Is Natural Health Trends Lying About A Chinese Regulatory Investigation?

| About: Natural Health (NHTC)

Summary

We reported to our members on Monday of this week that eyewitnesses noticed uniformed officials removing computers from NHTC's Beijing office.

The company followed this with a statement saying it was "unaware" of any investigation.

Tuesday morning, news broke on several reputable Chinese media sites claiming the company had been raided and is under investigation.

(GeoInvesting Members received parts of this article on Monday 1/11/16 and early morning Tuesday 1/12/16. For information on signing up as a member to get exclusive information before the public, visit geoinvesting.com).

Yesterday, we put out an article to our members that Natural Health Trends (NASDAQ:NHTC) offices had been raided, citing eyewitness accounts from neighboring businesses in the company's Beijing building. Confirming our story yesterday are two major media outlets in China, including SINA Finance.

Yesterday morning, the company issued a press release saying it was unaware of any investigation. We have to question whether or not the company was aware of this investigation at the time, as evidence now seems to suggest it might have known ahead of hand.

We are eagerly awaiting a statement from the company at this point. This morning, it was reported on two reputable news sites that the company's Beijing offices had been raided and investigated. There are also photographs on Twitter that apparently show officials at NHTC's Beijing offices.

Here is the original source of the document, and a link to SINA Finance, which picked the story up. The content from the SINA Finance article stated the following, which we have translated below:

Our paraphrased translation:

On January 11th, 3PM, Beijing Chaoyang District SAIC and Public Security Bureau (the Police) raided and investigated NHTC's Beijing Office. The 21jingji.com news reporter was on the scene and witnessed several office people and members to cooperate with the investigation. Until the time of release, 21jingji.com reporter hasn't heard initial results from SAIC and Public Security Bureau officials.

(The below text was issued as an article to GeoInvesting members on January 11, 2016).

Game Over for NHTC?

"Should the Chinese government determine that our operations violate any applicable laws or regulations, there could be a material adverse effect on our business, financial condition and results of operations."

"Because our Hong Kong operations account for a majority of our overall business, and most of our Hong Kong business is derived from the sale of products to members in China, any material adverse change in our business relating to either Hong Kong or China would likely have a material adverse impact on our overall business."

- NHTC's Forward Looking Statements Disclosure, latest 10-Q

It looks like this time may have come.

For over seven years, GeoInvesting has been sharing the truth about companies that have been operating fraudulently or misleading U.S. shareholders with the investment public. Geo's track record includes over 12 delisted companies and over $15 billion worth of market cap in fraudulent companies exposed. Our focus during that time has been U.S. listed companies with operations in China, and while Natural Health Trends is a company technically based in the United States, it conducts most of its business in Hong Kong and China, leaving U.S. investors guessing as to what is really taking place across the pond.

Today, we believe we are on the cusp of the next big collapse in China. We believe that we have found the next U.S. listed company doing business in China that will collapse and ultimately wipe out shareholders.

The linchpin that has held together Natural Health Trends Corporation's explosive growth over the last few years has been the company's growth in Hong Kong and China. The company does not have a direct selling license in China, where, along with Hong Kong, it produces more than 90% of its revenues.

Multi-level marketing in China requires a direct selling license, but for years NHTC has been doing business in China via an e-commerce platform it is running from Hong Kong without this license. The company has told its shareholders that it believes it is complying with Chinese laws in the way it operates its business, but reports from China last week, combined with evidence we'll present, seem to tell a different tale. We are confident that if the company has been found by authorities to be using an illegal multilevel marketing model in China, it could ostensibly end the business for good.

Last week, questions were raised about whether or not NHTC was under investigation by Chinese authorities. Today, we will present our evidence that the company is under investigation, and we share eyewitness accounts from our on-the-ground research that have told us government authorities were on the scene at the company's Beijing office removing computers.

We will present distributor material that we were able to source from a Chinese website that shows what we believe to be evidence that the company is running an illegal multilevel marketing company in China without a direct selling license.

All of this is corroborated by two suspiciously timed memos from the company to its Chinese distributors, admonishing them, just days after the commencement of the alleged investigation, to not use the company's name or logo when conducting business or communicating online and then notifying them of a planned suspension of NHTC's Hong Kong membership services website.

Confirming Last Week's Scattered Reports with Our Own Team

News broke in China on the morning of January 4th, as detailed in this Seeking Alpha blog that Natural Health Trends Corporation was officially the subject of a Chinese SAIC investigation. This link sourced the following text, which we have translated below:

The translation is (paraphrased):

A person close to Beijing SAIC told a reporter that the department has already obtained several major members' (members are in the Beijing district) account information on NHTC's Hong Kong website, which includes a list of over 1,000 members and consumer franchisees and these major members' cumulative profits. "Because the case is related to a large amount of money, the department is taking this very seriously. Based on materials obtained right now, this organization is suspected to be a multiple-level-marketing (MLM) and has been reported to the Public Security Bureau (a/k/a the Chinese Police)." Based on the reply notice provided by the whistleblower from the sub-division of Beijing SAIC on December 24, 2015, right now this case has already entered into the investigation process.

To the best of our understanding, the Public Security Bureau is capable of taking swift enforcement action, and the case appears to have been reported to them.

Rather than speculate, we sent our team to NHTC's Beijing office to ascertain whether the company is under investigation by the Beijing SAIC. We visited the company's Beijing's office on January 8, 2016, and interviewed an employee of a neighboring company to NHTC that was on the same floor in the same building. On our visit day, NHTC's office was closed and its employees were not reachable.

An employee of the neighboring company told us that there were a group of uniformed government officers that seized property, including several computers, from NHTC's office recently. The person we spoke to said that they did not know the nature of this governmental action.

Based on this information, we have to believe that NHTC's Beijing Office may have been visited and had computers seized by the Beijing SAIC and/or other governmental agencies around or shortly after December 24, 2015, the date SAIC commenced its investigation.

Company Tells Its Members To Stop Using Its Name On December 28th

Almost more peculiar than the report of a government seizure of computers are the company's actions in the days following the SAIC investigation that commenced December 24.

On December 28, 2015, NHTC posted a special notice on its official website that looks like this:

This memo, when translated, states the following:

Announcement: Please abide strictly to Members Rules

To: Dear Members:

Recently, there have been some member rule violations in the market. We hereby re-announce that all members shall strictly abide to the rules as follows:

1. Members shall not directly and/or indirectly recruit members from other members' system;

2. without NHTC's written confirmation, members shall not put NHTC's Chinese and/or English name or logo on any printed materials, audios, videos, internet and/or social medias (WeChat, WhatsApp);

3. In the event that any violation is found, the company will suspend the relevant person's membership, and even terminate their membership, pursuant to the relevant membership rules. A good marketing rule is the cornerstone for business development. We sincerely invite you to maintain NHTC's "Health is for the Future" company culture and jointly build our success.

We do not know the exact reason that the company posted this announcement, but it appears it may be a warning to NHTC members in reaction to the SAIC investigation in Beijing. In the event that the Beijing SAIC and/or relevant government agencies indeed seized computers from NHTC's Beijing office as part of their investigation, we find it extremely disturbing that the company told investors it is unaware of any investigation.

Snapshots From NHTC's HK Website Seem To Provide Evidence Of An MLM Model

We also believe we have found more relevant evidence that seems to confirm that NHTC is operating an illegal multi-level marketing scheme in China, where it lacks a direct selling license.

On January 8, 2016, someone posted several heavily redacted screen shots of NHTC's internal membership system on www.xueqiu.com, a Chinese financial message board website. Based upon the content in these pictures, it appears that NHTC's business clearly uses a multi-level marketing model, which is prohibited by People's Republic of China ("PRC") law and the Chinese government.

Here are the pictures, with our annotations:

These pictures seem to be taken from the account of an NHTC gold level distributor. It's easy for us to conclude that the images show a multi-level marketing model with a large downline of 1,222 members beneath this one gold level distributor, which we understand is prohibited by Chinese law.

The second picture with the URL "Agents Tree" seems to lay out the "L" (Left) area and "R" (Right) area associated with each member whose name is redacted. It appears to us that a standard multilevel marketing distribution tree is thus being depicted in the image.

In the event that NHTC has been found to be conducting multilevel marketing, it has violated relevant Chinese laws and regulations, which may have been the reason for the government's seizure of computers at NHTC's Beijing office.

NHTC Announces Temporary Suspension Of Its Distributor Website For Maintenance

On January 8, 2016, following all of this speculation and the company's crashing stock price, NHTC put up another announcement on its website that its distributor login/back end supportive website will undergo maintenance between 8AM and 2PM on January 12, 2016. However, it states that the company's Hong Kong website should still work. Here is a copy of the memo:

And a screenshot of the company's supportive website:

To the best of our understanding, this supportive website is where distributors can log in to access their NHTC accounts. We believe that the screen shots showed above were retrieved from this membership system. The timing of this website suspension for "maintenance" seems suspicious in light of the SAIC investigation and alleged government seizure of computers from the company's Beijing office. In light of the leaked screenshots of the membership support system that appear to indicate the operation of a MLM scheme, the "maintenance" shutdown of the back-end support site could be a cover for a cover-up.

Impact On Shareholders And NHTC Stock Could Be Devastating

On Monday, January 11, 2016, NHTC pre-announced its Q4 top-line results and stated that the company is "unaware" of an investigation by Chinese authorities, but did admit that "By January 11, our Chinese employees were in direct contact with the Beijing City's government officials". NHTC did not disclose the nature of these employees' "contact with Beijing City's government officials". We believe the company's claim to be false. Our research indicates that an investigation is well underway and NHTC may be engaged in a futile attempt to conceal it.

Regulatory action in China is probably the biggest possible negative catalyst that the company can face. We know this not only because the company did over 95% of its business in China and Hong Kong over the last quarter, but also because NHTC warns its investors and shareholders time and time again in its filings how crucial its HK/China business is and how devastating it would be if it were negatively affected by regulatory action.

The first page of NHTC's latest 10-Q includes lots of relevant language warning of all of the bad things that could happen to the company and shareholders relating to the company's operations in "foreign markets". Since NHTC does 95% of its business in China/Hong Kong, one can assume this is the main "foreign market" the company is referring to in its Risk Factors.

The filing also makes numerous statements describing the fragile nature of the China/Hong Kong business, like this one:

We believe that our China e-commerce retail platform operates in compliance with current laws and regulations in China. Further, after consulting with outside professionals, we also believe that our e-commerce direct selling model in Hong Kong does not violate any applicable laws in China, even though it is used for the internet purchase of our products by members in China. There can be no assurance, however, that the Chinese authorities will agree with our interpretations of existing laws and regulations or that China will not adopt new laws or regulations. Even if we are successful in obtaining a China direct selling license, our operations will remain subject to the uncertainties inherent in the complex regulatory environment in China.

Should the Chinese government determine that our operations violate any applicable laws or regulations, there could be a material adverse effect on our business, financial condition and results of operations.

The same filing shows that 95.9% of the company's business comes from China and Hong Kong:

On Chinese websites, there have always been some rumors that NHTC is conducting illegal multilevel level marketing in China. NHTC and/or its distributors have also put out some Chinese articles to argue that its business model in China is not based upon illegal multilevel marketing.

Regardless, the company seems to be in a fruitless pursuit of a direct selling license in China. In NHTC's 10-K, it states:

To augment our business in China, our Chinese subsidiary applied for a direct selling license first in 2005, provided a revised version in June 2006, and then updated again our application in November 2007. After the approval from the municipal and the provincial authorities, the application did not progress further with the central government. Eventually, the information contained in our most recent application became stale and we withdrew the license application in February 2009 with the intention of filing an updated application in the future. (2014 10-K)

In the 2015 Q3 NHTC earnings conference call, the company's president, Chris Sharng, announced as follows:

We have initiated a process for submitting our direct-selling license application in the Chinese province of Guangdong. We are hopeful that a license will enable us to drive incremental growth by leveraging our growing brand recognition in China as well as our Hong Kong distribution infrastructure. The timing for obtaining our direct-selling license or whether we can get one is uncertain. In the interim, we will remain highly focused on managing all aspects of our core business. (2015 Q3 NHTC earnings conference call)

These continued disclosures point to a company that has had no success in obtaining a direct selling license. In 2015, NHTC submitted a new application again.

But that likely won't even matter.

If the company's Beijing office indeed had computers seized by the government, and if the company is now taking steps to shut down, limit, or change its model in China, its chances of ever receiving such a license may have gotten closer to 0% than they ever were. We do not believe that, given this new information, the company will ever be able to obtain a direct selling license. Importantly, even if NHTC magically did obtain a direct selling license, Chinese law still prohibits the direct sales from being operated as a MLM scheme.

We believe that if the government has indeed seized computers and other assets from the company, that the likelihood of a total shutdown of the company's China business could be the next step.

The company has already told us that the entire business basically hinges on Hong Kong/China, and so a shutdown of the business there would clearly be devastating for the company's business and its shareholders.

If the business in China is eventually shut down, we expect the company is going to have a number of legal liabilities that it is going to have to deal with, including a number of class action suits which already seem to be in the works, judging by headlines that were out last week.

We know that the company has about $7/share in cash, but if there are investigations taking place similar to the ones that have been reported, this cash position will probably be decimated by legal fees and other contingent liabilities that will arise as a result of the company's business practices. A good portion of the cash would likely also be consumed to support its membership, which is likely to threaten to leave NHTC in the event of a shutdown by the authorities.

We had begun warning investors about NTHC's story back in 2014. Based on what we have uncovered recently, we believe the company's business to be in severe jeopardy, and we would caution all investors to think about the potential scenario that may be unfolding and just how quickly it could devastate Natural Health Trends and its shareholders.

Disclosure: I am/we are short NHTC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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