Avoid China Agritech Despite the Plunge

Feb.17.11 | About: China Agritech, (CAGC)

Shares of China Agritech (OTCPK:CAGC) plunged an alarming 19% Wednesday to $7.43, hitting a low not seen since 2009. Many investors are asking whether this low presents a buying opportunity. But while speculators may be able to make a quick buck, I doubt that China Agritech shares are worth purchasing for the long run at these prices.

China Agritech shares have been in a long steady decline from their high of more than $30 early last year, but the plunge has gained speed this month starting with an investigative report from the previously unknown Lucas McGee research firm. This report (.pdf) alleged that China Agritech was, frankly, a scam. Lucas McGee claimed that of the company's four factories, only one produced any product at all in 2010, and that China Agritech was, as a result, vastly overstating its revenues. The report also questioned the company's deals with customers, claiming in particular that a major deal with Sinochem was suspicious. The report also questioned management's credibility, suggesting that China Agritech's CFO was previously involved in other failed businesses.

John Hempton's Bronte Capital followed up on Lucas McGee's research and confirmed some of that report's findings while casting some doubt on others. For example, Bronte Capital investigated the Sinochem contract and concluded that: "This Sinochem contract is probably real (contrary to the suggestions of the Lucas McGee). But the contract is tiny and unlikely to be financially relevant." Regardless, Bronte Capital also took a short position in China Agritech.

On February 10th, China Agritech fired back (.pdf) at the Lucas McGee report with a categorical denial of nearly all the claims of the report, offering a point-by-point rebuttal with pictorial evidence suggesting that Lucas McGee has misrepresented the company. This rebuttal led to a small recovery in shares of China Agritech, and appeared to credibly discount at least a few of Lucas McGee's allegations. Lucas McGee Research has gone dark since their initial report, and their lack of reaction to the company's rebuttal raises some doubt to the accuracy of pieces of Lucas McGee's initial report.

Shares Wednesday plumbed new lows, however, following another credibility-damaging article from Bronte Capital which tried to poke holes in the China Agritech's rebuttal. In particular, Bronte scathingly attacked the company's claimed efficiency per worker, writing:

So with just over $2 million worth of equipment the company claims to be able to manufacture and load 2.5 million bags of fertilizer per year. Oh, and they do without an enormous army of low-paid workers – but a mere thirty-something superheroes.

Bronte Capital remains short the stock and seems convinced the company is not accurately representing itself to investors.

Bronte has also weakened another of the bulls' leading defenses of China Agritech shares. Bronte noted that the Carlyle Group, a large investor in China Agritech, also took a bath in the aftermath of the scandal at China Forestry. Combined with Carlyle's unwillingness to defend China Agritech when Bronte attempted to contact them, Bronte implies that Carlyle's large investment in China Agritech does not offer much protection for other investors.

While I'm sure China Agritech will respond to the latest concerns and the stock will probably bounce when they do so, I'd still avoid the stock. For one, it is difficult for outsiders to investigate whether or not the company is being truthful, and John Hempton and his fund Bronte Capital has a good track record, so I'd be cautious taking the other side of his trade.

The other reason I'd avoid China Agritech is simply valuation and performance versus its peer group (in particular, Yongye international (NASDAQ:YONG) and China Green Agriculture (NYSE:CGA)). If you want to take a flyer on a volatile Chinese fertilizer company, and you believe all three of them are being honest about their books, the other two represent better investment opportunities.

China Agritech compares very poorly, even after Wednesday's decline, with its competitors. If you are going to take a chance on a company facing serious allegations of fraud, you should get a better entry price than China Agritech's shares currently present.

China Agritech (OTCPK:CAGC)

China Green Agriculture (CGA)

Yongye International (YONG)

Market Cap

$154 Million

$205 Million

$339 Million

Big Four Auditor?

No (is in the process of changing to a big four auditor currently.)



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Quarterly Revenue Growth (year over year)




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(Data from Yahoo Finance and the companies' SEC filings)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.