The GeoTeam's  Instablog

If you have been keeping tabs on our due diligence into China Redstone (CGPI), you are most likely aware of the red flags we have identified as well as the follow-up correspondences that ensued between GeoInvesting and CGPI.  We have also elicited some in depth commentary by a scholar that has given his insight into understanding Chinese culture and how it may relate to CGPI or other businesses operating in China.  Although we may not materially agree with him on the business side of things, he did offer unique and educated feedback regarding Chinese culture, and we will most likely continue a back and forth with him.

Our initial report began as follows:

"In December 2010, we were contacted by a private investor who asked us to take a look at the CGPI story.  Specifically, he was seeking clarity on rumors circulating around whether or not CGPI possessed necessary land use rights to operate its cemetery business.  We asked our attorney, Bob, to delve into this story not knowing he would open Pandora’s Box.  Bob, along with our new on-the-ground due diligence team, have performed extensive due diligence on CGPI operations. What follows is a brief summary of our findings.  It is supported by a 19 page internal report and 52 pages of supplemental documents. We have maps, pictures, documents including land use rights and lease agreements and conversation notes with government contacts to back up our findings.  At first, the CGPI story appeared complicated, but after numerous conversations with Bob, we have been able to simplify our analysis. Our original goal was to summarize Bob’s conclusions on our focused China Due Diligence Board, “Ask Bob – GEO’s PRC Attorney”, at GeoInvesting.com, as we worked with CGPI and its IR firm to hopefully resolve open issues. They were cooperative."

See full report here

Subsequently, CGPI released a shareholder letter to address concerns laid out in the above-mentioned report.

Finally, GeoInvesting issued a rebuttal to CGPI's responses that began as follows:

"On March 15, 2011 CGPI published a letter to its shareholders. In this letter, CGPI summarized key issues raised by GeoInvesting and gave "facts" regarding those issues. In addition to its letter to shareholders, CGPI also sent GeoInvesting a "Cease & Desist Demand" letter via its attorney at the law firm of Richardson & Patel, LLP. In this letter, CGPI demanded through its attorney that GeoInvesting immediately and forever take down a grossly inaccurate and misleading report located on the GeoInvesting web site. What follows are (1) issues and "facts" (CGPI Response) summarized in CGPI's letter to shareholders, (2) our responses, (3) a written transcript (see supplement 1) of a conversation our assigned person had with the officers at the Funeral House and Cemetery Management Center of Chongqing Civil Affairs Bureau on March 3, 2011 and (4) an additional written transcript of a second conversation on March 25, 2011 (See Supplement 2) with the officers at the Funeral House and Cemetery Management Center of Civil Affairs Bureau including a recording of the conversation."

Please read full rebuttal here

A commenter (the scholar) produced a well thought out response regarding Chinese culture, offering a different perspective into the matter.  He closed his thoughts with a plea to the GeoTeam to exercise patience and prudence in our investigation:

 

"I believe that the GeoTeam has attempted to act in good faith based on information and/or questions which may or may not have been valid in totality. I also sincerely believe that the investigation and associated facts and innuendos will prove to be faulty because of an inherently flawed investigation due to cultural ignorance (by pure definition) and perhaps cultural insensitivity as well.  Additionally, I also suspect that the investigatory methodologies, themselves, may well have been tainted for the same reasons.  In short, statements of raw facts, in and of themselves, do not ensure an end product which will necessarily be absolutely truthful or accurate.  In any situation of a like or similar nature, one must logically and systematically examine ALL of the facts and background information, including cultural to obtain an end product that is truly objective, factual, and equitable to all parties concerned.

 

I would kindly and sincerely ask the GeoTeam to move forward expeditiously at this point.  Give Redstone the needed time, trust, and patience to produce requested and required information. I believe you will be positively surprised.  By the same token, China Redstone must keep its promises and commitments in order to strengthen investor confidence.  To do otherwise would reasonably substantiate doubts and concerns. All parties here must readily admit that China Redstone has responded to the GeoTeam in a timely manner to the best of its abilities and I believe this speaks volumes about the character of the company."

An excerpt from our response:

"Thanks for your comments an professional presentation of your opinions. I agree with some of the points you have made, mainly inferences that the divergent cultural "rules" when compared to the those in the U.S can complicate the analysis of Chinese companies.  However, that does not mean that these companies can play by different rules when they are attempting to access capital in foreign markets. That would be a like a U.S. company going over to China a breaking local PRC laws.. Would that be tolerated?....

Of course we understand that CGPI is trying to work with the local gov't to hopefully rectify its issues.  But investors need to know that CGPI does not currently have a its license, according to our findings.  Period.. This is clearly an event that requires disclosure under SEC LAW; As are the reasons  for why believe they have lost the license.  You acknowledge that there are risk factors, which is exactly why SEC filings have a section for risk factors...."

 

 

We attempt to give the benefit of the doubt to the companies we conduct research on.  We, as much as anyone else that has been following this space, have been in the corner of budding and established U.S. listed Chinese companies in hopes that our investments would reap great rewards.  Our intent is to help create an equitable environment for the retail investor who might not have the wherewithal or resources to build a FULL picture.  CGPI's picture is evolving, and we will be at the forefront of all developments as they unfold.

Disclosure:  No positions in CGPI

China Integrated Energy (CBEH) is another Chinese RTO company that has come under fire. The company recently reported 2010 vs. 2009 fourth quarter EPS of $0.38 vs. $0.30, exceeding analyst estimates of $0.34.

We were recently turned off by the CBEH story when the company raised money at insanely cheap valuations, despite having a "healthy" cash balance: 

CBEH raises funds

"XI'AN, China, Dec. 29, 2010 /PRNewswire-Asia-FirstCall/ -- China Integrated Energy, Inc. today announced that it has entered into definitive agreements with several institutional investors for a registered direct placement of approximately $15.3 million of common stock at a price of $7.00 per share. The Company will issue a total of 2,185,716 shares to the institutional investors.

In addition, the Company will issue to the investors warrants to purchase up to 1,092,858 shares of common stock, which, if fully exercised, would provide an additional $7.65 million in gross proceeds to the Company. The warrants have an exercise price of $7.00 per share and are exercisable for six months following the closing date.

The Company anticipates that the capital raised in this registered direct placement will be used for biodiesel capacity expansion and working capital for wholesale distribution of finished oil and heavy oil products.

GeoTeam® Note: What can we really say? Why offer stock?

• Cash balance of $79.7 million.
• Analyst estimates indicate that 2011 EPS will grow 28.5% to $1.85.
• Just appointed KPMG as auditor.

The company should let these positive developments play out before issuing stock at an absurd PEG ratio of 0.22. Dilution will only be 8%, assuming conversion of IN THE MONEY warrants. At least the this may end the overhang that this development was possibly having on CBEH's stock price."

In our recent blog note, we had originally commented that:

• The company had just finished working off past dilution. A new round of shares will once again hamper EPS growth in 2011. (We should note that EPS estimates have been raised to where now the street expects CBEH 2011 EPS to grow to $1.62 from $1.28. Previous 2011 estimates stood at $1.42)
• We believe CBEH has left the door open for another capital raise since its 10K states that it will have sufficient working capital to sustain its current business for the next 12 months, as opposed to commenting that it has capital to expand past current business goals.

On March 16, 2011 we issued an alert that we went short CBEH around $5.00, inspired by a convincing hit piece.

To see rest of column, please go here.

Disclosure: Short CBEH at time of note.

The GeoTeam has raised serious concerns regarding China Redstone. Please review our CGPI introduction below and use the hyper-link at the bottom of our introduction to see a full report as well as supporting documents.

Introduction:

In December 2010, we were contacted by a private investor who asked us to take a look at the CGPI story.  Specifically, he was seeking clarity on rumors circulating around whether or not CGPI possessed necessary land use rights to operate its cemetery business.  We asked our attorney, Bob, to delve into this story not knowing he would open Pandora’s Box.  Bob, along with our new on-the-ground due diligence team, have performed extensive due diligence on CGPI operations. What follows is a brief summary of our findings.  It is supported by a 19 page internal report and 52 pages of supplemental documents. We have maps, pictures, documents including land use rights and lease agreements and conversation notes with government contacts to back up our findings.  At first, the CGPI story appeared complicated, but after numerous conversations with Bob, we have been able to simplify our analysis. Our original goal was to summarize Bob’s conclusions on our focused China Due Diligence Board, “Ask Bob – GEO’s PRC Attorney”, at GeoInvesting.com, as we worked with CGPI and its IR firm to hopefully resolve open issues. They were cooperative.

History: Foguang was established in Fulin District of Chongqing City in 2002.  Foguang started to apply for the cemetery business and tourism business located in Changshou District.  Jan 2004, the office of Foguang moved to JiangnanTown, ChangshouDistrctChongqingCity.  Feb. 19 2004, Foguang received the land use rights for no consideration, from the Agricultural Machinery Bureau of Changshou District regarding the LongqiaoLake (339,444 m2).  Based on this agreement, Foguang can use the lake for its business. On Aug. 25, 2005, Foguang arranged an agreement to lease the land (570MU, 380,190 m2) surrounding the LongqiaoLake owned by Group 6, LongqiaoVillage with the government of Jiangnan town.  May 25, 2005, Foguang and two individuals establishes Chongqing Guiyuan Cemetery Industrial Co Ltd which obtains a Cemetery Service Business License to operate the cemetery on Aug. 22, 2006. Fonuang has a 51% ownership stake in Chongqing Guiyuan Cemetery Industrial Co until November 7, 2008 when it transfers stake to three individuals.

In 2010, CGPI went public via a reverse merger, communicating that Foguang, a VIE, operates Guiyuan cemeteries. CGPI claims it has a right to cemetery revenues through contractual agreements between a PRC WFOE (Ran Ji) and Foguang PRC (VIE arrangement).

The underlying themes in our report include:

• A loose ownership structure between the non-PRC and PRC entities jeopardizes investors’ claims to revenues.
• Misrepresentation of the entity that actually owns and operates cemeteries. We believe we have evidence that all the relevant parties of the cemetery business have not been disclosed in SEC documents.
• Misrepresentation of land use rights; it appears that developed cemetery plots are situated on a much smaller area of land than CGPI claims. It appears that the only “land” that CGPI owns is a lake.
• Illegal lease of land where cemetery plots have been developed.
• A nominal fine had been levied against cemetery operation helps to suggest that CGPI is operating an illegal cemetery operation; the right to operate cemeteries appears to have been revoked.
• There is real potential for increased competition in the cemetery business.
• The Company’s tourism business plan may be less attractive than portrayed. (since we opened the investigation on CGPI, the company has made a decision to terminate and divest this project entirely)
• Revenues may be overstated, supported by plot counts and receipts from cemetery plots a member of our team purchased.
• Assets may be overstated.

Conclusion:

The SEC documents of CGPI may not reflect its real business.  We feel there are several significant risks that can adversely influence its business.  We suggest that CGPI should revise its SEC documents and/or make substantial disclosures to clarify these issues.  We also suggest that the investors of CGPI pay attention to the issues summarized  in the attached report.

Please Read Full Report Here **Disclosure:  No Long or Short Positions in CGPI at time of article