Since listing on the Nasdaq in April, thinly traded Synutra International's (NASDAQ:SYUT) stock has nearly doubled. With a market cap of $1.1 billion, the Chinese maker of infant formula is one of the nearly two-dozen exchange-listed Chinese companies that have gone public in this country through the back door by merging with a shell.
(One of the most famous, or infamous, is Bodisen Biotech -- no stranger to readers of this space -- which was recently delisted.) By their nature, reverse mergers, as they're called, are controversial, in part because of their checkered histories and because they're popular with companies that might not pass the IPO muster.
Enter Synutra, whose IPO roadblock at the time of its reverse merger in 2005 might have been its size, but also a string of related party dealings with a handful of companies controlled by CEO Liang Zhang.
To Synutra's credit, the transactions are prominently disclosed in SEC filings. Still, disclosure doesn't mean anything more than, well, they're disclosed. And these aren't mere related party dealings. On the surface, in fact, they look somewhat like round trip transactions. In the first nine months of the year, for example, Synutra sold $10.5 million (or 7% of revenues) to a handful of companies controlled by Zhang. During the same period, it bought $17 million in goods from four of those companies.
In its filings, Synutra says the related parties "act only" as its suppliers or distributors. Maybe the company should say they act as suppliers and distributors. Consider that Synutra sells anhydrous milk fat and non-fat dry milk to related parties that sell whey protein powder to Synutra. And Synutra sells "formulation ingredients" to another entity that sells "spray-dried milk powder" to Synutra.
President Weiguo Zhang says he realizes the related party concerns, but that some of the products purchased from related parties, especially whey protein, a key component to infant formula, are difficult to get in China; the related party, he says, is one of the top importers and distributors of whey protein.
Which may be true, but stil: On the "way too close for comfort" scale, these dealings are off the charts.