Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Interview with Marco Ku, CFO of CMFO

|Includes: China Marine Food Group, Ltd. (CMFO)

I had the chance to sit down with Marco Ku, CFO of CMFO this morning. 

Zack: What is Hi power? What is in it?

Marco: Hi power is an algae extract. It is colorless, has no smell, and no taste.  We put other things into it into a can with the algae to make the Hi Power. 

What were the total revenues and net income so far by quarter for Hi Power?

In 2009,  Qiu  had 7.5 million for 2 quarters, about 4.5m in Q3 and 3.0m in Q4.  The reason for this drop in q4 was that q3 is, the summer, is peak selling time.  Q1 2010 revenue was 2.7 million, Q2 is currently over 7 million (latest update from sales team). The rest of 2010 will be about 10 million which should be able to achieve without doubts. The net margin is 20-25% for these products. 

Explain Hi Power to me in terms of:

Total number of cans sold?

In 2010, we should sell approximately 60 million cans. 

Price Per can?

3.50 CNY per can in retail. 2.30 CNY is the wholesale price.  That is about $.34 USD for the wholesale price.

How does the distribution work?

We hired sales expertise from other beverage companies. They have good relationship with distributors in respective areas. We leverage their experience and relationship to spread out our products quickly through strong distributors with extensive network.

How many retailers?

In Fujian, over 10,000 retail points at this moment which include retail food stores, convenient stores and strong concentration on small “corner” stoes, bars, restaurants.

I did a little math:

10,000 retail points with 60,000,000 cans sold means 6,000 cans per retail point?  

So in cans per day?

16.5 cans per day per retail point.  It is also important to consider they can be sold in larger cases, such as 24 can cases. 


Approximately 1.5 cans per hour

We have consulted market players for their expertise.  Marketing plan is on the benefits of algae. 

I am trying to look at the economics of the business on a per can basis.  Let's try an explain this to a 3rd grader

COGS of the can?

Packaging material is 60-70% of the total cost.  The rest comes from overhead, extract, and water.

 So if the wholesale of a can is $.34, this would be about $.20 per can in packaging material

Raw material and packaging cost per can?


Sales and marketing cost per can


Fees paid to bottlers per can?

About 0.2 RMB per can. We provide them with can, extract, flavor and packaging box. They do the bottling according to our formula and then pack into boxes.

Net Profit margin per can?


The Gross profit is 40%, the bottom line is 20%.  In between the SG&A will be 20%, most of it will come from sales and marketing. 

Explain the bottlers? Who are your bottlers? Can I speak with them about the volume they have been producing?

The bottlers are a private company, right now we have bottling facilities to work with us. We can arrange a visit when you are here. 

Who are the auditors?

ZYCPA.  We would allow you to consult them. They both come from Hong Kong and KPMG.   

What is your response to ZYCPA being in a number of other frauds besides being an auditor for CMFO?

I knew of this last year.  We are still waiting for the court to judge the guilty parties.  The auditors (ZYCPA) still claim to be innocent.  Our promise to investors is that we will switch to a different auditor.  New auditors will be used for the 2010 financial statements. Most likely a 2nd tier firm which would be a top 10 firm. 

Why were your SAIC documents different from your SEC documents?

It is tedious to file with the government.  They need to supply documents, ask for specific things, and it is very difficult.  Most companies try to use an agent firm to file these with the government.  I didn’t

do it myself when I ran my personal business based in Beijing some years ago because it is too tedious to do all the filing.  If you pay an agent it can be done without headache in a few days.  CMFO used an agent, paid a fee and got the business license done.  In the process, the agent doesn't care whether you earn how much or whether you lose money.  They just care whether your company is in operation.  The agent firm doesn't ask us for audited reports.  y.  We pay the fee and get the license back.  When I realized that the public can somehow access SAIC documents, ,we  immediately asked my team to do the filing on their own instead of agent firm.  That is why in 2009 the numbers will be consistent once realized people could go see their numbers. 

Should there be differences between SEC and SAIC for accounting

They will be slightly different for several reasons.  We filed based on a company basis for the PRC versus a consolidated basis for the SEC . Because the PRC documents are audited under PRC GAAP, there will be some small differences.  The SEC is primarily revenue recognition, because  US GAAP uses revenue recognition, while PRC GAAP is based off of invoice, where in China income is based off of the collection or the receipt.  The difference can be anywhere between 5-10%. 

Why is the SAIC not more furious with your reporting?  I can't imagine the Chinese government likes being lied to?

Probably, to be fair I have no idea.  We don't deal with the agent frequently.  We just tell them I need a new business license.  The most important is the filing with tax authorities. From what  we understand, SAIC does not focus about the earnings or the P&L statement, they just focus on the operations the operation of the company and require a set of other supporting documents to demonstrate this. . 

Why didn’t they just develop a beverage themselves?

We don't have the technology, how to extract those materials from the algae, it is not easy to redo.  it took them a couple of years to develop .

So why was this valuable patent sold for less than $10,000?

Their responsibility is to develop a tech and sell it to companies to commercialize it.  At the beginning, they don't know if it will be a successful project.  They have lots of formulas and patents, this is only one of them.  Mr Qiu is a very smart guy, he chose a very good one and he has been very successful.  At the beginning, no one could tell that it would sell 20 million in the first year.

Why was the capital raise necessary? Given the profitability of business and current plans for cap ex, couldn’t they have financed themselves?  Did they just want a warchest?

After the acquisition, our cash level would have been down to a very small level.  And we thought it was a good time to do the raise in order to replenish working capital needs.  If we wanted to purchase raw materials in bulk, we would have to use a bulk of cash to turn them into inventory. 

Let's walk through the allegations from the acquisition:

So it only cost 8,776 for the algae-based drink know-how?


Why was no rent paid for office space?

Actually, at that moment of time we did not have a relationship.  We provided limited office space which the young company used to focus on sales and book customer meetings on the phone and via e-mail.  We did this to build a relationship and know more about the operations of the new business because we were very interested in that business.

Why did CMFO apply for the trademarks?

Mr Qiu would like to apply for a trademark, and had little expertise, know how or time to do it  himself.  It is a pretty tedious process and requires a lot of forms, suppoting documents, time in the TM offices and frankly,  a good deal of follow up. .  We have experience with applying for trademarks, and so we said we could to do it for Mr. Qiu, it was only a few thousand rmb. .  It was similar to renting space in that it helped us further build the relationship. 

Why $414 for PP&E? What comprised that $414? I would like to add that Coke, while a somewhat different business model, has 9.5 billion in PP&E so the Sales:PP&E ratio is approximately 3:1. Pepsi has 12.7 billion in PP&E compared to 43 bil in sales, so the ratios are similar for both companies. 

The $414 could be a single computer or a printer, Hi-Power does't need any equipment.  We only need a few computers for Hi Power, some of the people bring their own.  Most employees go out to the distributors and points of sale all the time, they seldom go to the office.  They don't really need those fixed assets like bottling plants, distribution centers, huge office space, trucks, vending machines etc.   It would be nice to get there one day,  but this level of fixed assets was the reality of the business at the time we audited it.

A lot of companies in China will hire those bottling facilities to work with them.  Most bottling companies have that kind of arrangement.  Going forward we will have our own facilities and some of them will use the OEM facilities.  At that point it will be a mature company. Coke and Pepsi will need different things because they are different businesses.  We just need office equipment and computers. 

Is it basically a sales and distribution company? With a 3rd party bottler and 3rd party manufacturer

Yes.  We have the formula, trademark, and brand name, and use the OEM to do the beverage and what you have to do is select distributors to use so that your product can be spread to multiple retail points. 

Why is their only 11,000 in inventory? What was it made up of? Coke inventory is 2.3 billion with sales of 31 billion so the ratio is 15:1 in terms of sales:inventory.  Pepsi inventory is 2.6 billion with 42 billion in sales.  So coke and pepsi have similar ratios.

The 11,000 is for raw materials.  We use just in time methodology for our supply chain.  We just purchase the raw materials including cans, extract, and packaging materials and send them to the 3rd party bottler.  We only buy when we receive purchase orders.  So we then send raw materials to the OEM facility.  When production starts, the raw materials will be used up. After production, we do not have really any inventory.  In addition, we and our bottlers do not have space for many raw materials.  The raw materials are readily available in the marketplace so we can purchase them quickly.   

The most expensive raw materials are the packaging materials.  Apart from that, it will be the extract for the algae.  The raw materials are cheap, and when we have to order cans for a production run, we submit the order and they deliver they empty cans to the bottling facility. The third party bottler doesn't allow us to store a lot of raw materials into their warehouse. 

So you purchased Hi Power for about 30 times book value?  For reference coke is at about 5 times BV now.  Book value is not that meaningful in this acquisition as we’re not buying its assets but all about intangibles like formula, brand, distribution network and people.

Our projected eps in 2010 makes the forward pe ratio about 8 times.  If you use 2009 numbers then yes it would be 30 times book value.

CMFO can sell 60 million cans, how can this happen in the first year without any experience in the beverage industry or established branches, offices, and locations?

In China, another example is the Wang Lao Ji herbal drink.  I know them because they only have a single product in China. The revenue is 18 billion RMB, 2.5 billion USD.  I just want to tell you that the drink market is too huge for us to capture.  There is 1.3 billion people, so actually the market is too huge.  The drink market is fast moving in terms of the consumption market.  It is an unpredictable. 



Disclosure: no position