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It's never good to hold stock of a company whose trading has been halted, is part of the greater reverse-merger controversy, has had four different auditors, lost its CFO, and has multiple pending lawsuits. Especially when all this has occurred in the past 13 months. But this does not necessarily mean we should sign Universal Travel Group (UTA) off as a lost cause.

Do I think that UTA has some problems that will take time to recover from? Yes. Do I think that it is a complete sham? No. Below, I examine some of the largest issues that have arisen in the past year and explain why I believe things are not as dark as they seem.

CFO Upheaval
On August 17th, 2010 UTA announced that their CFO, Yizhao Zhang, had resigned the previous day and would be replaced with Jing Xie as Interim CFO.

Usually when a CFO resigns, we take it to indicate that there are problems with the company. Judging by the year that has followed Mr. Zhang's resignation, this certainly does not seem like a case to buck the trend. However, Mr. Zhang has a history of very short stints with companies (averaging roughly three years in any given senior position), most of which seem to be healthy Chinese small-caps, with the notable exception of China Green Agriculture. So does Mr. Zhang habitually work for short stints and regularly leave for little reason? Does he seek out the sham companies and ride them while he can before they tank? Look into his history yourself, but I tend to lean towards his frequent transitions being a reflection upon him rather than the companies he has worked for.

Secondarily, Mr. Xie, the interim-CFO, is a strong candidate who has gained much of his experience at UTA. As a director since 2006, he is very familiar with the operations of UTA - indeed, he served as interim-CFO for six months in 2009. While this does not speak to the reasons for Mr. Zhang's departure, I am confident in Mr. Xie's status as interim-CFO and suspect that he will be promoted to CFO soon.

The Reverse Merger Controversy
As part of the greater Chinese small-cap reverse merger controversy, UTA is immediately cast under suspicion. As it should be. But Baye's Theorem forces us to acknowledge that simply because UTA is a reverse merger and some reverse mergers are frauds, this does not mean that UTA is also a fraud.

Online Ticket Sales
Last September Bronte Capital sparked a debate by showing that you could not buy an airplane ticket on the English version of UTA's website. It shortly came out that you could, in fact, book vacations on the Chinese version of the website. Furthermore, if we look at the traffic statistics for the website we see that they are not only very solid but show consistent improvement in total page visits and also overall rankings. Also note that the time spent on the site is consistent with a large number of the visitors either buying tickets or looking at vacation options - not just a computer in UTA's back office racking up page visits.

All of this seems to indicate that the website is functional for its target audience - middle-class Chinese. The lack of a functioning English version indicates, as I hope will become clearer as we continue, that UTA is simply surprisingly poor at working with Western investors.

Multiple Auditors
This is where UTA begins to look more suspicious. We cannot know the full story of why Acqavella, Chiarelli, Shuster, Berkower & Co., LLP (September 2010), Goldman Kurland Mohidin, LLP (October 2010), or Windes & McClaughry Accountancy Corporation (April 2011), resigned. However, Windes cited several reasons including "Management and/or the Audit Committee being non-responsive, unwilling or reluctant to proceed in good faith and imposing scope limitations on Windes’ audit procedures" and "that Windes had lost confidence in the Board of Directors’ and the Audit Committee’s commitment to sound corporate governance and reliable financial reporting."

This casts a pall over the company that cannot be easily shed. These harsh allegations, with good reason, would scare away many investors. I suspect that these auditing problems arise from minor issues in the books and different expectations of what the audit entails rather than large-scale fraud.

For the record,
EFP Rotenberg & Co., LLP is the current auditor as of April 2011.

Trading Halt and Lawsuits
All three of these issues can be grouped together because they are all rooted in the same cause - the late submission of the 2010 10-K. After filing for an extension and missing the deadline, trading was halted. Nearly immediately several lawsuits were filed. Currently, as UTA prepares to trade again, it is on the threshold list.

While this could be interpreted to mean that UTA needed extra time to cook the books, I believe it is more likely that their books are in poor condition requiring extra time to prepare the form. Of note is that their auditor resigned on the same day that trading was halted - this undoubtedly adds to the complications of submitting paperwork in a timely manner. Since then, UTA has submitted the 2010 10-K as well as 10-Qs for Q1 and Q2 - not the behavior of most halted, fraudulent companies. Comments by a prior auditor support my belief that the company is inadequately keeping books rather than committing fraud. It identified the following weaknesses in the company:

  • "The Company’s policy documentation of all controls identified during their assessment and remediation process was incomplete."
  • "Lack of technical accounting expertise among financial staff regarding US GAAP and the requirements of the PCAOB, and regarding preparation of financial statements."
The halt has scared investors and the lawsuits will hang over the company for quite some time, but the behavior of UTA seems to be of a company that is poorly educated on our standards, not of one actively committing fraud.

Miscellaneous Good
While looking into the financials of UTA is beyond the scope of this article, it is worth noting that, if you believe them, they are remarkably strong and show consistent strong growth.

Now, if we look at the insider transactions, we see that in the past two years there have been sizable acquisitions from the CEO, CFO, former-CFO, and several directors. The latest purchase, worth nearly $250,000, was in December 2010 by Mr. Xie, the CFO - not at all the actions of someone who knew the company was a sham. (Note: I've linked to an incomplete list and therefore only refer to the CFO's purchase in December, though if you look deeper you will see a purchase by the CEO as well.)

The annual meeting has been scheduled and announced for September 19th, 2011. If it were not for trading being halted, it would appear as if everything was humming along quite well. If UTA is in fact a fraud, they are certainly working hard to keep the sinking boat afloat.

The Future of UTA
UTA has been hit by a lot of very bad news in the past year and it is very easy to create an argument why an investor ought to run for the hills. Yet that ignores the alternative, bullish interpretation of events.

Many Chinese small-caps struggle with meeting SEC regulations, GAAP accounting standards, and general investor relation expectations and I believe UTA to be no exception. Based on the functioning of their website, comments by their auditors, and their actions after the trading halt, it is clear that UTA management lacks certain experience and knowledge.

One could argue that no fraud acts like a fraud until it has been caught and has collapsed. However rumors have been circulating for more than a year that UTA is a sham, trading has been halted, and lawsuits have been filed - yet it continues to function as a company and even, at least on paper, grow. Companies much larger, more complex, and less transparent have collapsed much quicker upon such allegations.

UTA has a long road ahead of it, but that road will ultimately pay off.

Disclosure: I am long UTA.

Source: Universal Travel Group: Things Are Not As Bad As They Seem