Through our own set of recordings, we have confirmed details regarding the claims made by AlfredLittle.com that Harbin Electric (NASDAQ: HRBN) and Deer Consumer Products (NASDAQ: DEER) have likely misappropriated a combined approximately $44.0 million by exaggerating the price paid for land use rights. We are very familiar with issues surrounding land use rights. We have seen similar cases of misrepresentation of land use rights with stories we broke such as China Redstone (CGPI.PK) and Lotus Pharmaceuticals (LTUS.PK).
CGPI denied our claims of land use right misrepresentations despite recordings with government officials and the publication of a PRC newspaper article, after our research report, which agreed with our findings. Our findings were even supported by quotes from employees of CGPI! The stock now trades near $0.70 per share. The key lesson to be learned is that ChinaHybrid paper and words cannot be trusted at face value.
HRBN Summary of Findings
- We confirmed that Ms. Wang actually does exist and works at Xi’an Lintong Tourism & Business Development Zone Management.
- Ms. Wang confirmed a much lower land price than indicated by HRBN.
DEER Summary of Findings
- Contrary to DEER’s claims, we confirmed that Mr. Zhuang and Mr. Fei Li actually do exist and work at Wuhu Economic & Technological Development Area.
- They both confirmed much lower land use prices than indicated by DEER.
Earlier this week, China-based stock "fraud sleuth" Alfredlittle.com ("A*L") published a hard-hitting exposition of land fraud in China, focusing on and. A*L presented a series of recorded conversations and emails with government officials in charge of selling land use rights. He offered evidence that he believes proves that HRBN and DEER both dramatically inflated the prices (disclosed in SEC documents) paid for land use rights to large parcels of land the companies acquired for the purpose of expanding their production capacities.
Following the publishing of A*L’s report, HRBN quickly responded, denying the allegations but providing no evidence of why it appears to be overpaying by approximately $18 million for the land use rights and no explanation of why the official overseeing the purchase was unaware of HRBN’s alleged approximately $23 million deposit.
The recordings we subsequently attained give much credibility to A*L's findings. We too were informed by some of the same government officials that the prices paid for land by HRBN and DEER were much less than what land use rights sell for (as set by relevant government agencies) in Xi’an and Anhui, respectively.
- Government Official Name confirming information on HRBN: Ms. Wang.
- Government Official Names confirming information on DEER: Mr. Zhuang and Mr. Fei Li
According to A*L’s due diligence, in the case of HRBN, the $38 million purchase price was approximately $18 million higher than the highest price quoted by the official in charge of the land use sales in the local development zone. HRBN claimed in its SEC filings that as of June 30, 2011 it paid approximately $23 million deposit for land use rights. The government official overseeing the land purchases denied the price and other details of the transaction, including whether or not it had been formally agreed upon. Furthermore, the official was unaware of the approximately $23 million HRBN allegedly paid as a deposit. Where did the approximately $23 million prepayment really go?
In an effort to verify A*L’s report, we dispatched our investigator to establish the authenticity of A*L’s communication with the government officials recorded in its report. Our investigator contacted Ms. Wang at Xi’an Lintong Tourism and Business Development Zone Management, the official in charge of HRBN’s land use rights acquisition. In his brief conversation with Ms. Wang (Audio here; Transcript here), she verified the maximum selling price of the land use rights is significantly less than HRBN’s claim, thus supporting allegations HRBN was overpaying by approximately $18 million.
The government official also said that it is typical that a discount, not a premium, would be applied to large land use right purchase arrangements. Our investigator also confirmed that the price per Chinese acre ("mu") for the parcel of land in question should have been RMB 260 per mu as opposed to RMB 500 per mu HRBN claimed as its purchase price.
It is our belief that going-private financiers, specifically China Development Bank, may start to question the documents provided to them by HRBN and shareholder ABAX. That could torpedo the already controversial buyout. Would China Development Bank want to be involved in a story that may be fraught with fraud, especially as the SEC and PRC regulatory agencies are working together to stop rampant fraud by ChinaHybrids?
Interestingly, in the September 6 HRBN press release, chairman Yang refuted A*L by indicating that China Development Bank reaffirmed its position in the private transaction without providing any contact information for individuals at China Development Bank. We find this very interesting considering the fact A*L’s article came out at approximately 11:30pm China time. Subsequently, chairman Yang’s press release came out at 3:30am china time, an odd time business activity and to contact the bank.
The bank will likely consider the risks of an exit strategy if PRC authorities drop the hammer on HRBN post a going private transaction or if the SEC files a lawsuit. Investors need to be cognizant of a potential SEC lawsuit against HRBN and if this would lead to cold feet by potential financers of the company’s going private deal. We need to keep in mind that companies that are looking to go private are not immune to SEC action as was the case with PUDA.
Investors should know that 90% of the "going private" market cap is based on a bet that the CEO will complete a buyout despite of the following:
- Our PRC filing analysis of HRBN also parallels that of Citron and Chimin Sang who claim that SEC financial information significantly diverges from PRC financial filings.
- Evidence from 2 separate sources (Alfredlittle.com and GeoInvesting.com) indicates that the company may have materially overpaid for land use rights. We are compelled to ask, where did those excess payments go?
- U.S. regulators have halted and/or delisted companies with similar circumstances.
- There is real risk that a "going private" transaction will be thwarted if U.S. regulators actively investigate this story.
In the case of DEER, the $37 million purchase price was approximately $21 million higher than the highest price quoted by three different government officials in the development zone office. The officials explained that such payments in excess of the agreed price are rebated in 7 days to the account of the buyer’s choice. DEER has never disclosed the receipt of any such rebate. Where did the approximately $21 million rebate really go? We surmise that either it was not paid in accordance with normal practices in China, it was embezzled, or it was paid and DEER’s management needs to explain where those funds really went.
Our investigator successfully contacted Mr. Zhuang and Mr. Fei Li, two of the officials in charge of DEER’s land use rights acquisition. Mr. Zhuang confirmed (Audio here; Transcript here) to us the maximum selling price of the land use rights is significantly less than DEER’s claim. Thus, it appears that DEER clearly overpaid by approximately $21 million.
DEER responded that A*L’s allegations included "totally fabricated information, false identities, and false allegations." DEER provided no explanation for why it paid $21 million more than the maximum price quoted by three officials overseeing the transaction and offered no explanation of where this money really went. The company did manage to brazenly observe that A*L included HRBN in the investigative report. DEER went on to then tout HRBN’s private offering:
Deer also notes the short seller "Alfred Little's" attempt to link Deer to a heavily shorted and unrelated company, Harbin Electric, Inc. whose management team has announced a going private transaction at $24 per share in cash, with a shareholder voting record date of September 13, 2011, and advised by Goldman Sachs, Morgan Stanley and Lazard Freres & Co., as well as represented by several global law firms.
This statement seemed ridiculous to us since there is no reason for a reputable public company to divert attention from itself by going into so much detail regarding a private transaction for what is in their words, an unrelated company. We find their assertion of no relation peculiar given that Ben Wey played an integral part in bringing both companies public, establishing a connection between HRBN and DEER not immediately noticed by the untrained eye.
Now that we have verified the information in A*L’s recorded calls with the officials overseeing HRBN and DEER’s land use rights purchases, we strongly agree that regulators should take action. The facts of each case are very simple. The combined approximately $44 million in excess cost above the maximum prices quoted by government officials cannot be simply denied or explained away. HRBN’s and DEER’s attempts to brush aside these allegations should not be tolerated.
We believe that there is significant risk to long positions in both stocks due to a risk that each could be halted until independent investigations are announced, financials are restated and executives responsible for the misappropriations of corporate funds are terminated.
Our PRC filings for DEER do not match SEC filings on both sales and net income.
These findings that agree with A*L's findings are being sent to the SEC and Nasdaq.