Harbin Electric: Who Allegedly Doctored SAIC Reports?

On August 3, 2011, Harbin Electric (NASDAQ:HRBN) responded to a Citron Research report posted the same day at CitronResearch.com. In the press release, several statements caught my attention as they were related to SAIC reports and my access to those reports enabled me to have my own independent research as to who might not be telling the truth between the company and Citron. And this article is intended to address the truthfulness of the third point raised in the news release:

“3. The company believes that Citron used doctored SAIC reports. The company has recently reconciled its PRC tax filings on a consolidated basis with its financial statements reported in its SEC filings for fiscal year 2009 and has not found any inconsistency in any material respect. Its SAIC filings are largely in line with its tax filings in the PRC.”

Dial Back The Clock
Back in April 2011, I used my China source to pull SAIC reports of nearly all Harbin Electric’s subsidiaries. After reading through those SAIC reports, I did not feel that the SAIC representation of the company was far off from its SEC representation. To reuse the language of the company, I could say that I “reconciled its PRC tax filings on a consolidated basis with its financial statements reported in its SEC filings for fiscal year 2009 and has not found any inconsistency in any material respect.”
Then on June 1, 2011, Citron published a blog questioning the purpose of Harbin Electric’s hanging LBO, suggesting that the company might not be as big as it claimed in its SEC filings and the deal might not take place. What surprised me was not the allegation, but two specific SAIC audit reports provided in the blog of Harbin Electric’s most important subsidiary, Harbin Tech Full Electric (hereafter mentioned as “HTFE”). Those two SAIC audit reports for the year 2008 and 2009 looked vastly different from the ones I had.
When I first looked at the two SAIC audit reports provided by Citron, they did not appear high quality since I had read many well-documented SAIC reports before and I knew what a proper SAIC report should look like. The 2008 report provided by Citron was apparently organized out of order; the 2009 report was in the right order but it was computer-printed and it did not have signature or official chops. In comparison, the reports I had were well formatted and furnished with official chops and signatures. Not believing that Citron was sophisticated enough to make up those Chinese documents, my initial thoughts were that Citron was probably hoaxed by fraudulent documents.
Or so I thought. Nevertheless I took a second look at the SAIC documents I possessed and I made an astonishing discovery.
Before I go on discussing what I found, I would like to give readers a little more background knowledge on the SAIC reports. In addition to the annual audit reports typically short sellers obtain from China and provide to the investor community, the SAIC reports include all the document trails for company setup, name change, owner change, capital change and other significant company events. A typical SAIC report includes a cover page, an application form of about 10 pages long, denoting what changes need to be made, applicants, company information and so on, supporting documents, and revoked and renewed business licenses.
The SAIC reports for HTFE I obtained from China were very exhaustive. The size of the compressed package I received was 36 megabytes, and it contained 28 different sets of documents, covering every business life aspect.
In particular SAIC audit reports for the year 2007, 2008 and 2009 were included in the files retrieved. What astonished me from a second look was that the balance sheet of my 2007 file did not match the 2008 file I obtained in the same retrieval but matched perfectly with the file provided by Citron. What I mean by “match” is that the ending period of the balance sheet of the previous year should be the same as the beginning period of the balance sheet of the following year, which is common sense in accounting.
The following table summarizes the SAIC files pulled in April 2007 and you can see the highlighted yellow area shows mis-matched balance sheet items between the 2007 filing and 2008 filing.

Table 1 (Click to enlarge)

This following table shows how the 2007 SAIC file pulled in April 2007 matched the 2008 file provided by Citron. The green area shows the match.

Table 2 (Click to enlarge)

This discovery was very alarming. My pulling of SAIC files was through a third party unrelated to Citron, therefore it was impossible for Citron to know what data I had, and yet, what offered by Citron magically matched the data I obtained, number by number. A check of the file provided by Citron showed a creation date of October 21, 2010, half a year earlier than the time I pulled my reports.
With this discovery, I could no longer conclude that Citron was hoaxed. I had two dramatically different sets of 2008 and 2009 SAIC reports in front of me. They cannot both be authentic - at least one of them was compromised. But which copy?
Back to Today
I put the suspicion in the back of my head for two more months until the press release of Harbin Electric on August 3 rekindled my interest. Harbin Electric claimed that it believed Citron used doctored SAIC reports. So I pulled the HTFE SAIC reports a second time in August 2011, and what I saw opened my eyes.
This time I also received a huge zipped file, in which I found a dramatically different 2007 SAIC annual audit report and 2003, 2004 and 2006 SAIC annual audit reports that were not there before besides all other files existed in my April pull (2005 SAIC filing missing). This 2007 SAIC report contained refurbished financial information and the data, yes you guessed it, matched the 2008 data this time around. The newly available 2006 file also showed matching data to the 2007 SAIC report.
The following table shows how consistent the SAIC data look like now, and it portrays a large and profitable corporation. But there is one thing shouting out: Citron is not able to modify the digital files stored on the local SAIC computer network in China, but Harbin Electric is.

Table 3 (Click to enlarge)

Comparing the two 2007 SAIC reports, one pulled in April (the original document link is here and an English annotated version link is here) and the other pulled in August (the original document link is here and an English annotated version link is here), I could see that the August one was a rescanned paper version with only the pages related to financial information replaced. I noticed that the page number stamps on the right corner of those pages showed noticeable differences for those financial related pages.
The following graph compares those stamps side by side. To the left are the stamps taken from the April file, and to the right the stamps are taken from the August file. The left stamps show that the second “0” to the right has cuts on the top left corner, the bottom left corner and the bottom right corner. This characteristic is consistent throughout, including the page 6 stamp. The same page 6 stamp in the August file shows no such cuts, and the stamp shows more ink than the nearby stamps. All the “01X” stamps show an even base line for the first “0” and the second “1” except for the three stamps for the financial pages of the August report, which shows a lifted “0” base line compared to the “1." The shapes of the two digits also look different than the others.

Click to enlarge

Armed with this insight, I went further to compare the 2008 report I pulled in April and the 2008 report provided by Citron. The graph below shows consistent page number stamps from the Citron file but different page number stamps from the SAIC I pulled, only for the financial related pages.

Click to enlarge

Even though I do not have a file to compare with the 2009 SAIC audit file, the following graph of lined-up page number stamps from the file shows inconsistent stamps for the financial related pages. They have a pronounced “0” that does not exist in any other page number stamps.

Click to enlarge

If you disregard the differences of the page number stamps and trust the current SAIC files even though the 2007 file dramatically and mysteriously changed from April 2011 to August 2011, you would believe a sizable and profitable Harbin Electric that the company would like you to believe, as you find in Table 3. You would belong to the “Company Honest” camp.
If you do not take the company’s words for granted, and believe that the SAIC files with inconsistent page number stamps have been compromised, you would come to find a company much smaller in size, paid no income tax, and reported losses every year of its existence, as what is shown in Table 2. You would belong to the “Company Dishonest” camp.
Which side would you take?
My Short Thesis
With my recently gained insight, I have bought put options on HRBN.
I am aware that Yang, the CEO, and Abax Global Capital are using loans from China Development Bank Hong Kong branch to buy out HRBN. Abax would put in $38.8m cash equity, $25m debt, and China Development Bank would put in $400m debt to finance the deal besides rolling over the existing shares of Yang and Abax. Being a financial investor, Abax is looking to profit from the deal by reselling the business privately or publicly above the buyout price.
There are two possible outcomes. One, the deal closes. Abax bears the financial burden of repaying $400m to CDB and the rest of the investors get $24 per share. Two, the deal breaks due to triggering of one of the termination conditions described in Page 9-10 of the Merger Proxy Statement, failure of representation being one of them.

I would welcome the Outcome One to take place even if it means that I would lose my bet. The long investors other than Yang, Abax and CDB would be saved from loss in this case. But I seriously doubt that it would take place. With the great power of the Internet and the insatiable appetite of humans seeking truth, future investors and exchange regulators will read this article and view all the evidence I present today. They will do their own due diligence and choose which camp they belong to. Abax will have the enormous burden to find investors who belong to the “Company Honest” camp no matter where it chooses to relist the company, be it Shanghai or Hong Kong. China Development Bank will also suffer a loss if Abax is unable to resell the company with a profit. I view the exit from this big-ticket purchase a formidable job for Abax given the evidence I provide. I wish them good luck to find the next buyer.

The Outcome Two is more likely in my view.

Do Not Let Anyone Else Make Your Decision
Readers should still have doubts with my thesis. How can you be sure that I am not lying since I took on a short position and I have the motivation to move the price lower? How can you be sure that I did not doctor the files so that they appear consistent with my thesis?
These are very legitimate concerns and I am very prepared to address them. You should not automatically trust me, like I believe that Abax and CDB should not automatically trust the company’s representation. And you should not assume that I would not do bad things because I swear I am an honest person.
Always use a third independent party to cross check all the evidence. This is what you can do to verify what I presented ­- use a Chinese agent to get SAIC documents for yourself. In a separate file that you can download, you will find four SAIC agencies through whom you can get SAIC documents at around $120 each in about 1-2 business days. You can also use Google (search 代理查询工商) to find those agencies that can perform the procurement of SAIC documents. The bottom line is that you do not have to trust the documents I provided, you can use those agencies that are totally unrelated to gain access to the very original SAIC documents. And you can decide for yourself if the page number stamps on those filings are consistent. Do it fast, before the company figures out that they can cut and paste from the old documents and make it an Italian job.
If you are an institution directly involved in the transaction or invested in Harbin Electric, ask for those SAIC copies directly from the company now. Or if you already have them, check if the page number stamps are consistent.
I made all the SAIC files I gathered for HTFE available online, a total of 33 files. The file list and their locations can be found in this file, including the two 2007 SAIC reports annotated with English for easier understanding. Non-Chinese reading persons can also understand other audit files by comparing with the annotated version.
Before I publish this article, I emailed the company IR and gave the company an opportunity to provide evidence to back their claim that Citron doctored the SAIC reports. Three business days and a weekend passed. No response. Nada. Nil. Silence.
Disclosure: I am short HRBN.