Ian Bezek, notorious for his coverage of China Media Express Inc. (CCME) on SeekingAlpha, recently released another analysis of Yongye International (YONG). Ian hit CCME long before even their own auditor smelled trouble, so his coverage usually gets some response from readers and even the companies themselves. Today is such an instance of a company responding directly to Mr. Bezek and his claims of the various red flags at their company, and smells a lot like the last time they were forced to respond to such claims in early February. Here, I will go over some of the banter between the two sides and see if anything looks amiss.
Mr. Bezek says that the levels of volatility displayed by Yong over the past several years are not commensurate with the style of business they claim to pursue; retail models, by and large, should exhibit steady sales and growth without large differences in quarter on quarter revenues. The company, however, relates the differences to variable buying habits from a previous distributor. They stated:
The author says that his experience tells him that the company's sales figures must be false because sales from Hebei province for a particular quarter fluctuated over the last few years. Our sales figures are, in fact, accurate. The fluctuations that we experienced resulted from variable buying habits exhibited by our previous distributor in that province (whose customer list and related customer relationship we recently acquired). Our distributors' buying habits are their business. The bottom line is that we enjoyed strong sales in Hebei during the past several years and, other than his guess work, the author has no basis to say otherwise.
This seems plausible, but still is not as robust a response as I would have liked. Why were there any fluctuations if the product is so sound? Drought? Competitors? Was the distributor incompetent? On the other hand, I feel that if these numbers were imaginary that I personally would be making up some more stable growth estimates, not having 2000%, -60% and 428% growth. Sometimes the truth is crazy.
The next topic in Ian’s sights is the sales force of YONG. Here, he says that the 2009 10-K targets three to 10 stores each depending on their capability. I wasn’t actually able to find that quote when clicking the link Mr. Bezek provided in his article to that particular 10-K but even so, Yongye has responded with their own defense of that statement.
The author suggests that our sales figures must be lies because our sales force is not large enough to support our sales figures. The allegation bespeaks a misunderstanding of the company and its business. The primary job of the company's sales force is managing 25 provincial level and Hebei sub-provincial level distributors and helping them with training over 700 county level distributors who manage relationships with over 24,000 independently-owned, Yongye-branded retail stores.
This unique sales approach is one of the reasons that Yongye is so well received in local agriculture spheres; the stores already existed and the staff simply supports and monitors the overlying distributors who operate as suppliers for those stores. In the 2010 10-K released last week, Yongye speaks to this scalable business model when they state:
We sell our products in China through an effective distribution model mainly comprised of provincial distributors who purchase our products and sell them through a chain of local distributors whose terminal sales point is either a retail store or a large farm.
So, the sales force does not support individual stores as much as it supports the supporters of those stores. They continued to explain this relationship in today’s response:
Yongye branded stores were existing agriculture stores in local villages. As such, no stores needed to be "opened." These are existing stores recruited to join the Company's distribution network. In addition to selling Yongye's products, these stores also carry other agriculture products such as seeds, pesticides, and fertilizers. The store recruiting work is primarily driven by thousands of staff from the Company's various levels of distributors.
This seems to be a solid explanation for the discrepancy in sales staff; as the distribution network grows, the sales and support staff become tier-2 and tier-3 levels of support, if you are familiar with any sort of technical support situation. Tier-1 support is usually handled by people closer to the ground, with those various levels not considered direct sales and support staff.
However, all this still brings up the fact that YONG refuses to name their distributors for competitive reasons. They counter that:
Our decision not to publicize those names is for competitive reasons, and there is nothing wrong with it. We provide those names to our auditors to be used for their audit procedures on the financial statements. Once again, the facts, not the author's clever innuendo, are important.
I don’t think a company not revealing the names of their customers is a problem. If they are revealed to the auditor, then there should be no reason for every blogger on the internet to have access to customer/distributor records. However, the argument that SEC Regulation S-K Item 404(a) has been violated is an interesting accusation. It basically implies that a 5% shareholder which engages in a transaction with the company and has a direct or indirect material interest in the transaction must be disclosed and make the pertinent filings with the SEC. But, is Hebei owned by a related party? That is the key amidst the legal mumbo jumbo. If they are removed from YONG completely, then S-K should not be an issue.
The author says that as a result of a transaction with our largest distributor then, that distributor came to own more than 5% of our stock and should have, but did not, make the proper SEC filing, implying that the distributor was owned by a related party. Our Hebei distributor was not owned by a related party. Also, it is the responsibility of the greater-than-5% owner to make the filing. The company discloses all of its distributors to its auditors, on a quarterly basis as part of the company's audit and review procedures.
Now, the owner must make the filing but the company does have an obligation to make an effort to ensure they are doing so. Also, KPMG should be pretty aware of the SEC ramifications that are caught up in all of this. Of course, auditors don’t have the impermeable sheen they used to (re: CCME and Deloitte Touche Tohmatsu) and not enough skin in the game, but they still carry some weight. This is the sort of issue that could be verified with a little legwork and an actual opinion from legal counsel.
Finally, Ian approaches the admittedly confusing structure of YONG and describes his problems with several of the difference incantations of "Yongye." The management responds by saying:
The author … suggests from the existence of multiple companies that there must be some sort of conflict of interest. The fact is that the Mr. Zishen Wu, the company's chairman and chief executive officer owns other companies. That is not a secret. The website "china-yongye.com"; is the website of Yongye Group, listing all the businesses and management teams of all the Yongye Group businesses. Yongye International's business is focused on Shengmingsu products and has no conflict with the other businesses under the Yongye Group name. Yongye International has a separate management team. Mr. Wu spends almost 100% of his time on Yongye International.
This is not necessarily a competition, but the relationship between Mr. Wu and these companies does not look good. I am assuming the products released by Yongye Group will not be in direct competition with Yongye International, and why would they be? Complementary items would make more sense for all parties involved. However, more clarification is needed on why exactly Shengmingsu seems to be on everyone’s website.
It looks like another cross Pacific battle as Yongye International responds to claims by Mr. Ian Bezek that their business is built on stilts in the sand. It will be up to the management to give more evidence of their existence as a legitimate company, or else they will suffer from guilt by association in the wake of the CCME scandal.
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