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I invest in U.S.-listed Chinese companies. My website is at www.chinesecompanyanalyst.com. I take long and short positions in the public securities of companies that I discuss on Seeking Alpha. Although I choose to remain anonymous, I provide full disclosure of my positions at the time of the... More
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Chinese Company Analyst
  • CSKI and LIWA 0 comments
    May 26, 2010 12:17 PM | about stocks: CSKI, LIWA, YUII

    Recently, there have been several Seeking Alpha contributors that have written posts comparing the U.S. and Chinese financial statements for various U.S.-listed Chinese small capitalization companies.

    The relevant articles can be found here:

    Manuel Asensio and “Waldo Mushman” on China Sky One Medical (OTCPK:CSKI):

    http://seekingalpha.com/instablog/409241-manuel-asensio/22197-cski-s-chinese-financial-statements-contradict-revenues-and-earnings-in-sec-filings

    http://seekingalpha.com/instablog/409241-manuel-asensio/37083-discrepancies-bigger-than-ever-in-china-sky-s-financial-statements-filed-with-chinese-government

    Steve Chapski on Lihua International (NASDAQ:LIWA):

    http://seekingalpha.com/article/203949-still-not-copacetic-at-lihua-international

    http://seekingalpha.com/author/steven-r-chapski/instablog/2

    In these articles, the authors compare the SEC financial statements of Lihua International and China Sky One Medical to the financial statements shown in their “SAIC” filings.


    SAIC Filings


    What are SAIC filings? SAIC filings are the audited financial statements that all Chinese “foreign invested enterprises” (FIEs) must file with the local government offices of the Administration for Industry and Commerce (AIC). The term “SAIC” refers to the “State Administration for Industry and Commerce”. These financial statements are filed annually, as part of the “Annual Inspections Report” that all foreign invested enterprises in China must submit to their local government authorities.

    Some people, including the chief financial officer of CSKI, claim that companies can file “fake” SAIC filings, whereby they materially misstate their financial statements in their SAIC filings. Based on my discussions with numerous accountants, lawyers and CFOs of verifiably legitimate Chinese companies, I do not think this is true. My understanding is that there are significant penalties for any Foreign Invested Enterprise that materially falsifies financial statements that it is filing with the local Chinese government. These SAIC audited financial statements should approximate the relevant tax filings that companies file with the Chinese government. If companies falsify their SAIC filings, they would be also falsifying their tax filings. With a company like CSKI, we’re seeing SAIC financials come in at 90%+ below their SEC financials – the Chinese government would not tolerate under-reporting and tax evasion of this order of magnitude.

    As a result, the likeliest answer, in my opinion, as to why the SEC and SAIC filings are different is that companies like CSKI are falsifying their SEC filings. This is not especially difficult to believe, because the rapid growth and high margins of the companies are a bit too good to be true.


    Dubious Financial Claims


    CSKI has seen revenue grow from $8mm to $20mm to $49mm to $92mm to $130mm from 2005 to 2009. EBITDA margins have grown from 20% in 2006 to 38% in 2009. And what exactly does the company do? It makes a variety of traditional chinese medicines, such as the “Sumei Slim Patch”, which is a patch that people wear to foster weight loss; the “Pain Relief Patch”, which is a patch that alleviates fevers, headaches and heart dysentry; Hemorrhoids Ointments; herbal dental ulcer sprays; diagnostic kits for early stage diagnoses of heart attacks, etc. None of its products seem particularly special, and the company reports steady, rapid growth across all its segments, whether it be Patches, Ointments, Sprays or Diagnostic Kits.

    A critical article questioning the quality of CSKI's products can be found here: http://seekingalpha.com/article/132261-revealing-the-shoddy-practices-of-china-sky-one-medical?source=feed

    Lihua International’s claims of profitability is equally suspect. Its revenue has allegedly grown from $16mm to $33mm to $50mm to $162mm from 2006 to 2009. Its earnings have allegedly grown from $4mm to $8mm to $12mm to $17mm. Capex has been relatively small throughout the past several years. Given that the company is simply a manufacturer of "bimetallic composite conductor cable and wire products, and refined copper products”, it's difficult to see how the Company is achieving such high returns on invested capital in this sort of capital-intensive business. 

    Chimin Sang provides an excellent analysis of LIWA’s dubious business operation claims in:

    http://seekingalpha.com/instablog/482-chimin-sang/32150-is-lihua-international-cooking-its-books-part-i

    http://seekingalpha.com/instablog/482-chimin-sang/32264-is-lihua-international-cooking-its-books-part-ii

    http://seekingalpha.com/instablog/482-chimin-sang/34706-is-lihua-international-cooking-its-books-part-iii

    Recently, there have been interesting developments with LIWA. A few days ago, LIWA posted what it alleges to be its 2009 SAIC filings on its website at www.lihuaintl.com. The financial statements that Steve Chapski has acquired from Qingdao InterCredit Services are posted on www.waldomushman.com/Lihua.html. It appears that one of these sets of numbers is incorrect, and it's unclear at this stage which numbers are wrong. Qingdao stands by its numbers after having viewed the filings Lihua posted on its website, and claims that Lihua is falsifying its numbers. Right now, the whole situation is a bit confusing and I expect that additional news will surface in the coming weeks on this unusual dispute. Personally, I currently believe the third-party credit agency's claims over Lihua's in this specific scenario, but we'll see if that changes as new information surfaces.

    Conclusion

    Because of the CSKI, LIWA and similar fraud allegations, many U.S.-listed Chinese smallcaps have seen their valuations come under scrutiny, because investors cannot easily separate the “real” companies from the more fraudulent ones.

    I’ve found this disturbing, because I own a variety of small Chinese companies and have not been very pleased about the stocks declining in sympathy with some of their allegedly fraudulent brethren.

    As a result, in my next article, I’m going to discuss Yuhe International (OTCPK:YUII). I will compare its SEC and SAIC filings, and show how the numbers match. Then I will discuss a variety of other factors that give me confidence that Yuhe is a legitimate business enterprise that is accurately representing itself in its SEC filings.


    Disclosures:

    At the time of writing, I and affiliated entities have a long position in YUII. In the past, I have had a short position in CSKI. I may trade in any of the securities discussed in this article at any time, including within the next three days.

    In no part of this post do I attempt to provide false or misleading information. All facts presented in this post are true to the best of my knowledge.  All opinions presented on this website are my own and accurately reflect my actual opinion on the relevant subject being discussed. To the extent you believe I have provided false or misleading information, please contact me at chinesecompanyanalyst@gmail.com. If I agree with your assessment, I will make a relevant comment clarifying the false or misleading information in the question and answer section of this post or article.

    Stocks: CSKI, LIWA, YUII
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