Questioning the Operations of Orsus Xelent Technologies

Jun.24.11 | About: Orsus Xelent (ORSX)

Introduction

We have been looking into the Orsus Xelent Technologies (ORS) story and reached the following conclusions that are explained in more detail in this report:

  • ORS has no discernible business operations;
  • Even if the management team of ORS is conducting substantial business operations, US shareholders may have no ownership interest in whatever the true operations are;
  • ORS faces an immediate liquidity crisis that if unresolved will likely force the company to suspend operations at the end of QII or during QIII 2011.
  • Due diligence performed by Reuters corroborates our on-the-ground-findings.

Background

On May 23, 2010, we informed our premium users via our message boards that we were going short ORS.

ORS shares had been on fire since late May 2011, climbing from around $1.00 to a high of $7.29 on June 14, 2011. Shares of ORS have subsequently retreated, closing at $3.19 on June 17, 2011 as more investors have likely begun peeling away the onion on this story.

We speculate that investors were excited about what appeared to be strong 2011 first quarter results released on March 23, 2011.

A major bullet in the 2011 first quarter release was the $12.73 vs. $(0.18) EPS comparison for Q1 2011 and Q1 2010, respectively. However, a closer look reveals that net income was aided by a one-time noncash gain. A review of a few of the bullets:

  • Sales in the quarter declined to $3.91 million, compared with $7.6 million a year earlier.
  • The Company achieved income from operations in the period of $342,000.
  • However, mainly due to a non-cash reversal of allowance for bad debt generating other income of $32,022,000 in the quarter, the Company reported net income of $32.03 million or $12.73 per share, compared with a loss of $(446,000) or $(0.18) per share a year earlier.

By our calculations, after stripping out noncash items from both years, the year over year EPS comparison tells a different story:

  • 2011 vs. 2010 First Quarter Adjusted EPS was nil vs. $0.33.

Here are some other figures in the 2011 first quarter 10Q:

  • Cash = $4,000
  • Account Receivables = $94.1 million or 6 times the current annualized revenue run rate
  • Operating Cash Flow= ($1,000)
  • Tax Payable = $33 million

Investors may have also been excited about a few things addressed in the company's 2011 first quarter release:

  • The renewal of its accounts receivable insurance:

The reversal of the allowance for bad debt is a consequence of the fact that following a year-end write down of those doubtful accounts (accounts receivable) in 2010 which were not covered by an expired third party guarantee agreement, on March 30, 2011 the Company entered into a Credit Guarantee Contract with Beijing Xingwang Shidai Tech and Trading Co. Ltd. ("Xingwang") and Zhong Hui Guarantee Corporation ("Zhonghui"), by which Zhonghui renewed its guarantee for any sales to Xingwang. Under this new agreement, coverage was increased from RMB 300 million (U.S. $44.2 million) to not more than RMB 500 million (U.S. $73.6 million) up to the period ending December 31, 2011.

  • The possibility that ORS's growth tract will awaken if it were to receive a life line:

Mr. Guoji Liu, CEO of the company, stated,

We are pressing ahead with our previously described plans for a strategic merger and/or a capital raise and/or a loan to resolve our cash flow problem. We believe we have made progress in this regard, but have not yet succeeded and cannot predict the final outcome of our various discussions. It is only with success in securing additional cash that we will be able to move forward with plans to strengthen operations. These plans include a focus on product sales in developing regions such as Africa and the introduction of new products that conform to consumer demand and the needs of China's telecom operators.

Quite honestly, this is news we would have gone long on when China Hybrids were in vogue not too long ago. As expected, such news has since led to an increase in the company's stock price as investors possibly have re-priced its risk premium.

However, there are still significant risks to this story.

  • The status with the exchange is at risk:

NEW YORK, NY--(Marketwire - Apr 27, 2011) - Orsus Xelent Technologies, Inc. ("Orsus" or the "Company") reported today receipt of a letter from the NYSE Amex LLC ("the Exchange"), which stated the Company is not in compliance with Section 1003 (a) (i) of the Exchange's Company Guide based on the Company's reporting of less than $2 million in stockholders' equity and losses from continuing operations and net losses in its two most recent fiscal years ended December 31, 2010; and Section 1003 (a) (iv) of the Exchange's Company Guide with respect to its financial condition, which makes it questionable in the opinion of the Exchange as to whether the Company will be able to continue operations or timely meet its obligations. Additionally, the Company has been advised its common shares may not be suitable for auction market trading due to their low selling price.

  • The company very clearly stated that more pressing matters are at hand besides attaining accounts receivable insurance:

The Company noted the reversal in the quarter of the previously expensed bad debt did not generate cash. The Company's most pressing concerns -- and the continuing primary focus of management attention -- are cash flow and related going concern issues. (2011 first quarter release)

  • The 2010 10K reveals that the clock is ticking for the company to resolve its liquidity issues.

We anticipate that our cash reserves will be sufficient to fund our cash requirements only until the second quarter of 2011. We are evaluating various alternatives that may include, among other things, a strategic merger possibility and an offering and sale of equity, which, if successful, would improve our cash flow situation.

To be clear, ORS has been very up front about the risks it currently faces, risks that are worthy of being aware of.

On-The-Ground Due Diligence

Based on our initial findings concerning, we decided to conduct some on-the-ground due diligence ("OTGDD") to learn more about the company.

Our OTGDD findings follow:

We could not find evidence that ORS currently has any substantial business operations in China;

Also based on ORS's 2010 10K filing, the company has only one PRC subsidiary, Beijing Orsus Xelent Tech& Trading Company ("Beijing Orsus"). Beijing Orsus's official registration SAIC address is, A206, Chengming Building, Xizhimen South Street, Xicheng District, Beijing.

Our investigator visited this address and found that Beijing Orsus has no active business being conducted at this address. We found one other address for Beijing Orsus, 12th floor, Block B, Chaowaimen, No. 26, Chaowai Ave, Beijing.

Under Google finance, this is ORS's address.

Our investigator also visited that address and once again found that Beijing Orsus has no business operations of any kind at that location. Furthermore, this address belongs to a clothing wholesale company.

We also had our investigator visit two other addresses that are listed for ORS in its form 10-K filing in 2010:

  1. The first address is, 29th Floor, Tower B, Chaowai MEN Office Building, 26 Chaowai Street, Chaoyang Dist., Beijing. Our investigator found a company at this address called Beijing Huanyitong Tech & Trading Company ("BHTT"). Based on BHTT's SAIC file, we learned the company is 100% owned by Mr. Yongli Shi.

    When reviewing the company's history we found that Yu Liu was BHTT's legal representative and formerly owned but no longer owns 50% of the company. At the same time, Yu Liu was and still remains a director of ORS. We believe that BHTT has some kind of relationship with ORS since its address is listed in ORS's Form 10-K. We do not, however, know the nature of the relationship between BHTT and ORS. Regardless, since Mr. Shi owns 100% of BHTT, US investors have by definition no ownership interest in what is apparently ORS's only connection to an operating business.

  2. The second address listed in the Form 10-K is, No. 1, Fuyou Street, Airport Huoyun Road, Shunyi Dist., Beijing. When our investigator visited this address he found no substantial business or even a sign indicating ORS occupied the address.

Key Take Away from Our OTGDD

It appears that ORS's subsidiary is not conducting any operations. More importantly, per an address in SEC filings, the only company that may have a valid business, (Beijing Huanyitong Tech & Trading Company), is not directly or indirectly owned by U.S. shareholders. Instead, it is 100% owned by one Chinese individual, Mr. Yongli Shi.

Also, ORS claimed that it "on March 30, 2011, the company had entered into the Credit Guarantee Contract with Beijing Xingwang Shidai Tech and Trading Co. Ltd. ("Xingwang") and Zhong Hui Guarantee Corporation ("Zhonghui"), by which Zhonghui renewed its guarantee for any sales to Xingwang." However, we still cannot confirm this news released by ORS.

Additionally, even if this news is confirmed, based on our OTGDD ORS does not currently conduct any substantial business activities and may not sell a material amount of products and/or services to Beijing Xingwang Shidai Tech and Trading Co., Ltd. after March 30, 2011. Therefore, this guarantee to the accounts receivable may be useless to the shareholders as there may not be any accounts receivable to insure.

Conclusion

The immediate short term will be critical for ORS given their statement that they only have enough funds to sustain operations through June 30, 2011. We are currently short this ORS, but acknowledge that its small float could send shares sharply higher if the company is able to structure a lifesaving deal that investors are willing to trust in an untrustworthy China Hybrid environment. We also suspect that stock promoters have dug their heels in this name, which may have played a role in the rise in ORS shares in the face of a tumbling ChinaHybrid market.

The Key Question is:

Even if ORS does rectify its liquidity problems or enter into game saving transaction, can we trust the management team of a company where smoke and mirrors seem to exist?

We choose not to believe management and deem ORS not to be investable.

If ORS does receive a lifeline in the way of financing, an acquisition or undertakes another RTO transaction, we need to consider at what cost it will be in the current China RTO environment. Investors will be asked to trust an RTO:

  • that appears to not have lived up to expectations in the past;
  • with SAIC filings that appear to significantly diverge from SEC filings;
  • which operates in an unpredictable industry that can lead to volatile quarterly financial results;
  • that retains Kabani as its auditor;
  • that U.S. investors appear not to have a claim on operating assets.

Note: Reuters has also been following the ORS story. In general, their findings agree with what our DD has unearthed. Reuters' more recent note was published after the close on Friday, March 17, 2011. Please refer to the following passage from Friday's (May 17, 2011) release:

Li Yinsheng, (the personal secretary to Orsus Chief Executive Liu Guoji) gave a new Beijing address for the company, on a different floor in the same building listed on the website, and the new address was verified by Reuters.

We are speculating that part of the rise in ORS shares is due to investor excitement over Reuters' validation of the "new Beijing Address." Reuters mentioned two addresses (two different floors) of ORS in the same building and one of those is the "new Beijing address" verified by Reuters.

As we stated before, we did find two floors in the same building which may be relevant to ORS. The first one is allegedly on the 12th floor which is currently occupied by a clothing wholesale company, while the 29th floor location is now occupied by BHTT. Furthermore, our investigator visited the administrative office of the building. The manager of the building showed him the complete registration book for the building and Beijing Orsus is not listed as a tenant.

As stated before, ORS does not claim any direct and/or indirect ownership control of BHTT in its SEC filings. Investors should realize that the operations of BHTT on the 29th floor are not directly and/or indirectly owned by U.S. investors. More plainly said, given the current corporate structure, US investors do not have a claim on the cash flows of BHTT's 29th floor operations which we assume is the "new Beijing address" mentioned by Reuters. We have contacted Reuters to confirm with them that the "new Beijing" address they reference is the same as the 29th floor address we visited. This is currently our assumption.

Disclosure: I am short ORS.