Kingold Jewelry: Kingold or Fools Gold? (Part 2)

Aug.19.11 | About: KINGOLD JEWELRY (KGJI)

The pdf of this can be accessed here.

Foreword:

To address some concerns of intention, shorting stocks isn’t my game. These reports (see Part I here) were never going to be lucrative for me relative to my other options, but I was still hoping they will bring some clarity because what I believe I’m seeing here is absolutely ludicrous.

Commentary:

This can all be boiled down to a simple question; Why would a Chinese shareholder liquidating his position sell his shares based on a net profit of 9M USD instead of 19M USD? In other words; the thesis here is not in conflicting tax filings, or the subsidiary selling at a lower price, the issue is two separate shareholders with conflicting claims of how much profit KGJI actually generated in 2010.

What we have here ladies and gentlemen, is a good ‘ol fashioned Mexican Standoff.

In the red white & blue corner, we have the audit of Friedman LLP and the actions of Mr. Zhihong’s share buy-back with a supposed 19M USD in net profit. In the red & yellow corner, we have the audit of Wuhan Tinali Accountants and the actions of Beijing Shouchuang selling it’s stake based on 9M USD in net profit.

Which corner is using the real net profits? 19M USD or 9M USD?

There are two scenarios here. (1.) Mr. Zhihiong is correct, the SEC filings are accurate and Beijing Shouchuang is massively short-changing themselves by selling at a valuation by using only half the company’s profits. Or (2.) Mr. Zhihong has inflated the company’s profits on paper and his personal buy-back program is just essentially him ‘doubling-down’ on a bluff he made long ago. (Keep in mind, he will be buying back stock with cash he raised from public investors.)

Let’s look at the tail of the tape and examine both parties' incentives: Mr. Zhihong has been married to Kingold since 2002. It’s his baby and his fate is tied to it. Conversely, Beijing Shouchuang has been with Kingold for at least 4 years, however, Beijing Shouchuang is not tied to Kingold like Mr. Zhihong is. This is just business as usual for Beijing Shouchuang, whom can, and is, simply walking away.

So if Kingold isn’t lying, why then would Beijing Shouchuang claim Kingold had only 9M USD in net profits as it was exiting it’s position?

This is all I want Kingold’s management to explain.

Kingold managed to send me a cease and desist letter in less than 24 hours, and yet after ten weeks and counting, they haven’t been able to draft an explanation as to why one of their oldest and most connected shareholders would chop their reported profits in half.

Worth Considering - Kingold’s Troubled History

On Aug. 4th 2008 Kingold was denied a domestic IPO in China by the China Securities Regulatory Commission (CSRC). On Aug. 7th a formal letter from the CSRC (File No. [2008] 178) said the main reason for the denial was doubt that the company would be able to hire and train enough technicians to fulfill their business plan. In the CSRC’s opinion, the company would have to hire an additional 359 technicians in one year to reach its prospectus targets, given that it had taken the company 4 years to recruit & train its then current 141 technicians.

That was the official reason, however, at the time of this failed domestic listing, the Chinese media, led by economist Xia Cao (夏草), nicknamed ‘the financial detective’, asserted allegations as to why Kingold was actually denied it’s listing:

· The origin of KGJI’s seed capital was considered very suspect. Chairman and founder Jia Zhihong (贾志宏) claimed to have acquired his 100M RMB from speculative stock market trading. (His source was never clarified) (Source)

· Coincidently, the company from which Kingold bought their machines from (Xiamen Ximei Jewelry Co., Ltd (厦门喜美首饰有限公司)), vanished abruptly with some claiming it was still in operation behind the scenes. (Source)

· There were also allegations that Jia Zhihong personally evaded taxes (publicly alleged by Xia Cao, but never confirmed). (Source I & Source II)

· And lastly there were suspect stock transfers by Jia Zhihong (贾志宏) and Chenwei (陈炜) in order to satisfy minimum # of shareholder requirements. (Source I & Source II)

After the denial, the company quickly went dark and stopped answering questions from reporters. Was this non-listing ruling just a result of an ill timed application during rapid growth or a result of jumping through one too many legal loop-holes? (Source I & Source II)

SAIC & SAT Filings

My normal channel to acquire SAIC filings was unable to retrieve Wuhan Kingold’s SAIC financials. Even my secondary alternative channel was unable to get the SAIC filings. These same channels that were able to get many other Chinese RTO SAIC filings came up empty handed. All these agents came back saying that the local authorities had the SAIC filings under a ‘protected status’. However, my SAT guy was able to get the SAT numbers, most likely since SAT numbers are always safeguarded, his channel to SAT figures was unabated by ‘protected status’.

Another source for financials was the balance sheet KGJI reported to the National Statistics Bureau, which I’ve included below. A data-point which I was unable to attain was Kingold’s monthly or annual gold volume purchases from the Shanghai Gold Exchange. The Shanghai Gold Exchange confirmed that Wuhan Kingold is a member, however, the Shanghai Gold Exchange is very tight lipped about its members transaction volumes. (Gold purchases would only help verify revenue and still leave questions for the profits.)

KGJI Financials in Millions of USD

Filed with National Statistics Bureau for 2009

Filed with SAT for 2009

Filed with SEC for 2009

Reported by Beijing Capital for 2010

Filed with SEC for 2010

Revenue

-

73.7

250.5

389.5

523

Operating Profit

-

6.5

15.7

12

31

Net Profit

-

1.46

9.1

9

19

Total Assets

69.5

70.4

62.3

54.2

84.3

Total Liabilities

34.7

36

10.6

5.2

10.5

Total Equity

34.9

34.3

62.3

48.9

73.8

Click to enlarge

As you can see from the table, there is another discrepancy worth noting, specifically, Kingold’s 2009 domestic SAT reported net profits reported to the Chinese tax authorities of 1.46M USD are materially lower than the 9.1 M USD Kingold reported to the SEC. Furthermore, the SAT filings we were able to obtain outlined a balance sheet that reasonably matched the numbers reported to the National Statistics Bureau. It would seem that Kingold significantly inflated both their 2009 and 2010 profits reported to the SEC.

The net profit is the litmus test of a company’s health. When the difference in numbers reported ranges from 9 to 19, the long term level headed investors will flee and only speculators will remain. Perhaps that is what’s already happened here and I’m simply just late to the party. In any case, without any explanation of Beijing Shouchuang’s actions, Kingold’s stock should stay stuck somewhere in this Nash-equilibrium purgatory.

I’m not trying to game the system here, I’m hoping to make enough of a stink so that the company and/or its independent directors will do something more proactive than simply have DLA Piper send me a cease & desist letter calling me a liar. (I believe DLA Piper should also send a CC to KGJI’s shareholder, Beijing Shouchuang) This is normally where one would hope for Mr. David Sherman to come in like a white knight and set the record straight. Hopefully, this will happen. All it will take is an explanation and then I’ll look like an idiot. Or maybe Mr. Sherman won’t pick up the reins. Maybe this skeleton will just get stashed in KGJI’s closet and everyone will forget until the next time the chinks in the IR armor start to show.

In conclusion, I still strongly suggest you get someone you trust who reads Chinese to go over Beijing Shouchuang's posting and contact the relevant parties. In the Yahoo forums someone has found another Chinese news report - I have included the posting in its entirety in the appendix. (Note: the #’s on the Chinese site are in 10,000’s of RMB).

I believe there is litigation risk here, and until this issue gets clarified, I see nothing but downward pressure. I do not imagine any ‘big money’ will enter the stock with this issue unsettled.

For your convenience:

Kingold’s 10-K filing can be accessed here.

Chart of Chinese and English Business names translations:

Entity

English Name

Chinese Characters

Chinese Phonetics (‘ping-ying”)

Web Links

4.17% owner of equity interest in Wuhan Kingold (as listed in 10-K)

Beijing Shouchuang Investment Co. Ltd, /
Beijing Capital Investment Co. Ltd.

北京首创创业投资有限公司

Beijing Shouchuang Chuangye Touzi Youxian Gongsi

http://capitalvc.com/

4.17% owner of equity interest in Wuhan Kingold as listed on Beijing Equity Exchange (technically the holding company of the fund listed in KGJI’s 10-K)

Beijing Capital Group

北京首都创业集团有限公司

Beijing Shoudu Chuangye Jituan Youxian Gongsi

Official: http://www.bjcapital.com/
Overview: http://baike.baidu.com/view/108134.htm

Domestic Auditing firm

Wuhan Tianli Partners Accounting Firm

武汉天立合伙会计师事务所

Wuhan Tianli Hehuo Kuaijishi Shiwusuo

Listing: http://4692400.71ab.com/
2nd Listing: http://www.71ab.com/view_4692400.html

Kingold Jewelry Inc’s mainland subsidiary. The subject of the VIE Contracts.

Wuhan Kingod Co., Ltd.

武汉金凰珠宝股份有限公司

Wuhan Jinhuang Zhubao Gufen Youxian Gongsi

Chinese Site: http://kingold.com.cn/
(Western Site for KGJI: http://www.kingoldjewelry.com/s/History.asp)

Exchange where this 4.17% stake in the subsidiary is listed for sale

China Beijing Equity Exchange

北京产权交易所

Beijing Chanquan Jiaoyisuo

Official: http://www.cbex.com.cn
2nd link

Kingold Founder

Zhihong Jia

贾志宏

Jia Zhihong

Kingold GM

Bin Zhao

赵彬

Zhao Bin

Click to enlarge

Clarification that this posting is for KGJI’s subsidiary:

  • Both Beijing Capital’s posting and KGJI’s 10-K list Wuhan Kingold’s date of incorporation as August 2 2002.
  • Both Beijing Capital’s posting and KGJI’s S-1 list the original registered capital of of Wuhan Kingold as 120M RMB.
  • Both Beijing Capital’s posting and KGJI’s 10-K both list the same shareholder %s for Jia Zhihong; Zhao Bin & Beijing Capital all match up with KGJI’s 10-K filing:

o From the 10-K:

Wuhan Kingold is 55.31% owned by Zhihong Jia, our founder, chairman and chief executive officer, 1.67% owned by Bin Zhao, our general manager and director, 4.17% owned by Beijing Shouchuang Investment Co. Ltd., a PRC state owned enterprise, with the balance of 38.85% owned by a total of 44 other shareholders, who are all PRC citizens. All of Wuhan Kingold’s shareholders, other than Beijing Shouchuang Investment Co. Ltd., have entered into the VIE agreements. (source: 10-K page 13,)

o From Beijing Capital’s post on the Beijing Equity Exchange:

No.

Wuahn Kingold Top Ten Shareholders

Stake

1

Jia Zhihong

55.3054%

2

Tianjin Fortune wealth equity investment fund center (limited partnership)

10.7292%

3

Beijing Capital Group Ltd. / Beijing Shouchuang Investment Co., Ltd.)

4.1667%

4

Dai Garden

3.3333%

5

TANG Po

3.3333%

6

Shenzhen, Dong Fang Anying invested enterprises (limited partnership)

2.6042%

7

Yellow River

2.5%

8

Shenzhen Venture Capital Management Co., Ltd. Huayang St.

2.3438%

9

Zhao

2.0833%

10

Zhao Bin

1.6667%

Click to enlarge

The original Beijing Capital posting was here and was taken down after its June 15th expiry. Here is a link to picture of the full webpage. And below it is pasted in sections. (Here is another Chinese news source citing this posting.)

Disclosure: I am short KGJI; The fund manager I’m employed by is short the stock.