by Lucas Scholhamer
There are thousands of publicly owned businesses capable of reeling in lucrative profits and making shareholders wealthy. But it only counts if done legally, and it is sometimes difficult to differentiate between the legitimate companies and those that are too good to be true. Investment Underground took a deeper look at three businesses that have been accused of fraudulent behavior:
Advanced Battery Technologies Inc. (ABAT): ABAT is a Chinese manufacturer of rechargeable Polymer Lithium-Ion batteries used in electric scooters, other electric motor vehicles, and numerous household items. Shares depreciated 1.38% to $1.43 at the time of writing, although the largest fall took place in late March, where stock prices dropped from $3.51 to $2.01 in a single day. ABAT has a very low P/E ratio of 2.5.
Several analysts have done extensive research on ABAT to justify labeling the company as a fraud. One Seeking Alpha article uncovered some shady moves by its management, including a transaction in which ABAT Chairman Fu Zhiguo transferred his remaining holdings in Heilongjiang ZQPT, a major subsidiary, to ABAT back in 2006 (as reported in ABAT’s 2007 10-K filing), thus giving ABAT full ownership. Yet in ABAT’s 2009 10-K filing, the company mentions that HLJ ZQPT is fully owned by Chairman Fu, without explanation of how ownership of the subsidiary was ever transferred back to him.
Furthermore, ABAT appears to have spent $20 million on the acquisition of a company in which Chairman Fu had previously held high-level positions—a deal potentially yielding the now-ABAT chairman a substantial sum of money. But that’s not all. ABAT’s reported success does not seem to be economically (or even physically) possible. Sure, it seems unlikely that a battery company can grow its revenue from $1.1 million in 2004 to $97 million in 2010 without introducing a revolutionary product. But Prescience Investment Group took the investigation a step further by talking with ABAT’s customers and even hiring inspectors to visit several of ABAT’s manufacturing plants. These reports suggested that the facilities were severely overhyped and not equipped for cutting-edge production methods that could make ABAT’s numbers even feasible.
In Prescience’s comparison of EBIT margins with 106 leading battery companies, ABAT had the highest EBIT margin by far (39%, the next highest was 23% and the majority fell below 15%), despite admittedly having no technological advantages. The full Prescience report can be read here. All of these findings paint a grim picture for ABAT, and it is hard to dispute something as black and white as the presence of equipment in a factory. I personally find the arguments against ABAT to be compelling enough to keep me a safe distance from the company.
Gulf Resources, Inc. (GFRE): Gulf Resources, Inc. is one of China’s largest bromine manufacturers, operating through two subsidiaries (SCHC and SYCI) that it fully owns. Shares appreciated 8.21% to $3.03 at the time of writing, continuing a gradual decline from the 52-week high at $11.95 last December. GFRE boasts a P/E ratio of just 1.8 and a market cap of $90.5 million.
In late April, Glaucus Research published a report of an investigation the group carried out suggesting that Gulf Resources was a fraud. Most of the argument was centered on Ming Yang, the chairman and founder of GFRE. Ming Yang is also the owner of a privately-held conglomerate that claims to own all of GFRE’s assets and business. Furthermore, Yang is listed as the CEO of Haoyuan Group, a privately-held company that boasts suspiciously similar operations and assets as GFRE. In other words, if Glaucus’ accusations are correct, Gulf Resources is essentially the same company as the privately owned Haoyuan Group operating as part of Ming Yang’s conglomerate. By this logic, publicly-owned GFRE is merely a shell of a company, as Ming Yang never actually transferred his ownership of the business (contrary to SEC filings), and shares are worthless. According to the same Glaucus Research report, GFRE has also allegedly funneled money out of the company through “capital expenditures” carried out by seemingly falsified contractors, among several other offenses.
However, GFRE’s management has addressed the allegations, claiming that the company actually acquired subsidiaries from Haoyuan Group in a reverse merger and that the corporate structure presented on Haoyuan’s website is simply out of date. GFRE also claims to be working on proving the legitimacy of the aforementioned contractors. The company attributes a suspicious record inventory turnover to the fact that it holds small inventories and manufactures bromine (a dangerous element) upon demand for safety reasons. Yet some of the elements required to do this are said to be just as deadly to store.
GFRE’s response has holes, but it’s a start. The company appears ready to present whatever documents are required to prove its validity, and I think the case against it is slightly less convincing than that against ABAT. Still, GFRE’s response places a lot of blame on simple communication errors that seem far too obvious for the company to have overlooked. Right now, I’d recommend that both value investors and short-sellers stay away from GFRE until the picture becomes a bit clearer.
Ebix, Inc. (EBIX): This Atlanta-based provider of software and e-commerce services for businesses in the insurance industry has recently found itself at the center of a dramatic online blame game. Shares appreciated 5.98% to $20.57 at the time of writing, as the company tries to recover from a mid-March attack from an anonymous blogger whose detailed allegations of accounting deception and management wrongdoing caused stock prices to drop 26% in a single day. EBIX has a P/E ratio of 12.5 and a market cap of $812 million.
In the previously mentioned article the company is accused of a number of different offenses by an anonymous author who is admittedly short EBIX. In one instance, EBIX’s impressive 11% organic growth in 2010 is attributed to the inclusion of acquisitions as organic growth and failure to consider the impact of foreign exchange revenue, thus painting an overly optimistic picture for potential investors. Additionally, EBIX allegedly has a tax rate of just 3% (while most tech-sector competitors have rates well above 20%).
The author of the article pointed to a loophole that EBIX had been exploiting, transferring large portions of income from U.S. operations (which accounted for 75% of total revenue) to its foreign operations in India and Singapore, where the company could take advantage of more favorable tax rates. This, in turn, helped EBIX achieve an unbelievable 140% operating margin abroad in 2010. Furthermore, EBIX has apparently had 4 different auditors in the last seven years and has regularly paid only around $350,000 in auditing fees (compared to the several million dollars paid annually by competitors). If these accusations are indeed true, then stock prices may be inflated from years of deception and shareholders stand to lose when the true numbers draw significantly less demand from potential investors—not to mention the harsh damage from fines and bad press that could result from faulty accounting practices.
However, Ebix responded to the allegations, saying that it saw no reason to believe that the dramatic drop in stock prices was justified. The 35-year-old company claims that it is more financially healthy than it has ever been before. So it really comes down to an our-word-versus-yours conflict. I do not suspect that the report was a deliberate attempt to manipulate the stock price—somebody with the resources and knowledge required to execute such in-depth research would surely be aware of any legal ramifications they could face should their identity be discovered. Furthermore, the allegations are not based upon physical assets such as manufacturing plants (as in ABAT’s case) or more clear-cut issues like ownership (as in GFRE’s case).
While EBIX does boast some suspiciously impressive statistics and a questionable lack of transparency in parts of its SEC filings, I would be impressed if a single blogger could connect the dots with 100% accuracy from outside of the company. I’m not ready to condemn Ebix just yet, but I’m also hesitant to write it off as completely clean. If you’re a bull, then fortunately for you, shares are decently affordable right now. Take that as you will.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.