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Lucas McGee is a consultant and private investor with more than ten years of business and finance experience throughout Asia, including China, Hong Kong and Vietnam. Lucas has provided consulting and advisory services with regard to operational business issues, due diligence, investment... More
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  • China Agritech: Factory Visits Reveal a Scam

    Based on our research, which includes factory visits and discussions with customers, competitors, and government officials, as well as examinations of Chinese financial filings, we think that China Agritech does not have a currently functioning business generating anything close to $100 million in revenue. We’re very confident that the company is a scam.

    We have put together a report discussing our research, which can be downloaded here: CAGC Research Report

    Our report features the following highlights:

    • Despite a $230 million market capitalization and claims of $119 million revenue in 2010, our factory visits revealed that Agritech’s manufacturing facilities are currently all idle and only one out of its four factories produced anything at all in 2010. We visited each Agritech facility and found each one idle and highly unlikely to produce significant amounts of fertilizer.
    • Even though it has raised over $70 million in capital since 2005, Agritech appears to have acquired only several million dollars worth of capital equipment. By contrast, it has paid its two founders at least $4 million in rental fees and real estate purchases during that time.
    • Companies Agritech claims as clients, such as the big state-owned fertilizer company Sinochem, deny having any contracts with Agritech. Sinochem has told us that it does not sell any Agritech products.
    • Agritech’s stated suppliers cannot be found in any directory under possible Chinese names that would correspond to the transliterated names or under the alphabetic names. They do not appear on industry lists of companies making humic acid or ingredients for organic fertilizers.
    • Revenue, profit and fixed assets reported to the Chinese government are 10x, 5x and 3x lower than the figures reported to the Securities and Exchange Commission.
    • Agritech’s CFO has been involved in two listed companies before Agritech in which he personally collected seven-figure sums while the companies went to zero. Another Seeking Alpha analyst has written on this previously (here and here). Insiders have sold over $2.5 million worth of stock over the past 12 months.

    We discuss highlights of the report below.
     

    Factories are Idle, Distribution Centers Cannot Be Identified, and Products are Nowhere to Be Found

    After visiting Agritech’s reported manufacturing facilities in Beijing, Anhui, Xinjiang, and Harbin, we found virtually no manufacturing underway. Pictures are available in our report. The single exception was the facility in Pinggu County on the outskirts of Beijing, where the plant was not in operation on the Friday when we visited but local people told us that it has sporadically produced some liquid fertilizer over the last year. Plants in Bengbu, Anhui (supposedly the largest), Harbin, and Xinjiang were completely shuttered.

    The Harbin facility – supposedly a major manufacturing facility for the $100 million revenue business – had a sign hanging on the gates last summer reading “this factory is for sale.”

    Although the company has announced 21 regional distribution centers, we have not been able to locate any. In May 2010, Agritech issued over 1.4 million new shares, raising just under $19 million for the construction of distribution centers. But we have not been able to find evidence that any distribution centers were actually built.

    We attempted at some length to purchase at least one bottle of the Agritech product but were disappointed. Fertilizer distributors listed on a popular industry website did not carry Agritech product. We looked for the addresses of retail locations. Then we tried buying online via the popular site Taobao or an agricultural products site, with no luck. Then, we telephoned the company. We asked for retail locations, but the staff member who answered the phone said that they could only fill our order directly. We explained that we wanted one bottle as a sample before making a bigger order. She said that the company is able to fulfill only wholesale orders. When we persisted, the staff member said that a distributor would be passing through our area, Beijing, the following week and would drop off a sample, but that did not happen. When we called the number for the “distributor” the following week, the phone was unanswered.
     

    Non-Existent Customer Relationships And Mysterious Suppliers

    Last month, Agritech announced that the company had previously renewed a “contract supplying organic liquid compound fertilizers to Sinochem, China's largest fertilizer distributor. The sales contract is worth RMB 61 million (approximately $9 million) and the Company will also continue to supply Sinochem with organic granular compound fertilizer under another existing contract.” We spoke with a manager at Sinochem and he told us that Sinochem has no contract with Agritech and in fact has never bought or sold organic liquid fertilizers.

    A January Agritech announcement states: “In May 2010, the Company signed a renewed contract supplying organic liquid compound fertilizers to Sinochem, China's largest fertilizer distributor. The sales contract is worth RMB 61 million (approximately $9 million) and the Company will also continue to supply Sinochem with organic granular compound fertilizer under another existing contract.” But a manager with Sinochem told us that Sinochem has no contract with Agritech and in fact has never bought or sold organic liquid fertilizers.

    The companies that Agritech lists in its corporate materials as suppliers of raw materials, including Harbin Haiheng Chemical Distribution Co., Beijing Zhongxin Chemical Development Co., and Shenzhen Hongchou Technology Co., cannot be found in any directory under possible Chinese names that would correspond to the transliterated names or under the alphabetic names. No companies with names resembling these appear on industry lists of companies making humic acid or ingredients for “green” fertilizers. In fact, we speculate that the companies, if they ever existed, form an outdated supplier list, since at least three of Agritech’s four factories are closed down.

    For example, Agritech lists a supplier they call “Beijing Zhongxin Chemical Development Company.” No such company exists, although there is one in Beijing called “Beijing Zhongxin Trading Company” listed on the Internet. However, when we called the Beijing operator for directory assistance, she could find no such company listed in the active directory. We gave her the phone number listed on the Internet site (010-66067374) and asked her to do a “reverse look-up” of the number. She advised us that this is a number for a public phone booth, not a legitimate business phone number. All other searches for the suppliers mentioned in the 10K filing were futile.

    Agritech gives no information about customers or distributors in the two most recent 10Ks; we had to go back three years to find the names of any such companies. We decided to contact each of the companies mentioned in that three-year-old 10K. We could verify only one of the names – Sinochem, which had already told us they do not do business with Agritech. We were not able to find active businesses with active phone numbers for any of the other supposed customers listed by Agritech.
     

    SAIC Filings Show Dramatically Lower Revenue, Profit and Fixed Assets than SEC Filings

    Below are CAGC revenues, profit and fixed assets reported to the Chinese government for the year 2009 in every subsidiary we were able to trace — including the Beijing subsidiary, which is mysteriously unreported by the company. We were able to review CAGC’s results from its companies in Anhui, Beijing, Heilongjiang, and Xinjiang. The branch company in Chongqing, we were told by government sources, does not keep a separate P&L but instead records its revenue through its parent company. We did not find a record of a Xinjiang branch company.

    Gross revenue, profit and fixed assets reported to the government in these companies for 2009 was as follows:

    Subsidiary Name 2009 Gross Revenue (NYSEARCA:RMB) Profit (Loss) (RMB) Fixed Asset Value (RMB)
    Harbin Pacific Dragon Liquid Compound Fertilizer Co. 580,000 (7,000) 1 million
    Agritech Fertilizer Company (Beijing) 46.65 million 7.61 million 10.95 million
    Anhui Agritech Agricultural Development Co. Ltd. 530,000 (94,000) 2.73 million
    Xinjiang Agritech Agricultural Resources Co. Ltd. 3.82 million (250,000) 20,000
    Totals Reported to SAIC (in RMB) 51.58 million 7.259 million 14.7 million
    Totals Reported to SAIC (in USD) $7.58 million $1.067 million $2.16 million
    Numbers reported to the SEC $76.13 million $5.69 million $5.98 million
    SEC figures as a multiple of SAIC 10x higher 5x higher 3x higher

    Below are further notes on China Agritech’s SAIC filings:

    1. The Harbin company, Pacific Dragon, has cumulative losses since 1994 of over 4 million RMB. None of its 2009 revenue was actually received but all was entered into “accounts receivable.” Meanwhile, the debt-to-asset ratio is 98%. There were no sales expenses at all, only administrative expenses. In short, the 2009 audit report on CAGC’s Harbin company shows a relatively worthless company.
    2. The Anhui facility has generated losses every year since its establishment in 2006. By the end of 2009, it had lost 3.89 million RMB. The company had zero cash on its books.
    3. The Xinjiang company reports zero fixed assets, meaning that it owns no equipment for production. Moreover, its 75% parent is the Anhui company, yet the Anhui company never reported making the required investment in the Xinjiang subsidiary.
    4. The Beijing facility has licensed registered capital of $20 million, but by the end of 2009 had received 88 million RMB, so only more than half of the legally required amount. But despite the missing capital, half of the registered capital was still sitting in the account in cash in 2009, indicating that the company had not purchased much, if any, equipment.
    5.  

    Humic Acid Fertilizer Manufacturing is a Low-Margin Business

    We visited one of China’s largest manufacturers of pure humic acid, a factory that produces 2,000 tons of humic acid per year. 2,000 tons of humic acid can yield about 75,000 tons of fertilizers. Currently earning 10,300 RMB per ton of humic acid, this company estimates 20 million RMB in gross revenues for the current year, or about $3 million. The managers believe that, if they can use all their production for their own end product, they may be able to triple revenues. Even these optimistic estimates, however, would not bring the company anywhere close to the revenues claimed by Agritech. Not permitted to expand production and concerned that its existing outdated equipment may have to be replaced, this company is now shifting to manufacture blended fertilizers under its own brand in order to extract more value from the existing facility.

    As market prospects for humic acid have dwindled, China Agritech, China Green Agriculture, and other producers of natural fertilizers have been driven into compounds, where the admixture of chemical fertilizers adds volume and market acceptance.

    The problem is that compounds earn slim or negative margins. In 2008, the compound fertilizer production volume showed negative growth, as raw materials prices soared and farmers limited consumption to manage their costs. According to the China National Chemical Industry Information Center (CNCIC), China’s production capacity for compound fertilizers in 2008 was 200 million tons per year, while actual production was only 50 million tons. Product prices are essentially determined by the input costs plus 1-3%. That means manufacturers of compounds, if they produce at all, are doing so at razor-thin margins. Given that Agritech claims to produce 200,000 tons of granular compounds against 13,000 tons of higher-margin liquid compound fertilizers, a 28.5% EBITDA margin in 2009 should be viewed as a feat of magic by large competitors like Sinofert (HKG: 297). In 2009, Sinofert sold about 1.01 million tons of granular compounds. The company’s EBITDA margin in 2009 was negative. Although only 20% of Sinofert’s revenues is derived from its own manufacturing rather than agency sale of compounds, margins are similar on that side of the business.

    Faced with industrial fragmentation and losses, China’s government agencies in 2008-2009 issued policies designed to consolidate the industry, shutter high-cost manufacturers, and convey expansion capital and other benefits to large producers. Lower prices of nitrogen in 2009 bolstered production of compounds to about 55,000 tons, often at a small profit. But small producers and newcomers like Agritech were not able to obtain production licenses for compounds. Local government officials told us that Agritech had not obtained licenses for manufacturing compounds in any of its facilities and was restricted to making liquid compounds at the facility in Beijing. A government official in charge of regulating a part of Agritech’s business and who was very familiar with the company estimated that, nationwide in 2010, Agritech did not have more than 50 million RMB in revenues.
     

    Self-Dealing and Fundraising

    China Agritech has been active in the capital markets since going public, completing three significant private placements and a fourth secondary public offering since 2005. In total, the company has raised more than $70 million. Yet SAIC filings show that the company had no more than $2 million of fixed assets since 2009. Even according to SEC filings, the book value of its fixed assets were only $8.3 million at the end of the third quarter 2010.

    Rodman & Renshaw handled the public offering in April 2010 of 1.24 million shares of CAGC stock, raising almost $19 million. The money was intended for the buildout of distribution centers, Agritech said. But the company by summer 2010 had still not received production permits for granular fertilizer, while demand for liquid fertilizers was limited. We have not been able to identify any distribution centers that were built with the share proceeds.

    While the capital raises have not been re-invested in productive manufacturing capacity, company insiders have profited handsomely from CAGC. Real estate companies owned by founders Chang Yu and/or Teng Xiaorong have earned at least $4 million from China Agritech since 2004. Since its reverse merger, Agritech has been renting certain of its Harbin and Beijing premises from its founders, with the rent cost totaling more than $500,000 annually over the past few years. The premises are mostly empty. Agritech has also purchased real estate from its founders. Last August, the company paid Ms. Teng $1.49 million to purchase 750 square meters of office space in Beijing from her.

    Share sales have been an even more lucrative form of monetizing their involvement with CAGC for insiders. Over the past twelve months, at least 200,000 registered insider shares have been sold by Ms. Teng, CFO Gareth Tang, and officer Zhu Mingfang (Steve Zhu) for a value exceeding $2.5 million.
     

    Conclusion

    Our careful examination of China Agritech’s business indicates that along all parameters, Agritech has grossly inflated its revenue, failed to account for tens of millions of investor dollars, and now has virtually no product in the market. We believe this company should not be listed on NASDAQ. Fundamentally, CAGC is worth no more than the $2-per-share cash that is still in the company’s accounts – if insiders don’t empty it first.

    Disclosure: We have short positions in the stock of CAGC

    Tags: CAGC, ONP, CHBT, CEAI, CGA, HRBN, CMFO
    Feb 03 9:58 AM | Link | 13 Comments
  • Consumer Stocks with Emerging Market Exposures

    In a previous post, I discussed how Yum! Brands (NYSE:YUM) was a viable way for U.S. investors to allocate capital towards the China and emerging markets growth story without stepping out of their comfort zones. In this article, I’m going to take that topic one step further and look at three other stocks that benefit from a similar theme: consumer companies with easily identifiable products that have developed relatively high exposures to Asia and emerging markets.

    The investment thesis is relatively simple. In all cases, the companies highlighted are consumer product companies that have developed leading products over the course of decades. To transform themselves from stodgy large caps to attractive growth stories, the companies have made a concerted effort to replicate their proven business models in emerging markets, exporting not only their products, but also their marketing and distribution knowhow.

    I selected my three sample companies from scouring a few websites and research reports on companies with high exposures to emerging markets. In particular, Chris Sholto Heaton has a nice list in this article.

    Mead Johnson Nutrition

    Mead Johnson Nutrition (NYSE:MJN) sells nutritional products for infants and children, including infant formula and children’s nutritional products. Its Enfa family of brands comprised more than three-quarters of sales in 2009 and is the world’s leading franchise in pediatric nutrition. Founded in 1905, the company became a leading producer of infant formula throughout the early part of the century and was purchased by Bristol Myers Squibb in 1967. In 2009, the company split off from BMS via an IPO and split-off, and is now an independent public company.

    MJN operates through two reportable segments: (i) Asia/Latin America and (ii) North America/Europe. Below are statistics for the last three fiscal years for MJN:

    As we can see, MJN’s emerging market sales and operating income comprise 58% and 60% of the total company’s operating results, respectively. Asia/Latin America sales grew 24% in 2008 and 7% in 2009, while Asia/Latin America EBIT grew 27% and 25% in each of the last two years. Like the other companies profiled in this post, MJN is taking proven consumer products and replicating their marketing and sales infrastructure in emerging markets. The company’s attractive growth profile was featured in Third Point’s quarterly letter here. Unfortunately for investors, the company’s growth profile has been recognized by the market. The business trades at a steep 29x P/E multiple, and much of the business’s growth, as well as its potential to be a takeover target, has been priced into the stock.

    Colgate

    Colgate, the world’s 51st most widely recognized brand as ranked byInterbrand, is a global leader in oral care, personal care (soap, shampoo, deodorant, etc.), home care (Ajax, Murphy’s Oil Soap), and pet nutrition. Here is Colgate’s geographic segment breakdown:

    Colgate’s emerging market exposure is relatively strong. Asia, Africa and Latin America accounted for 53% of the company’s 2009 sales (excluding pet nutrition), up from 49% in 2007, and for 56% of the company’s 2009 operating income (excluding pet nutrition), compared to 50% in 2007. Operating income has been benefiting from improving margins in the Greater Asia / Africa region. The Company’s end markets are not growing quite as fast as YUM or MJN, but still at a healthy clip. Recent quarterly results were disappointing partly due to the impact of foreign exchange in their Latin American and Europe/South Pacific operations. At 18x P/E, the company appears relatively attractive as a bet on emerging market growth.

    Nike

    Nike, the world’s 26th most widely recognized brand as ranked byInterbrand, designs, develops and markets high quality footwear, apparel, equipment, and accessory products. Nike has a burgeoning emerging markets presence, but its exposure to fast-growing economies in Asia and Latin America remains materially behind the likes of YUM, MJN and Colgate. Below is its revenue and EBIT breakdown by geographic end market:

    As we can see, the United States, Europe and Japan represent 70% of sales, which makes Nike still a company that predominantly caters to developed markets. That’s unfortunate, because growth has been mainly coming from China and emerging markets (excluding central/eastern europe), where sales grew a combined 10% in 2009 and 15% in 2008. Operating profit in China and emerging markets grew a combined 23% in 2009 and 24% in 2008.

    Over time, Nike’s emerging markets presence will overtake its Western operations, similar to what we’ve seen with YUM and MJN. The company’s current valuation is at 21x P/E, which doesn’t immediately jump out as either overly cheap or expensive.

    YUM! Brands

    Finally, here are the geographic segment metrics for YUM:

    Unfortunately, we can’t quite tell what portion of YUM’s sales and EBIT come from emerging markets because YUM lumps Europe, Australia and Canada with the likes of Brazil and Mexico in its “International” division. But a good estimate is that 40% to 50% of sales and profit come from fast-growing emerging economies. YUM has the highest China exposure out of the companies I’ve examined in this post, and out of any large U.S.-based consumer company I've been able to find. At a 22x P/E, the stock appears reasonably valued. An investment in YUM may not generate quick returns, but the company is a sound long-term investment if emerging markets, and particularly China, continue to outpace the developed world.



    Disclosure: Long YUM
    Tags: YUM, CL, MJN, NKE, China
    Nov 06 7:55 PM | Link | Comment!
  • Instructive Charts on China's Long-Term Trends

    The power of China’s economy is one of the most important themes in today's investing environment, regardless of whether one is interested in investing in China or not.  In the following post, I’ve compiled some important charts demonstrating the growth China has experienced in recent decades, as well as how the economy is changing.

    In particular, I look at some of the factors often cited for China’s growth and examine whether they are likely to continue fueling the economy’s rapid expansion, or whether new drivers will need to emerge.

    The first chart that we’ll examine is one depicting historical Gross National Product:

    China’s GNP growth is daunting. But the above chart doesn’t necessarily tell us how fast China’s economy is expanding on a yearly basis. So our next chart of year-over-year GDP growth rates might help put China’s growth into perspective a bit better:

    Investing in an economy that’s growing at a minimum of 6% per year is like shooting fish in a barrel. The question is whether the drivers behind this historic 6%+ growth are going to continue for the next decade, or whether there may be signs that this growth is likely to slow down.

    One of the primary sources of China’s strength is its tremendous population. This chart shows how China’s population has been growing:

    Unlike our chart on China’s gross national product, this chart is surprisingly not growing at an exponential rate.  It isn’t compounding the way our first chart did.  This is likely the result of both China’s one child policy as well as cultural and demographic changes encouraging less population growth.  As a result, mere population growth will not be enough to sustain China’s economic growth rates.

    With GDP/GNP rising and population growth slowing, we can guess that per capita metrics are also improving.  A big part of this is the well-documented migration of rural agricultural workers into the cities. Is this migration continuing at an exponential rate or is migration slowing? The chart below shows urban employment in China:

    This chart shows us that the flow of migrants to the city has been somewhat constant over time. If GDP/GNP is growing exponentially, city populations are growing linearly, and the population is growing at a slower and slower rate, then wages must be increasing.  The following chart shows us how wages have changed over the last decade:

    The upward trend is obvious, and the sawtooth pattern is caused by seasonal changes in demand for labor as a result of Chinese holiday seasons.  Social rights issues aside, it can be gathered from the chart above that quality of life is improving in China. However, an argument could be made that this improvement in quality of life could even be higher if China modified its monetary policy. The chart below shows how inflation has affected China:

    Government policy to keep the Yuan cheap relative to the US dollar and other global currencies has resulted in significant inflation which has historically come in waves. The Chinese CPI doubled from 1978 to 1989, then again from 1991 to 1996.  It looks like another wave is about to begin.  The good news for China is that a low currency keeps unemployment low as Chinese labor remains cheap and “competitive”.  The bad news for China is that inflation reduces the value of China’s savings.  All those decades of hard work slowly evaporate as inflation chips away at purchasing power.

    It is easy for an investor to get stuck looking at daily forex fluctuations or the latest headline GDP growth rates.  But occasionally looking at these important charts depicting trends over the course of decades puts things into perspective.




    Disclosure: No Positions
    Nov 05 10:29 AM | Link | Comment!
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