China Information Technology, Inc (CNIT) is small Chinese company traded on NASDQ global select market, with market cap of $55 million, and stock price of $1.67 at the close of 8/13/2015. The trading pattern showed highly unusual movements and upon further investigation, we believe that it is manipulated and the management has left clear path of fraudulent dealings. Below is the timeline of recent events.
1. CNIT stock rose mysteriously from $3.44 to $7.17 between March 9th and May 20th this year amid report of annual loss of $30 millions on revenue of $68; this on the back of 5 straight years of dwindling revenues from $163.8M in 2010.
2. On May 21st, 2015, the company announced a private placement with unnamed parties to sell 2,102,484 shares of ordinary stocks at $6.44. The agreement was signed on May 20th, and the buyers of the private placement were also granted 525,621series A warrants with strike price of $7.73 and 1,051,242 Series B warrants with strike price of $7.09.
3. CNIT stock price dropped like rock immediately after the announcement to $3.36 on June 19th.
4. On June 22nd, CNIT announced that it received a "going private" offer from CEO at price of $4.43.
5. Even since then, the CNIT price has falling again like rock, finishing at $1.59 on Aug. 12th.
So what is going on with this stock? Why do I make the bold statement that the company has committed stock manipulation and fraud? The key event in this whole process is the private placement.
The first obvious question is: why did the stock rise so quickly and then abruptly reversed its course upon private placement, and why were the buyers in the private placement so dumb to buy the stocks at such an inflated price?
The answer, as it turns out, is all part of a well planned scheme to rip off retail investors.
By now you should have realized that the rapid rise of the stock in step 1 is artificial manipulation, with the sole purpose of setting a very high private placement price. Our first impression was that the company had set up to screw the buyers in the private placement deal, and the buyers in the deal had been taken advantage of. As it turned out, we can't be more wrong.
The key to pierce through the fog is in the Series B warrants. In the press release dated May 21st reads just like an usual placement:
"SHENZHEN, China, May 21, 2015 /PRNewswire/ -- China Information Technology, Inc. (the "Company" or "CNIT") (Nasdaq GS: CNIT), a leading provider of integrated cloud-based platform, exchange, and big data solutions in China, today announced that it entered into a securities purchase agreement (the "Purchase Agreement") with certain institutional investors for the sale of 2,102,484 ordinary shares in a registered offering at the price of $6.44 per ordinary share. In addition, Series A warrants to purchase an aggregate of 525,621 ordinary shares and Series B warrants to purchase an aggregate of 1,051,242 ordinary shares will be issued to the investors.
The investors' Series A warrants are initially exercisable at $7.73 per share and will be exercisable immediately as of the date of issuance until three years after the date of issuance. The Series B warrants are initially exercisable at $7.09 per share and will be exercisable at any time immediately as of the date of issuance until six months after the date of issuance. The exercise price of the warrants is subject to anti-dilution adjustment in the case of future issuances or deemed issuances of ordinary shares below the respective warrant exercise prices, as well as customary adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. A holder of the warrants also will have the right to exercise its warrants on a cashless basis if the registration statement or prospectus contained therein is not available for the issuance of the ordinary shares issuable upon exercise thereof. In addition, commencing on the 40th day after the date of issuance, the Series B warrants may be exercised on an Alternate Cashless Exercise basis as set forth in the Series B warrants.
The net proceeds to the Company from the offering, after deducting placement agent fees and the estimated offering expenses payable by the Company but excluding any proceeds from warrant exercise, are expected to be approximately $12.7 million. The net proceeds from this offering will be used for working capital and general working capital purposes."
You should pay attention to the wording on the series B warrants. It mentioned cashless exercise and alternate cashless exercise but fail to provide any details. We all know what is cashless exercise of a warrant, so what's the big deal? The big deal is, the company has a completely different meaning with cashless exercise of warrant when they add the magic word of "alternate". As you will see below, this is not "alternate" in the conventional way, it is a vehicle a fraudster invented to escape punishment. We will see if they are successful when it goes to court.
To understand how this works, one has to read through the 6-K filing that was deliberately written in the most confusing way, with the key components placed in different places and formulae written in the most confusing and erratic way. I had to read the article multiple times over the course of a two day weekend, and take notes to finally figure out what happened, and I have a PhD in science.
As it turns out, the "alternate" cashless exercise allows the buyer to potentially get limitless number of shares at no cost. Leaving out the minor details, here is how it works:
After 40 days, if the stock price is below $4, the series B warrant holder can get for each warrant the following number of shares free: (yes you read it right, FREE!)
1.85*(6.44/0.9/C-1), where C is the market price at the time of exercise
To save you from the math, I include a table here below to guide you:
Stock Price (in $) | Free Shares for Each "B" Warrant | Value of the "B" Warrant (in $) |
4 | 1.13 | 4.51 |
3.9 | 1.20 | 4.70 |
3.8 | 1.29 | 4.88 |
3.7 | 1.37 | 5.07 |
3.6 | 1.46 | 5.25 |
3.5 | 1.55 | 5.44 |
3.4 | 1.65 | 5.62 |
3.3 | 1.76 | 5.81 |
3.2 | 1.87 | 5.99 |
3.1 | 1.99 | 6.18 |
3 | 2.12 | 6.36 |
2.9 | 2.26 | 6.55 |
2.8 | 2.41 | 6.73 |
2.7 | 2.56 | 6.92 |
2.6 | 2.73 | 7.10 |
2.5 | 2.92 | 7.29 |
2.4 | 3.11 | 7.47 |
2.3 | 3.33 | 7.66 |
2.2 | 3.57 | 7.84 |
2.1 | 3.82 | 8.03 |
2 | 4.11 | 8.21 |
1.9 | 4.42 | 8.40 |
1.8 | 4.77 | 8.58 |
1.7 | 5.16 | 8.77 |
1.6 | 5.60 | 8.95 |
1.5 | 6.09 | 9.14 |
1.4 | 6.66 | 9.32 |
1.3 | 7.31 | 9.51 |
1.2 | 8.08 | 9.69 |
1.1 | 8.98 | 9.88 |
1 | 10.06 | 10.06 |
0.9 | 11.39 | 10.25 |
0.8 | 13.04 | 10.43 |
0.7 | 15.17 | 10.62 |
0.6 | 18.01 | 10.80 |
0.5 | 21.98 | 10.99 |
0.4 | 27.94 | 11.17 |
0.3 | 37.86 | 11.36 |
0.2 | 57.72 | 11.54 |
Now consider these facts:
- the warrant is worth nothing until the price is either higher than $7.09 or below $4.
- the warrant is worthless in 6 months
- the buyers have 2 million plus shares to sell and 1 millions plus warrants
- the value of the warrant increases rapidly with the drop of share price of CNIT
- the buyer can get increasing numbers of shares as the stock price decreases
- the average daily trading volume is around 200K and there is no institutional backing of the stock; total shares of outstanding is about 21.5 millions.
Now put yourself in the shoes of warrant holder, what would you do to maximize your value?
I think I guessed it right, SELL! Sell aggressively to quickly drive down the price! Convert some B warrants to get more shares to sell! Convert more B shares to get even more shares to SELL!
The price movement of the stock showed exactly that. What should have happened did happen. Now the BIG questions:
- Why would the company go through such a private placement when they know the buyers will make big bucks? (Note: the table above only shows the warrant value at the market price, the fact is that all the sold shares are at higher price, so the buyers can easily get 100% or even high return within a very short period of time, at no risk.)
- More seriously, why would the company craft a structure that strongly encourages the buyers of the private placement to drive down the price of its own stock?
- What is the purpose of the "going private" offer at $4.43 amid rapidly falling stock price?
- Who are these buyers that can buy into such lucrative deals, and what are their relationship with the company management, especially CEO and CFO?
To Be Continued