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We engaged a team of 13 independent consultants (located both in China and the United States) with expertise in law, finance, medicine and accounting to examine CMED and the Chinese medical device sector over the last 12 weeks. Our consultants reviewed and analyzed the company’s SAIC filings, conference call transcripts, press releases and SEC filings.

CMED is a medical device company that manufactures and markets immunodiagnostic and molecular diagnostic products for the detection of various cancers, diseases, and disorders, as well as companion diagnostic tests for targeted cancer drugs.

A few weeks ago an anonymous short seller posted a blog entry on GeoInvesting’s website alleging that CMED committed fraud by, among other things, overpaying for acquisitions from undisclosed related parties. We here at Glaucus Research follow the U.S.-listed Chinese space closely, so we were naturally curious. We decided to investigate the allegations of fraud.

In our report, which is available at our website, we provide compelling evidence that CMED paid $28 million for an acquisition from a seller who we believe was secretly related to CMED’s chairman. Evidence also shows that CMED radically overpaid for the acquisition: a few months before selling the company to CMED, a company controlled by parties related to CMED insiders bought out minority shareholders at prices suggesting that the business was worth $5-$8 million, not the $28 million paid by CMED for the acquisition. In our opinion, CMED’s chairman orchestrated an acquisition to embezzle roughly $20-$23 million from the public company.

THE ACQUISITION OF BBE

On November 26, 2007, CMED announced the acquisition of Beijing Bio-Ekon Biotechnology Co. Ltd. (“BBE”) from an allegedly independent third party for $28.8 million, consideration to be paid in cash.

But according to publicly available filings in China, (a) the alleged ‘independent third-party seller’ is a party closely related to CMED’s founder, chairman and CEO, Wu Xiaodong (“Chairman Wu”) and (b) BBE was worth far less than the $28 million CMED paid to acquire it. The evidence supports the allegation that Chairman Wu used a complex web of international shell companies and closely related lackeys to embezzle between $20 and $23 million from CMED’s investors.

Cops and Robbers

Since the formation of BBE, publicly available SAIC filings show that the largest shareholder of the entity was a company named Beijing Yimin Weikang Technologies Co.,Ltd. (The “Chinese Front Company”). The founder, chief executive and legal representative of the Chinese Front Company was none other than the former executive assistant to CMED’s Chairman Wu.

The resume on the next page shows that Shujun Chen (who we will refer to as the “Cop” because he is a former Beijing police officer) served as the “Assistant to the General Manager”of a privately-held company, Beijing Chengxuan Economic and Trade Co., Ltd for almost three years. SAIC filings show that Chairman Wu was the Executive Director, legal representative and General Manager of the same entity. Chairman Wu and his wife were also the two primary shareholders of that entity.

click to enlarge

The resume also shows that other than his experience as an executive assistant to Chairman Wu, the Cop had very little in the way of business experience. Connecting the dots, it appears that Chairman Wu had his former executive assistant serve as his front man for the Chinese Front Company, which was the primary shareholder of BBE.

In order to follow the complex web of multi-jurisdictional related party transactions, below we have included the first in a series of slides.

Minority Shareholders Be Gone!

After Chairman Wu took CMED public on US capital markets, the Chinese Front Company (controlled by Chairman Wu’s former assistant) bought out the other minority shareholders of BBE for $0.16 - $0.23 per share in separate transactions, each taking place between January and March 2007. These transactions indicate that the value of BBE was $5-$8 million, not even close to the $28 million that CMED paid a few months later to acquire the business.

Below we calculate the weighted average price for the acquisition of BBE shares by the Chinese Front Company from minority shareholders and compared it to the price per share eventually paid by CMED.

We believe that Chairman Wu was using the Chinese Front Company to buy out the other minority shareholders of BBE in anticipation of selling BBE to CMED for a substantially inflated price. Thus, we believe that the share prices paid to other minority shareholders in January though March 2007, which puts the value of BBE between $5 - $8 million, are a much closer approximation of the value of the company than the price CMED eventually paid for the acquisition. See below.

Collecting Shells

After buying out his minority partners, we believe that Chairman Wu controlled BBE through his Chinese Front Company. But this was not ideal, because any sale of the BBE business directly from the Chinese Front Company to CMED could easily be traced back to Chairman Wu through publicly available SAIC filings.

To circumvent the transparency of such a transaction, we suspect that in May 2007 Chairman Wu had the Chinese Front Company sell BBE to a Hong Kong shell company called East Crest Enterprises Limited (the “Hong Kong Shell Company”). The Hong Kong Shell Company was, as our chosen nomenclature would suggest, nothing more than an empty shell. It had (and has) only HK$10,000 in registered share capital and is owned by Clear Castle Investments Limited, a BVI entity (the “BVI Shell Company”).

The advantage of transferring BBE to the Hong Kong Shell Company (which was owned by the BVI Shell Company) is that the financials of privately-held Hong Kong and BVI companies are not publicly available. So both Hong Kong and especially the BVI are ideal jurisdictions to hide the identity of the beneficiaries of large cash payments. We believe that CMED’s Chairman Wu was the ultimate beneficiary of the BVI shell company.

In May 2007, just 5 months before CMED acquired BBE, we believe that Chairman Wu had his Chinese Front Company transfer BBE to his Hong Kong Shell Company for an aggregate consideration of $7.6 million. Again, note that the purchase price is similar to the valuation put on the company by minority shareholders, and substantially less than the $28.8 million paid by CMED to acquire BBE just a few months later. Here is the SAIC excerpt showing the transaction.

The Sting

After all of the pieces were in place, all that remained was to execute the final move. In November 2007, a matter of months after three independent transactions established the value of BBE at a range of $5.5 - $8.4 million, CMED paid a whopping $28.8 million for the company ($0.78 per share).

Other evidence supports the conclusion that CMED significantly overpaid for BBE. Notably, CMED failed to provide BBE’s income statement or balance sheet for the periods prior to the acquisition. Why? Probably because, according to SAIC filings, in the fiscal year prior to being acquired by CMED, BBE generated only $4 million in total sales and lost over $3.3 million in net income.

While not dispositive, we believe the meager sales and the paucity of assets on the balance sheet provide supporting evidence to what the previous section already showed: CMED paid way too much for BBE.

The allegation that Chairman Wu was the ultimate beneficiary of the $28 million payment by the company to acquire BBE is supported by the fact that CMED deliberately concealed the identity of the seller(s)of BBE.

Suspiciously, CMED was silent on the identity of the seller in the Form 6-K announcing the acquisition. The company put out a detailed press release describing BBE’s business, but conveniently left out any mention of the counterparty to the transaction.

In the Form 20-F for the FY 2007, CMED stated that it acquired BBE from Finnea International Limited (“Finnea”). We now know from BBE’s SAIC filings that no entity named Finnea ever owned BBE. Suspiciously, CMED did not give any jurisdiction of incorporation for Finnea. Nor did we find any reference to Finnea when conducting Baidu and Google searches. We can find no evidence that Finnea ever existed. We believe that the company made up Finnea to distract investigators from the real beneficiary, Chairman Wu, who cashed in through his alphabet soup of global dummy corporations and front men.

In conclusion, the chain of custody supports the allegations of fraud. Here is how we suspect the transaction played out. Chairman Wu set up a company in the name of his personal assistant (the Chinese Front Company), which owned a significant stake in BBE. He then bought out the minority shareholders in BBE at prices suggesting the company was worth $5 - $8 million. Once in control of the entity, he needed to cover his tracks. So he then transferred BBE from the Chinese Front Company to the Hong Kong Shell Company, which was controlled by the BVI Shell Company. This would allow all of the proceeds of the sale to flow directly to the BVI Shell Company, which sat in a jurisdiction where no one could discover who got the cash from the sale. Chairman Wu then had CMED buy the asset for $28 million, thus embezzling anywhere from $20 to $23 million from US capital markets.

Note that in the 18 months before the BBE acquisition, CMED successfully executed an IPO and a secondary equity offering and issued convertible debt. In the Chinese RTO space, we have seen many examples of companies diverting cash raised from capital markets by overpaying for acquisitions from parties related to insiders. In our opinion, CMED followed this playbook to the letter.

Source: Chinese Filings Show That China Medical Technologies Acquired A Business From Parties Secretly Related To Chairman