Based on the work of Citron Research, Chinese Company Analyst, and China Stock Detective, I have become convinced that China Biotics is engaged in fradulent activity. The company has clearly lied about store locations, filed questionable and inconsistent financial statements, and retains an auditor with a dubious track record. Nevertheless, some investors remain bullish.
The Stores.
The case for fraud: Citron Research hired private investigators to visit claimed China Biotics retail stores finding 95% of them to be supermarkets and other retail outlets. China Company Analyst visited 43 claimed CHBT retail stores and found only 2 to be legitimate China Biotics locations. 25 locations did not carry any China Biotics offerings at all. China Stock Detective visited 5 claimed stand alone stores finding three supermarkets, one administrative complex including a preschool, and one actual CHBT store. According to China Stock Detective, supermarket employees reported China Biotics products to be poor sellers.
The case against fraud: Retail locations accounted for a relatively small portion of sales. 9% of 2008 sales, 26.7% of 2009 sales and 11.7% of 2010 sales were derived from retail outlets. The company's distributors and bulk additives business have higher margins, and in the face of increasing wages, and rising real estate prices, it no longer makes sense to operate a large number of retail outlets.
The Cash.
The case for fraud: In it's latest quarterly SEC filing, China Biotics reported interest income of $87,876 while claiming $159,753,695 in cash and cash equivalents. This works out to an annualized return of just over .22%. Most Chinese companies are earning a cash return of well over 1%. China Biotics justifies their unusually low rate of interest income by claiming to make very short term deposits in Chinese banks while keeping 75M in U.S. dollars for over a year. Given that Yuan deposits earn significantly higher interest rates than dollar deposits, and that the RMB is widely expected to appreciate against the USD, China Biotics cash management does not add up.
The case against fraud: China Biotics has shown bank statements to analysts and investors proving the legitimacy of their assets.
The Auditor.
The case for fraud: China Biotics auditor, BDO Limited (not to be confused with BDO Seidman) has been the auditor of two know frauds, China Expert Technology, and Orient Paper. It is not inspected by the PCAOB, and currently is signatory to only 10 U.S. listed companies.
The case against fraud: BDO limited is part of the BDO Alliance, a large group of many different audit firms around the world including BDO Seidman.
The Investor Day.
The case for fraud: On September 20th 2010, China Biotics hosted an investor day during which they provided presentations, store and facility tours, product samples, and documentation of assets. The investor day was designed and administered by the CHBT PR department. There is a prevalent industry in China of hiring fake business associates to impress investors, and it is relatively easy to produce fake documents. One day of a few truths and many illusions should not fool investors. It should also be noted that the hard assets shown on the investor day do not come close to proving that CHBT shares have any positive value.
The case against fraud: The investor day presentation should be considered proof of a real business. The company has invested in a new corporate office, as well as high tech research, and manufacturing facilities. The documentation shown to investors and analysts is incontrovertible evidence of most company assets.
The SEC and SAIC (China) Filings.
The case for fraud: China Biotics SEC and SAIC filings do not come close to adding up. In fact SAIC filings value total assets at less that 1/5th of the SEC filings. Most legitimate U.S. listed Chinese companies have SEC and SAIC statements that are reasonably comparable.
The case against fraud: SAIC filings do not matter. In fact some private equity firms do not look at SAIC filings as they consider tax documentation to be a more accurate measure of a company's earnings.
Numerous indiscrepancies, lies and red flags should warn any long investor to stay on the sidelines or get out immediately. If you intend to establish a short position in the stock, it should be noted that CHBT shares are expensive to borrow and will carry a very high interest expense. In my opinion it is worth considering selling in the money calls, or a synthetic short position.
Disclosure: Short CHBT calls
China Biotics - Summarizing The Evidence
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