Daxiang Media, which argues against the exclusivity claim.
2. China MediaExpress’ Patent Did Not Win Any National Prizes as It Claimed
The company claimed that its patent "Automatic control device technology of passenger car audio/ video playback equipment" of China MediaExpress was awarded "National Prize for Progress in Science and Technology" and "Second Prize of National Invention Award for Patented Technology" in June 2006. The claim can be found here. A screenshot is shown below.
I believe that this is an outright lie.
These two prizes are publicly searchable. Both the Ministry of Science and Technology ("MOST") and the National Office for Science and Technology Awards ("NOSTA") keep the records. For 2006, "National Prize for Progress in Science and Technology" roster can be found here and here. And “National Invention Award for Patented Technology" can be found here and here.
Though the records are in Chinese, I can responsibly tell my readers that China MediaExpress’ patent is nowhere to be found there, even after I expand my search to all searchable years.
There are another two factors working against China MediaExpress’ patent award claim. One is that the patent was approved on August 9, 2006, which is a later date than the supposed award date, June 2006, claimed by CCME. Two is that the patent is a utility model patent, inferior to the invention patent in the Chinese patent hierarchy, which makes it impossible to win an award in invention category at all. (More knowledge of the Chinese intellectual property rights can be found here.)
Readers can also view the original copy of this patent here. It shows that it is a utility model patent, applied on July 16, 2005 and approved August 9, 2006. The gist of this patent is a door controlled electric relay. To award such a patent first National Prize sounds like an insult of the Chinese technology, which has developed the fastest train in the world and has sent human into the space.
The above two points illustrate that the management has a habit misleading the investors, and this is just a small part of a whole lot red flags that I will share with you.
Before I submitted this article, Muddy Waters Research published a comprehensive report on China MediaExpress, calling it a massive "pump and dump" scheme.
Investors be cautious!
Disclosure: I am short OTCPK:CCME.