Anyone who has followed the Harbin Electric (HRBN) buyout drama knows that:
- By all evidence HRBN is a fraction of the business enterprise it claims to be. There have been numerous credible allegations of fraud from various quarters in recent history. (See links at the bottom of this report to review some of these allegations.)
- The CEO, Mr. Tianfu Yang, has been taking all of the logical steps at significant expenditure of time and expense to pursue what seems to be a legitimate attempt to take HRBN private at a significant premium to the company’s apparent enterprise value.
- Mr. Yang has diligently worked to keep the stock price up (see Appendix A) by:
- Vigorously responding to every negative report or price drop with press releases as quickly as possible, even during the middle of the night.
- Making boiler plate announcements related to the buyout in an almost compulsory response to market action. Whenever HRBN’s share price drops you can be sure a press release or some other announcement will follow. Essentially, management has developed their own plunge protection strategy to support HRBN’s share price.
- Asking shareholders to contact their brokers and instructing them not to lend their shares to short sellers.
Most investors probably don’t realize that HRBN took out a $50 million loan (35 million USD + 100 million RMB) on November 20, 2010 with terms that would make most loan sharks blush. Despite the fact that HRBN had $80 million cash and liquid receivables and inventory that could easily have been pledged as collateral, the bank extracted collateral from CEO Yang as security for the loan. The loan requires Mr. Yang to:
- Pledge collateral in cash or shares should the mark to market value of the initial collateral drop below 167% of the total loan exposure (about $92 million)
- Sign a full personal guarantee to ensure maintenance of the margin and full repayment of the loan.
- Failure to maintain the collateral level allows the lender to take possession of the CEO’s shares and sell them in open market.
The loan terms required Mr. Yang to post, as escrowed collateral, the greater of 7 million HRBN shares or 200% of the full loan exposure (including principle interest or about $110 million in collateral). See SECURITY AND PLEDGE AGREEMENT, page 11-15.
This loan leaves the CEO personally vulnerable to margin calls should the share price drop below $13.14. Mr. Yang’s Personal Guarantee of the loan and possible margin calls on the collateral pledged to secure it put his personal assets at risk in the event of a material drop in HRBN’s market price. In fact, he is not in possession of the vast majority of his shares (7 million shares) as they are held in escrow as part of the security for that loan. In other words, it is very much in Yang’s interest that HRBN’s share price does not drop. Most, if not all, of his personal assets are at risk if it does.
Mr. Yang has been quite successful at supporting HRBN’s share price. During 2010, while in negotiations for the initial $50 million loan, he was able to generate sufficient investor interest to support the share price by simply talking about his planned buyout. That easy strategy fell apart in early June 2011 when the share price dropped to $13.30. In fact, by June 16, 2011, the shares dropped by over $6 below the margin call level (the red phone must have been ringing repeatedly at Mr. Yang’s house).
Immediately following the plunge in HRBN shares, Mr. Yang conveniently signed loan documents and announced that he secured all necessary financing for the buyout. True to form, the press releases came almost daily afterwards until the stock price finally stabilized and started to move higher again.
Since that time, as anyone who has followed HRBN knows, Mr. Yang has been watching the stock closely and responds immediately to any price drop with further press releases related to the buyout. In one recent case, HRBN was fortunate enough to have its buyout case touted in an “unrelated company’s” press releases published by DEER on September 6, 2011. We can’t help but wonder if the press release from DEER really was unrelated since Ben Wey brought both companies to the U.S. markets
The following chart (click to enlarge image) graphically illustrates our point of just how effective HRBN’s plunge protection team has been.
HRBN Price History with Chronology of Company Communication
The key questions that have arisen during this buyout drama are:
- Why did the bank making the $50 million loan require CEO Yang’s personal guarantee and collateral if HRBN is the company management claims it is? If such onerous terms were required for a $50 million loan what would they be for a loan 10 or 15 times as large? Can we really accept the notion that the terms for additional financing so much greater than the original loan would be less stringent? We don’t think so.
- What end game could there possibly be for CEO Yang if the buyout intentions are not real? Why would the CEO pursue all of the extensive steps for a buyout at such significant cost to the company and personal risk to himself?
- If the buyout intentions are real, why would the CEO work so hard to keep the stock price up? What is the worst the buyer would face if the stock price drops? A cheaper purchase price for the buyout?! The company should just leave well enough alone.
- Why would a healthy company that claims to have over $80 million cash on hand take a $50 million loan at terms that require the CEO to maintain mark to market collateral at 200% of the maximum loan exposure and provide a full unlimited personal guarantee not only for repayment, but for the maintenance at all times of mark to market collateral of at least 167% of maximum loan exposure?
Now for the End Game
It has become clear to us that CEO Yang’s end game in this drama is to secure the $50 million needed to repay the November 20, 2010 loan and free himself from the personal guarantee and get his shares back. It appears to us that the whole buyout game is an attempt to buy time to find the $50 million and avoid margin calls.
In other words, the drama may be all about Yang protecting his personal interests, but his interests may not be necessarily aligned with those of public shareholders. If Yang gets himself off the hook do you think he will be so diligent in the future, effectively propping up the share price? The public shareholders will be left holding the bag if and when the buyout attempt fails.
In the end, investors need to make their own decisions. For us, we just don’t buy the “HRBN going private” story and consider the stock an excellent short selling opportunity given that the ceiling for the stock is limited to the proposed buyout price of $24 and the bottom is much lower if anything whatsoever goes wrong with this deal.
- GeoInvesting (here and here).
- A*L (here and here).
- Citron Research (here).
- Financial Investigator Research (here, and here and here).
- Chimin Sang (here).
- Rick Pearson from TheStreet.com (here).
Disclosure: I am short HRBN.