In my previous article on Silvercorp Metals (SVM), I congratulated the company on being able to prove that it isn't a fraud. Silvercorp investor relations called me up and thanked me for writing such a good article. They even put my article on their website.
While I'm flattered that they thought my article was written well enough to put on their site, and the investor relations people are very nice, my allegiance lies with Seeking Alpha and its readers. I'm here to give the truth and facts as accurately as I can, no matter how uncomfortable it might be. It's my opinion that I was lied to by Silvercorp's investor relations people.
I spoke with several investor relations people in detail to gather deep information for my Silvercorp articles. I spoke with one investor relations woman quite a bit more than the rest. Since I don't want to embarrass anyone, I'll call her "Xian". There are many issues about Silvercorp that make me furrow my brow, but the following questions are the ones I'm most concerned about:
1. Who really analyzed the SGX mine?
I asked Xian questions about the SGX mine report (.pdf) done in May 2011. The SGX mine is owned by Henan Found, Silvercorp's only profitable subsidiary. When asking about the geologists who researched the mine, Xian said that they are from Spokane, Washington. "OK, and they flew from Washington to China earlier this year?" I asked. "Yes," she answered.
After Alfred Little's report (.pdf) came out, I quickly sold my long position. I had another conversation with Xian and I asked deeper questions. According to Alfred Little's article, no geologist has visited the mine since 2008. Xian again asserted that Silvercorp bought the geologists plane tickets and they came to look at the mine earlier this year. However, upon further questions, Xian said they have no proof or documents for the plane ticket purchases. I asked if I could speak with the American geologists Mel Kohn or Chris Broili from BK Exploration Associates who made the mineral resource estimates of the mine, she said she didn't have their contact info. I found this strange since most mining companies encourage investors to contact their geologists.
On the mine report on Silvercorp's website here (.pdf), on pages 111 to 113 are the personal reports of Mel Kohn, Wenchang Ni, and Chris Broili. Mel Kohn states the last time he visited the mine was in 2007, Chris Broili said he visited it in 2008. The only one who said he inspected the mine in 2011 was Wenchang Ni who, as stated in the Silvercorp produced report, also happens to be a non-independent full time employee of Silvercorp and owns Silvercorp stock and stock options.
When I told her the above, she started back tracking and said she knows that Silvercorp bought Kohn and Broili plane tickets, but maybe they didn't visit the mine. Why would Silvercorp fly them to China and not have them visit the mine? And why can't she produce any proof of these plane tickets that were supposedly just purchased a few months ago?
2. Silvercorp says the auction was a Government sham. Huh?
The first time I spoke with Xian to get info for my first Silvercorp article, I asked about the selling of 5% of the company's main subsidiary, Henan Found. It was sold for $7 million, which would only value Henan Found at $140 million. So if Henan Found's reported earnings is legit, this buyer will get a 100% return of his investment back and more in only two years. To this, Xian told me that its JV Partner, who is a Chinese government entity, made this sale to an affiliate who Xian said was probably government employees. At the time, I bought Xian's explanation. It would make sense to sell privately to the employees as incentives and maybe there are some back end deals going on. Xian also said Silvercorp signed a contract with the JV Partner that it would only sell shares to an affiliate. Again, she couldn't provide me with evidence or proof of this contract with the Chinese government.
Then, once I found out from Al Little's article that the 5% selling of the subsidiary was actually done at an auction, and not a private transaction to an affiliate, I felt betrayed. So I contacted Xian the second time, to have her explain. As I listened in disbelief, she said that the auction is actually all a hoax by the Chinese government! I guess the premise is the Chinese government has to put on these fake auctions in order to make it look like it's a free market society, but in reality, it sells the business to whomever it chooses. I found this very hard to grasp and believe, but Xian said that "things are done differently in China" compared to Western countries.
Here are pictures (.pdf) from the auction. So according to Silvercorp, that entire setup, the banner with the JV Partner's name, the auction organizer, all those people, the guy holding the sign up making a bid, is all an act by the government-owned JV partner. It's all theater. Whether that is true or not, I wouldn't want to get involved with this kind of business. How can you trust it?
This allegation that the auction was fake isn't only told by Silvercorp investor relations. It's also mentioned by metals analyst Chen Lin in this interview here. He said it's really just an auction among the JV Partner's affiliates. How many affiliates does the JV Partner have? Lin also doesn't mention how curious it is that the share purchase will give the buyer a $80M/$140M = 57% annual return if Henan Found maintains its stated reported earnings. This interview, led by James Puplava, is a pure pump job on Silvercorp. Out of all the analysts interviewed not a single one questioned the integrity of the Company and only had good things to say about it.
A question Silvercorp shareholders should ask, and I know this is a stretch, is that maybe Silvercorp is overstating its earnings in order to pay more taxes to the Chinese government. Even though this is probably not true, I believe one should still at least ponder the question. If the Chinese government is willing to go to such lengths to have this fake auction, what else are they faking?
3. The Hercules of silver mines?
Then I started questioning the actual purity of the mine. Xian started talking about how the way the Chinese measures it is different from the way the West measures it, and comparing the two is like apples to oranges. This is more talk about how the Chinese are different. I didn't talk too long about this, as I'm not a geologist and I have no idea what's the right way to measure deposits in a mine. But upon looking at the numbers, it's not rocket science. Here is a list of silver mines and their purity.
"g/t" means "grams per tonne". Meaning for every tonne of ore found in the mine, that many grams of silver is found in it. Silvercorp states that its SGX mine has a total measured silver g/t of 845 on page 20 of its NI 43-101 report (.pdf). So according to the company, its SGX mine not only beats the competition, but completely demolishes it. 845 g/t almost doubles the purest mine out of the list. These mines weren't hand picked to compare against Silvercorp, it's a random sampling of a bunch of silver mines. Upon researching the internet, I never saw a silver mine even close to an average purity of 845 g/t. I saw one that peaked at a higher g/t in certain sections of it, but the average for the entire mine was much lower.
Being an ex-poker professional, I'm an odds kind of guy. And what are the odds that a company like this, that exaggerates and speaks in half truths, just happens to have the most pure silvermine ever discovered in the history of mankind? That's quite a coincidence. I also think that if they really did have such a freak of nature of a mine, they would have a more well known geologist analyze it. Not just have some obscure geologists, BK Exploration, who checked it out three years ago write something on it again.
After doing a google search, I found that BK Exploration doesn't even have a website. There also is no link that shows the contact info of geologists Mel Kohn and Chris Broili. Furthermore, the only webpages found on them are regarding the Silvercorp mine report. Which leads me to...
MY CHALLENGE TO SILVERCORP
If Silvercorp is legit, what it should do, especially now that it's experiencing so much scrutiny, is pay for its SGX mine to be examined by a large, independent, respected and trusted, geology company. For example, maybe this company could be hired. It's very important for the geologists and mining experts to give a non-biased report on the average silver g/t of the whole mine. It would be best for the geology company to be chosen by a neutral third party, like possibly the British Columbia Securities Commission. I'd be willing to wager that the new report would show a g/t significantly less than 845. I think the investing community would like to see this happen to clear up any uncertainty about the mine's value.
Is Silvercorp A Takeover Target?
Last week, Silvercorp's CEO, Rui Feng, was quoted on Bloomberg as saying:
I'm worried that Silvercorp is now a takeover target, its price is much lower than its peers.
I believe this is pretense and I think he said this in order to raise speculation on the stock and to make the short sellers worried.
There are at least three reasons that I see that Silvercorp is not a takeover target, and this is assuming that it's not a fraud, which I think it is. Obviously, if Silvercorp is shown to be a fraud, no company would touch it at the current share price.
1. Most of its cash is in China. It's hard for a foreign company to buy a Chinese company and be able to transfer the cash to their country.
2. Similar to #1, the Chinese government owns pieces of Silvercorp's subsidiaries. A western company doesn't want to deal with the complications of partnering with the Chinese government.
3. Even if Silvercorp is a completely honest company, the stock isn't that cheap! It has a P/E of over 14. It has a book value of about a 3rd of the stock price. It only has one profitable mine, none of the other ones have ever shown a profit. Compared to its peers it's hardly a bargain, and that's assuming that everything they do is above bar.
I think investors are in denial about this company being a fraud. Clearly it's not a China MediaExpress (CCME.PK) or a RINO International (RINO.PK), but it's also clear it's not 100% above board. Analysts like Raymond James who reiterate their $16 price target, investment advisors like Casey Research, and silver guru and Silvercorp bull David Morgan are defending the stock to defend their investment, clients, and pride. For them to not think that this company might just be a little bit fraudulent, and adjust accordingly, is unprofessional in my opinion. Part of being a successful investment analyst is having the ability to change your evaluation of a stock when new information emerges.
In conclusion, I think the stock will likely go down further, with a very small chance of appreciation. The only chance I see of it going higher is if silver makes another run towards $50 soon. SVM could possibly go under $4, but shorting here and covering somewhere just below $6 would be the more conservative play.
Disclosure: I am short SVM.