Investors and analysts have for the past year or so have hurled accusations of fraud at Yongye International, Inc. (NASDAQ: YONG). Its seemingly too good to be true business model appears riddled with related party transactions and the acquisition of assets of dubious quality from those related parties for tens of millions of dollars. In this analysis, we present further evidence of Yongye playing fast and loose with the facts as it seeks to present a bullish case to investors and evade auditor scrutiny. Specifically, we believe Yongye is overstating its raw material costs by at least 50x in an effort to manage the margins it reports on an inflated top line.
We urge the NASDAQ, the SEC, and KPMG to closely examine the evidence put forth in the public domain in their efforts to protect public shareholders and defend the integrity of our financial markets. (Our initial analysis can be found here.)
Yongye claims that humic acid – the supposed key ingredient of the company’s Shengmingsu fertilizer – makes up a great part of its costs. In its response letter to an SEC inquiry, Yongye stated (question 7), that “Humic acid accounts for over 50% of our cost of goods sold and is derived from lignite coal. We believe that our gross margin will show incremental improvement if we start to use our own coal in the future.”
Our research reveals that its response to the Securities and Exchange Commission is implausible and, further, that its investment in a coal mine is not likely to produce the gross margin improvements that the company is touting.
According to Yongye’s most recent 10-K, in 2010, the company’s cost of sales was $94,833,834 and it sold 18,800 tons of Shengmingsu, implying an average cost of $5,044/ton per Shengmingsu (Shengmingsu made up 97% of sales in 2010). According to Yongye’s response to the SEC inquiry, of this amount more than half, ~$2,500/ton of Shengminsgsu, is due to humic acid costs.
This is impossible; Yongye’s statements to the SEC simply do not add up with claims made in its own fertilizer license filed in China and market realities. Humic and fulvic acid (i.e. water-soluble humic acid) can be sourced for well under $1,000/metric ton (examples here, here, here, and here). According to Yongye's own fertilizer license (here and here), each ton of Shengmingsu requires 50 kilograms of humic acid. Thus, a ton of humic acid is sufficient to produce roughly 20 tons of Shengmingsu.
In other words, assuming Yongye pays at the upper threshold of market prices for its primary raw material, it pays $1000/ton. Each ton of raw material is sufficient to produce 20 tons of Shengmingsu according to Yongye’s patents, so based on market prices humic acid costs the company no more than ~$50/ton of Shengmingsu.
Yongye claims in its SEC response to spend $2,500/ton of Shengminsu on humic acid, seemingly exaggerating its cost by at least 50x. There are a number of reasons why Yongye may choose to inflate its costs:
- Margins would otherwise look high beyond any realm of reality, especially in light of what we believe may be revenues inflated on the basis of sales made to related parties.
- Since the purchases flow through Wuchuan Shuntong (which it has been alleged, and we believe likely, is a related party), the cash may be getting ‘recycled’ (i.e. laundered).
- KPMG, Yongye’s auditor since 2009, would surely be asking questions about the absence of cash in Yongye’s bank accounts
In summary, we find various parts of Yongye’s response to the SEC’s questions wholly inadequate and in this case misleading. We strongly believe the Company is playing fast and loose with the facts as it seeks to present a bullish case to investors, and we have great doubts regarding Yongye’s customers, its purported revenues and reported profits.
Based on a business model riddled with inconsistencies, we believe Yongye International has historically served as a conduit for transferring wealth from outside investors into the pockets of company affiliates. We again urge the NASDAQ, the SEC, and KPMG to take a look at Yongye’s largest customers and suppliers and to examine the many allegations made by others – including the ones here, here, here, here and here – in an effort to protect the public interest and defend the integrity of US financial markets.
Disclosure: I am short YONG.
Additional disclosure: Please read Prescience Investment Group LLC's full disclaimer at the end of our initial report (here), which we hereby incorporate by reference in full.