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  • Glaucus’ Web of Lies and Their Attempt to Deceive L & L Energy Shareholders 1 comment
    Sep 5, 2011 5:40 PM | about stocks: LLEN, YZC

    Recently Matthew Wiechert of Glaucus Research Group posted a “report” on L & L Energy, Inc. (NASDAQ:LLEN) meant to put into question the integrity of the Company’s financial reports and management.  It is our position that the information that was posted in this “report” was intentionally misleading, taken out of context and created for the sole purpose of exciting fear and confusion within the marketplace.  The purpose of this article is to provide a factual response to the false, deliberately misleading and manipulative practices that this “report” used to manipulate the stock price of LLEN and allow for Wiechert and his associates to capitalize on their short positions.

    In reviewing this “report” we found zero factual information that carried any merit or proved any malicious wrongdoing at LLEN.  Conversely, based on over three years of on the ground due diligence in both China and the United States, we have found that this “report” is riddled with unsubstantiated claims that have been manipulated and pulled out of context for no conceivable reason other than to negatively influence the stock price of LLEN materially hurting a large class of individuals – its shareholders.

    Our passion found within this report is based on our belief that the investing public is not only entitled, but has a right to fair, balanced and factually based information.  We were very disturbed to find that the author, in an online interview with Street.com, clearly notes that he has no background in investment research, managing money, due diligence or operations in China.  Further, the only somewhat practical financial experience that he holds was as a sales trader for Roth Capital. We note that the generally accepted job description of such a position is to create relationships with investment funds so that the investment bankers and investment research providers (who are registered and regulated by FINRA and the Securities and Exchange Commission) can pitch clients on their work product in order to generate transaction volume for the firm.  Regardless of such description, the author clearly discloses that this past experience would not qualify him to conduct accurate and fundamental research on any company and has essentially admitted that he was wrong or unable to determine the facts in other companies he has targeted for the benefit of himself and his paying clients.

    Glaucus Point #1

    According to publicly available SAIC filings, Dickson Lee, the CEO, founder and Chairman of LLEN, is the sole owner of Zone Lin, a coal coking factory purportedly acquired by LLEN in the third quarter of 2009. Holding assets acquired with corporate funds in a sole proprietorship is at best a major violation of SEC disclosure rules and at worst textbook fraud.

    On February 6, 2010, L&L Yunnan Tianneng Industry Co. Ltd. (“TNI”), a direct subsidiary of LLEN, purportedly acquired 100% of the equity of Luoping County Zone Lin Coal Coking Factory (“Zone Lin”), a sole proprietorship, from Lao Zhong Yang (“LaoYang”) for $2 million.

    Below, we present an SAIC filing from June 2, 2010, showing that Zone Lin is a sole proprietorship and that LaoYang is the registered owner of all of the outstanding equity interests of the firm. This in itself is problematic. LLEN purported to acquire “100% of the equity” of Zone Lin, yet even after the acquisition date, the business was still held in a sole proprietorship by a related party.

    This SAIC filing clearly shows that as of June 2, 2010, LaoYang, not LLEN (or its subsidiary) was the sole owner of Zone Lin and held the business in a sole proprietorship.

    The whole truth:

    There are a number factual inaccuracies in this claim.  The reader must first understand that SAIC filings are an annual filing for the prior calendar year.  They are filed once a year, around the middle of the following year (i.e., calendar year 2009 SAIC filings would be filed in mid 2010).  So any 2010 filings that Glaucus has are for the calendar year 2009 (meaning, Glaucus’ “SAIC filing from June 2, 2010” is actually for calendar year 2009).  ZoneLin was not acquired by LLEN until February 2010, so the purported SAIC filing that Glaucus found would not reflect LLEN’s ownership yet. 

    See below an excerpt from LLEN’s most recent 10K:

    Through TNI, L&L acquired 100% equity of ZoneLin Coal Coking Factory in China (“ZoneLin”) on February 3, 2010 with an effective acquisition date of November 1, 2009.

    The legal transfer was February 3, 2010, and the company was able to account for the receipt of revenue, expenses, etc. of ZoneLin on LLEN’s books and records to November 2009 for accounting purposes due to the contractual arrangement of the agreement and the structure by which the Company acquires targets.

    It should be additionally recognized by the reader that there is no confirmation that these “SAIC filings” presented by Glaucus are factually true.  In China, for governmental filings to be accepted as verified and true, a stamp of a red star within a circle would be present on the document.  This appears nowhere in Glaucus’ report.  The author also does not reference the source of such SAIC filings, which the reader must therefore question the accuracy and completeness of such data.

    Furthermore, beyond the factually inaccurate claim made above by Glaucus, it is worth taking an aside to discuss how LLEN generally conducts its acquisitions.  In this example, the company stated that there was a contractual arrangement which gave LLEN the rights to the financial results of the business effective as of November 1, 2009, upon closing of the acquisition, as stated in the SEC filings, was on February 3, 2010.  LLEN has previously explained that this is done in order to help maximize the amount of due diligence conducted on a potential target; in order to witness, first-hand, the operations of a target company.  They do this to ensure that the acquisition target is functioning as they would expect it to be.  According to the company they attempt to mitigate risk of acquisitions by running this operational due diligence process early on, primarily to ensure (among other things):

    • That the prior management is running the business properly;
    • That the prior management is abiding by relevant laws and regulatory procedures;
    • That the acquisition is operating properly over an extended period of time; and
    • That the two business cultures will be able to fit under the common LLEN umbrella.

     

    Glaucus Point #2

    Then things get even fishier. Below is a screenshot taken yesterday from the SAIC website showing that Dickson Lee, LLEN’ s founder, CEO and chairman (not LLEN or its subsidiaries) is the sole owner of the Zone Lin coal-coking business and that he holds the business in a sole proprietorship.

    We corroborated this screenshot with a second independent SAIC report. Put simply, the above SAIC screenshot shows that Lee deployed corporate funds to acquire an asset that he (not the company) now holds in a sole proprietorship. Holding assets acquired with corporate funds in a sole proprietorship is at best a material omission of a related party transaction from SEC financials and at worst textbook fraud.

    The whole truth:

    This is a case of failing to provide the reader with the full picture.  In the screenshot, Glaucus selectively translates part of the Mandarin to English to show Dickson Lee as the “person in charge” of ZoneLin.  First, it should be noted that Dickson Lee, the CEO of LLEN, is in fact the “person in charge” of LLEN’s subsidiaries (having legal liability for the operations), as with any mining company in the US or any business for that matter.

    More importantly, if the rest of the document were translated to English, the reader would realize that the website states that this information should, in no form or fashion, be relied upon legally as there is no requirement to update the information (which was as of May 2008) nor is there an obligation from the website to ensure that it is complete and accurate information.  This disclosure, in itself, is material information.  Nevertheless, for the author to put out a defamatory report utilizing this website that says explicitly not to rely on its information, and to call the company a fraud and not verify such information with the company or attempt to verify the information with the company, is itself absurd and we believe to be very irresponsible in nature.  See below for the rest of the translation that Glaucus failed to provide:

    The above information is based on the registered information made by enterprise on 15 May 2008.  Due to the periodic data updating, the above information is only for reference. If it is needed to inquire for the latest and detail enterprise register information, please contact the government office of enterprise register.

    The website of  Administration of industrial and commerce ,Yun Nan province, freely provides the information for inquiry, according to the international tradition, all the information provided from website are only for the reference, it has no any lawful effect. If the information provided from the website is not in accordance with the paper documents, please take the paper document as the standard.

    Any aftermath due to the nonproper using of information provided from website, the Administration bureau of industrial and commerce of Yunnan province will not take any responsibility. Any medias and organizations can not misrepresent and modify the information, any reproduction of information needs to contact the related unit to have the proper authorization.”

     

    Glaucus Point #3

    Local Chinese filings also reveal that LLEN does not legally own another important asset.

    According to LLEN’ s SEC filings, the company purportedly acquired 100% of the equity of the Hong Xing coal washing facility (“Hong Xing”) on November 30, 2009, through its subsidiary TNI.

    Based on our conversations with Chinese lawyers and accountants, it is our belief that under Chinese law, LLEN’ s subsidiary TNI, as a sino-foreign JV entity , would not be permitted to acquire Hong Xing as long as the entity remains a sole proprietorship. It is our understanding that under Chinese law, (a) the interests in a sole proprietorship may only be owned by a Chinese national, (b) all assets, investments and income from the sole proprietorship belong to the natural person who owns the interest in the sole proprietorship and (c) such natural person is responsible for all liabilities and debts of the sole proprietorship.

    Even though LLEN states that it “owns 100% of the equity of Hong Xing” in fact the equity could not have been transferred toTNI so long as Hong Xing remained a sole proprietorship. SAIC filings corroborate this conclusion.

    According to an SAIC filing signed April 15, 2010, Hong Xing remained a sole proprietorship that was wholly owned by Hong Xing Li, the same individual who was supposed to have sold the factory to LLEN.

    The above filing shows that as of April 2010, five months after the consummation of the purported sale, the company did not legally own the equity of the Hong Xing coal washing factory even though LLEN claimed to have acquired 100% of the equity of the entity in its SEC filings.

    The whole truth:

    This is the same factually incorrect conclusion as before:  The “SAIC filings” as of April 15, 2010 are actually filed on April 5, 2010, for the year-ended December 31, 2009.  Similar to how US citizens file their taxes on April 15, 2010 for their earnings for the year ended December 31, 2009.  LLEN did not own the Hong Xing asset until after December 2009, which would of course not be reflected in any 2009 “SAIC filings”.  LLEN completed the purchase of Hong Xing until January 2010, per their press release and 10Q and 10K filings  (“…and acquired 100% of the equity of SeZone County Hong Xing Coal Washing Factory (“Hong Xing”) on January 1, 2010”).

    As before, Glaucus presents a “SAIC filing” that we believe is not only a non-official government filing, but also does not reflect what the author is saying for any relevant time period. Once again the author makes no attempt to confirm with management, their lawyers, their auditors or anyone with any knowledge of the Company.  We must question the motives of an individual willing to defame a company, and hurt their shareholders, purely for their benefit, and is unwilling to attempt to seek out the actual truth.  Anyone willing to try to paint a negative picture based on a subset of information we believe is operating with malicious intent and with a goal to harm a class of individuals for their own benefit.

     

    Glaucus Point #4

    Glaucus spends the next two sections discussing the “undisclosed minority shareholders” and “mining rights” of LLEN.  While the intent is to put doubt in the minds of investors, the basis of their argument boils down to the primary claim that LLEN is transferring (or rather increasing) ownership of mines without any consideration.  However, if one reads the press releases for mine acquisitions (and the 10Q, 8K and 10K reports), it becomes clear that the structure of the acquisitions by LLEN are relatively consistent:  The company acquires control of the target, then increases that ownership over time as LLEN performs and meets the covenants and hurdles of the acquisition agreement (such as infrastructure build-out, safety improvements, etc), or increases the ownership of the operations based on agreed terms that are fully and accurately disclosed in the companies filings with the SEC.  Anyone taking the time to read such filings in their entirety, as well as possessing the most basic background capable of reading such reports, would have clearly understood this acquisition structure.

    While Glaucus attempts to imply that LLEN is increasing their ownership in these assets for no consideration, and therefore a red flag should be raised, the truth is that LLEN is investing heavily into these acquisitions (as evidenced by their financial statements as well as evidenced by the governmental acceptance of L&L’s operational and safety performance – read here). The company has also filed the acquisition agreements for its acquisitions either via 8K, 10Q or 10K during such relevant periods, and if there was a modification to such an agreement they filed it within their SEC filings during such period of time.

    Furthermore, it should be noted that pursuant to the most recent audited 10K filed on July 29, 2011 and amended on August 3, 2011 for an error during edgarizing, LLEN’s auditor independently commissioned a legal opinion from a major Chinese law firm to confirm the ownership structure present in the 10K. This highly qualified and substantial law firm in China performed an extensive review of such agreements and confirmed that LLEN is in covenant and agreement with the targets and is 100% accurate in its ownership claims.

     

    Glaucus Point #5

    “LLEN’ s [sic] By the Numbers”

    This section is meant to convey that LLEN is “too profitable to be real”. The entire section can be summarized by Glaucus’ conclusion at the end:

    In short, LLEN is one of the most efficient and profitable (adjusted for size) coal mining companies in the world. It boasts even more impressive returns on equity and returns on assets than even its Chinese competitor. This seems ridiculous. What makes this story even harder to believe is that LLEN conjured its spectacular coal mining business . . .

    The whole truth:

    Glaucus’ claim that LLEN is one of the most profitable coal companies in the world is based off of a comparison to only one other Chinese company, YZC (Glaucus admits that comparing LLEN to US coal companies is a worthless exercise, which we would agree due to completely different operating dynamics, pricing and environments), which has a $14 billion market capitalization (LLEN’s market cap is approx $110 million).  Glaucus uses no other relevant comparables; either publicly traded or privately held companies.  This comparable table simply relies on only one other company that happens to have a market capitalization of 118 times that of LLEN.  From this far incomplete data set, Glaucus decides to make the ridiculous conclusion that LLEN is “too profitable”.

    Several additional extremely relevant factors that Glaucus conveniently chooses not to take into consideration:

    -          Much larger miners are often unionized, which creates a significant added expense to the company.

    -          Much larger players are often more vertically integrated which results in lower profit margins (coal washing, coal coking, etc.), as witnessed in LLEN’s own vertical integration.

    -          Much larger players are often forced to compete for larger assets and take on less profitable opportunities to continue their growth.  As they grow from a much larger base they are unable to target the small to midsized opportunities that could be very fruitful, yet wouldn’t move the needle in their particular financial statements or company performance.

    -          Mining in the northern region of China involves significantly more transportation costs due to demand for transportation in the region, as well as the antiquated rail systems in the north that are currently  operating in excess of their established capacity.

    -          As a result of transportation costs many operators in the north sell their coal locally or at the mine site for a much lower sales price than what can be demanded at the customer site (FOB mine versus FOB customer).

    -          Larger players are inherently faced with larger operational costs as a result of operating a much larger operation.  In the mining industry we believe the law of big numbers does not exist given the amount of regulation within the industry.  A much larger organization demands a much larger staff, relative salaries and overhead expenses.

    We could continue to go on but we believe our point above is clear. 

     

    Glaucus Point #6

    SAIC filings corroborate our suspicion that LLEN’ s incredible financial performance is simply not credible. According to publicly available SAIC filings for the calendar year 2009, LLEN’ s revenues are much smaller and its assets are worth considerably less than the company claims in its SEC financial statements.

    According to 2009 calendar year SAIC filings, LLEN’ s assets are only 25% of the value that the company claims in its SEC filings and the company’ s net sales are four times smaller than the company claims in its SEC filings.

    The whole truth:

    Putting aside the fact that Glaucus didn’t even include all of LLEN’s subsidiaries in this chart (they left out Hon Shen, which was sold in 2010), it is common knowledge that one simply cannot reconcile the SAIC filings to the SEC filings for Variable Interest Entity (VIE) structures (see, for example: http://geoinvesting.com/geowire/273/the_sec_vs_saic_fact_finding_mission ), which in 2009 LLEN had VIE structures prior to restructuring the agreements as discussed in the SEC filings.  Glaucus provides no backup data or proof of how these numbers came into existence. Seeing how they clearly misunderstand Chinese filings so far in their report, it’s no wonder that they got this wrong as well.

    We have communicated with the Company post reading the latest audited 10k (which was a very well prepared document with significant detail), and they have confirmed that as part of the audit process the auditor independently confirmed with the tax authorities in China regarding the SAT filings that are filed for every subsidiary within China and their particular province.  SAT filings are actual tax filings in China.  SAIC filings are a business commerce filing and may or may not be relevant for certain operating structures.

     

    We believe the balance of the Glaucus article is meant to slander and question management’s integrity and intentions.  Furthermore we believe the Glaucus report was filed with the intent to benefit a few select parties, while significantly harming a class of individuals and firms (the LLEN shareholders). For an author who has yet to have a conversation with management, let alone pose his questions to them, one has to take a step back and understand what the author’s motives truly are in this “report”.  In the rest of the “report”, there are no outright accusations, only attempts to smear the reputations of management by presenting a biased, one-sided view of the argument coupled with factually inaccurate and or misleading attempts to explain the business model.  A proper analysis of this “report” clearly shows that the author must either have no working knowledge of the company or alternatively simply attempted to manipulate and twist the information that was available out of context and in a way that would create unreasonable fear and anxiety in the marketplace.

    Furthermore, attempting to tarnish Mr. Lee’s reputation for his act of generosity of donating stock or cash back to his alma mater is in horribly bad taste. It is common practice among corporate America for executives to give back to the community, and if this was bad practice then the management teams from almost every Fortune 500 company would be guilty.  Drawing a conclusion that such acts are fraudulent is a reckless leap in logic.

    For an individual with the reputation such as the author to attack the reputation of this management team is simply ludicrous.  Please read the blog linked here to learn more about Glaucus’ reputation.  We believe the management of LLEN, as well as the team on the ground, is highly capable and professional. Our on the ground due diligence over the past three years has provided our team with the knowledge to properly and adequately evaluate the business plan as well as the management team.  Though no company is without its faults, we note that over the past three years we have been very impressed by the mining capabilities at the company as well as the mining capabilities of the target acquisitions themselves. Furthermore we encouraged to see Syd Ping extend his relationship with the Company.  He is world-renowned in both the U.S. and China with regards to underground mining.  He has been involved with the Company for a number of years and we believe he has been instrumental in the due diligence and mining aspects of the business.  His joining the board from the advisory board further aligns his interest with the company and we believe is another leap forward with regards to the LLEN’s capabilities.

    We are pleased that the company to date has spent very little time and effort bickering back and forth with individuals or firms that are not only unqualified and non-registered with the relevant authorities to provide such research, but are doing so purely to benefit the pocketbooks of themselves at the expense of every shareholder in the company.  We find it very unsettling that individuals were harmed so Glaucus and their colleagues can profit, but we believe in the end the truth will prevail and we are confident that it will in this case as well.  Long term we are confident that this has been a minor blip in what will be a very successful company. 

    We thank those shareholders that have responded individually in support of the company and we hope to be in touch shortly with regards to progress on such matters.  

     

    Note: this article has been written using the best possible data available to us and our best understanding of the Company and are an accurate representation of the Company and its filings with the Securities and Exchange Commission. Our statements above are purely our opinion and may differ from the opinion of the Company. If you have comments on any of our statements or analysis above please feel free to contact us.

    Themes: China, Mining, Coal Stocks: LLEN, YZC
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  • henrylim
    , contributor
    Comments (5) | Send Message
     
    Well said Mark. Thank you for your efforts!
    6 Sep 2011, 10:58 AM Reply Like
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