China Expert Technology: Return To Prior Trading Range Unlikely

| About: China Expert (CXTI)
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Only months ago, I thought that China Expert Technology (CXTIE.OB) had bright prospects. The Chinese e-government service provider had announced a series of large contracts and appeared poised for a profitable year. After CFO Simon Fu resigned, shares took a huge tumble. Sensing a bargain, I dipped my toe in the water. I was encouraged initially by CEO Huang (Michael) Tao’s press conference, which appeared to be forthcoming. That was then.

Now Tao and the rest of the CXTI gang have ceased communications with the investor community and are delinquent in their SEC filings. They had to promote an insider to the CFO position, perhaps an indication that no qualified outside candidate would accept. Major holder JLF Asset Management has slashed its holdings.

I know from your emails that many of you view this as an asymmetrical bet. Here’s your hypothesis: at current prices, it can only go down $0.68, but any good news or even a cessation of selling could lift shares much more than that. I agree, but here’s the rub: as time goes on it becomes less and less likely that this turns out well.

A few random thoughts to consider:

1. History rhymes. Yes, I realize that approximately two years ago, CXTI plunged to well under $1, only to recover and eventually move to fresh highs. But there are critical differences. That drop only lasted a few days and did not have nearly the volume of this one. Moreover, the prior drop in my view was caused by the overhang of a toxic convertible offering. This one is a different animal, propelled by fears that the entire company could be a hoax.

2. JLF, JLF, JLF. Many readers believe that this was prompted by a margin call at major holder JLF Asset Management. After a little research, this theory appears to be wishful thinking. Last week, JLF had around 4.5M shares. At $2, that is less than a $10M position for a fund with holdings last reported at $674M.

Other theories posit that JLF learned inside information from former CFO Simon Fu, who has since taken a position with HollySys (to be acquired by another JLF holding, Chardan North China Acquisition Corp. ). I have my doubts. Selling on inside information would obviously expose JLF to enormous legal liability. At the same time, I don’t think that JLF would allow Fu to take the helm at HollySys if it believed that he operated a hoax on them. JLF now owns exactly 5% of outstanding CXTI shares, after sselling over 2.6M shares on 9/10/07.

3. The Contracts. Blogger Cabeza Howe, who is fluent in Mandarin and appears to be very balanced in his views, was unable to confirm the existence of any of five contracts he investigated. Note that most of these contracts are attached to SEC filings. Is it possible that they were made up out of whole cloth?

4. BDO McCabe Lo. CXTI’s auditor that signed off on the last 10-K was the asian arm of respected BDO Seidman. The 3rd Standard for Field Work under Generally Accepted Auditing Standards (GAAS) requires auditors to confirm the reliability of financials with “sufficient competent evidential matter” to be obtained through “inspection, observation, inquiries and confirmation.” It seems to this layman that BDO would have had to confirm at least some of the contracts and operations, but I have no idea whether or not this occurred.

5. The Website. It's a joke, which would be a problem in any case but is worse here because CXTI is supposed to be a technology services company. Also, IR company Hayden Communications resigned due to its inability to communicate with the company.

All of these facts point to two possible scenarios: (1) the company and contracts really exist but the company has decided to cease communications with investors, perhaps to conceal fraud raised when Fu resigned, or (2) the whole thing was a hoax. The only certainties are that CXTI will not go lower than zero, and that it will soon be trading on the pink sheets. A bounce is likely here, but a return to its prior trading range is not.

DISCLOSURE: Long CXTIE.OB (a small but regrettable position).