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Is Lihua International Cooking its Books? Part I

|Includes: FSIN, Lihua International Inc (LIWA)
In one of my previous posts, I discussed Lihua International's very interesting business. Lihua International (NASDAQ:LIWA) tripled its revenue in Q2 2009 vs. Q2 2008, and its net income also doubled. Lihua's business does not seem to have much brand equity and technical barriers, but it is commanding a staggering 65% ROE. Lihua's price over book ratio is a whopping 6. 
Lihua International reversely merged into a shell company set up by Broadband Capital Management principals last year. It then had a low-profile IPO of 2 million shares at $4 on September 4th, 2009. Merely 18 days later, the company filed with SEC for resale of 9 million secondary shares in the open market, which went into effect on Sep 29th. 
On Oct 11th, a little more than one month after the IPO, and half a year since appointed, Mr. Su Liu, an independent director, resigned, making Lihua International in danger of being delisted from Nasdaq

Effective October 11, 2009, Mr. Su Liu, an independent director on the Board of Directors of the Company and a  member of the Audit, Nominating and Corporate Governance and Compensation Committees resigned from the Board of Directors.  No executive officer of the Company is aware of any disagreement between Mr. Su Liu and the Company on any matter relating to the Company’s operations, policies or practices.

Su Liu's short bio can be found on Lihua's website

Su Liu, Independent Director. Mr. Liu has served as an independent member of our Board of Directors since April 8, 2009. Mr. Liu is a Lawyer in the PRC and has been a Partner at Beijing Zhongying LLP since 2006. He was a Partner at Beijing Zhongkai LLP from 2002 through 2006. Mr. Liu attended Beijing University.

The early exit of the independent director does not sound right for a new IPO company. All three committees, auditing, nominating and corporate governance, and compensation, are composed of Mr. Liu and two other independent directors. Mr. Liu was the chairman for the nominating and corporate governance committee. Remote in Beijing, a full time lawyer, and owning only 5000 shares, Mr. Liu may find himself barely influential on the corporate matters. Nevertheless, Mr. Liu should have had the right expectation when being appointed in April. But then, what prompted Mr. Liu to resign from such a symbolic role? 
It is the question that motivated me to perform research further, and my research yielded unexpected results. 

(I will be very frequently referring back to the "Prospectus", a SEC filing of Lihua on Oct 2nd. The link is here. )

A. Speeded-up Insider Share Unlock Schedule

The prospect shows that except for the CEO and other managers, ALL the external investors are able to sell ALL their shares from Sep 29th, 3 weeks after its IPO. The prospectus also shows that the CEO and other managers' share will be unlocked on November 6th, 2009, 2 months after its IPO. Compare to a typical 6 month lockup period of IPO, this IPO looks quite unusual.

The next screenshot can be found on page 23 of the prospectus.

On page 98 of this earlier prospectus, we see clearly how the stocks are unlocking:

B. Discrepancies in 2008 Revenue between SEC Filings and Local Media/Government

My research stumbled into a news piece dated March 22, 2009 from "Voice of Danyang", a local radio station in Danyang, where Lihua International is located. Its screenshot is pasted below:

[NOTE: as I expected, the company had the local radio station to remove the news piece, but there is something called baidu in China. Here is the cached link]


I am not translating the whole article, but here are some interesting points:
  1. Lihua International made 100 million RMB revenue last year (2008).
  2. Chairman Zhu claims: "We are going to accelerate our 'speed' 10 times to make 1 billion RMB this year. " 
This is NOT what Lihua stated in its SEC filing, in which Lihua claimed that it made $50 million (350 million RMB) revenue in 2008 and $33 million (230 million RMB) revenue in 2007

Another link that shows similar content is from a local government site. The content is a speech transcript of Lihua's CEO. Based on the date and content, the radio station news piece is likely based on this transcript. 

In case that Lihua would like to have the local government remove the page again, I would like to suggest that PLEASE do not bother, because the baidu cache link is here

C. Discrepancies in 2008 Purchase Amount from Fushi Copperweld 

Lihua do NOT manufacture CCA wires per se. Instead, it "primarily uses CCA wire with a line diameter of 2.05 mm, produced by its bimetallic wire suppliers, to manufacture superfine CCA wire."
Its prospectus states that "For each of the fiscal years ended December 31, 2006, 2007 and 2008, and the three months ended June 30, 2009 our five largest suppliers accounted for 100% of our total purchases, and our single largest supplier accounted for 31.9%, 26.8%, 46.5% and 21.1% of our total purchases, respectively." (page 70)
Its prospectus listed the five suppliers by name (page 70), and they are
  1. Fushi International (Dalian) Bimetallic Cable Co., Ltd.
  2. Soviet Cloud Electricity Limited Company
  3. Jiangsu Heyang Wire and Cable Co., Ltd.
  4. Changzhou Jieer Letter Composition Metal Material Limited Company
  5. Suzhou Guoxin Wire and Cable Technology Limited Company

Even though unnamed directly, Fushi International (confirmed in Q&A session in the CFO presentation in Roth Capital China Conference held on October 14, 2009) is their largest supplier. Fushi (NASDAQ:FSIN) is the largest CCA manufacturer in China and happened to list on Nasdaq as well. 

The cost of sales for Lihua in 2008 was $33 million, so Lihua purchased about $33 x 46.5% = $15 million worth of raw materials from Fushi. However, Fushi's 2008 10-K reveals that the largest customer of Fushi had only $10 million revenue (page 9). 

We don't know if the largest customer of Fushi is Lihua, if it is not, the difference between the two numbers are even higher. If we assume that the largest customer of Fushi is indeed Lihua, Lihua's purchase from Fushi is 50% higher than Fushi's number. Lihua and Fushi cannot be both telling the truth


Is Lihua International cooking its books? I will continue my discussion tomorrow in Part II and point to more evidences that could raise serious suspicions. 

Disclosure: Short LIWA, No position in FSIN