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Yongye International (YONG): Is Their Story Too Good To Be True?

|Includes: Yongye International Inc (YONG)
Introduction

     Surfing the internet, you read that the last marathon was run in 56 minutes. What do you think? For anyone who follows the marathon and achievements of human endeavor, the conclusion is obvious – the report is incorrect. If the report is not a typo, it has to be a hoax. The word record currently is over 2 hours and times simply don’t improve that fast. No one is going to run under 1 hour anytime soon. Just like no one is going to lose 100 pounds in one day. 
     A similar experience can be had reading the financial reports of Yongye, filed with the SEC. Yongye International (Yongye) reports increasing their branded stores from 200 to 18,700 in 2 and ½ years, from January 1, 2008 to June 30, 2010. Yongye claims that it didn’t sell its first product until April of 2005. Then Yongye reports going from $3.7 million in sales in 2006 to $95.8 million in 2009 to $114.3 million for just the first half of 2010. The revenue and growth primarily come from one product, fulvic acid, which they sell to farmers. The second product, fulvic acid as a nutrient for cows, has negligible sales that are dwindling. This claimed growth came while only increasing employees from 197 on January 1, 2007 to 399 on January 1, 2010.
     Oddly, Yongye refers to their branded stores while, at the same time, reporting that these stores are independently owned and operated. According to Yongye, they paint these stores owned by others in Yongye’s colors and drape the front of the stores with Yongye’s banners. Yongye claims to provide the stores with a computer to run their promotional material and receive premium staging for their products. Yongye claims that their own sales and support staff manage the relationships with the stores, overseeing 3 to 10 stores per salesperson, walk the fields with the farmers, provide training and education and after sales support to the farmers.
     What do you think? For anyone who follows business and its achievements in expansion and growth, can this story be anything other than a complete hoax, like the story of the marathon being run in 56 minutes? Let’s review some of the general problems that come to mind and then delve into specific problems with Yongye.

The Fertilizer Business in China is highly Competitive, With Large Competitors and Skeptical Customers 

    The fertilizer industry involves a commodity product that has been studied for many, many years by large companies that have been in business and dominant for a long time.  It is a highly competitive industry.  Regarding the particular fertilizer Yongye makes, fulvic acid, Yongye reported over 164 companies in China making and selling the same product, with five of them adding the exact same nutrients Yongye does. Yongye identifies humic acid as a very similar, competing product and reports over 500 companies in China making and selling humic acid. Yongye reports it is competing with all companies that make fertilizer, of which there are thousands, if not tens of thousands in China, including very large, dominant companies.
                The customers of Yongye’s products, Chinese farmers, are notoriously difficult to sell to, especially for any new companies claiming to sell new products. Farming has been done for thousands of years in China. The farmers believe they know best how to farm and are very resistant to any change or new products. The farmers are also notoriously thrifty and unwilling to spend money. The farmers are very cautious about changing their methods or trying new or different fertilizer, for fear of unknown effects.
                 Obtaining shelf space in agricultural stores is difficult for a newcomer to the fertilizer business. A large competitor, such as Sinofert, who sells millions of tons of product, compared to a few thousand by Yongye, has a huge advantage. In the event a newcomer could get shelf space, it is likely that any premium positioning will be given to large, well known fertilizer companies like Sinofert. While shelf space will be difficult, it would be well nigh impossible to get many store owners to allow another company to paint the outside of the store in its colors or hang its banners on the front of the store.   

Problems with Yongye’s Story

     The Current Executives Have No Background in the Fertilizer Industry

     Despite Yongye’s primary product being fertilizer, the officers of the company have virtually no experience in the fertilizer industry. The bios of all the executive officers, including the CEO, Vice Chairman, CFO, VP of Sales and Marketing, and the VP of Corporate Strategy, do not indicate any previous experience in the fertilizer field. The only exposure to even the field of agriculture is only in the bio of the CEO, where there is a vague reference to Mr. Wu being appointed to various managerial positions of state owned conglomerates in textile, diary (diary is the spelling in the filing), and agriculture industries. There is no identification as to when he had any managerial position in any agricultural entity or what he did. The only person that claimed any background in fertilizer was the chief scientist, Professor Goa Jing, who is no longer with the company. 

The Mysterious Creator of ShengMingsu and His Curious Disappearance

     According to the CEO, Mr. Wu, his good fortune began on the day that Professor Jing share with him the formula for Shengmingsu, which Professor Jing devoted 40 years of his life creating. The two co-founded the company together and the rest, as they say, is history. But this history was not so good for Professor Jing.
Professor Jing apparently parted with his life’s work, without any reported compensation. Professor Jing did not receive any stock in Yongye, not a single share. Professor Jing also never received any salary for the position of Chief Scientist that he held in 2006 and 2007. By 2008, Professor Jing was replaced at Yongye as Chief Scientist without any explanation. The only detail reported of the incident was that he signed a non-compete agreement for no reported compensation. He was replaced by a Chief Scientist with a background and expertise in . . . .  animal nutrition and husbandry.
     Moreover, the story about Professor Jing and the creation of the formula appears quite doubtful. Professor Jing’s bio reveals very little experience in the fertilizer industry. Prior to co-founding the company in 2003, Professor Jing was the Deputy Director at the Petrochemical Research Institute of Inner Mongolia between 1982 and 2001. The only experience referenced in his bio regarding fertilizer is a stint as Deputy Production Director For Wumeng Fertilizer Company, but the year(s) he spent in the position are revealed. 
     In any event, as Yongye admits, fulvic acid is a commodity product produced by many companies, so it was unnecessary to tell this elaborate story about Professor Jing devoting his life to finding a special formula. Anyone can find how to extract fulvic acid from humic acid from simply searching on the internet and start producing it a short time later.

     Fulvic Acid Fraud? California Bans the Use of the Term Fulvic Acid in Product Advertisements

     Fulvic acid is one of the modern day snake oils. Do a Google search on “fulvic acid” and there is no end to the promises of this “miracle” molecule. Ingest “fulvic acid” and there is no end to the magical effects - you will have increased energy, improved concentration, increased sense of well being, faster healing time, and improved healing. Virtually any positive effect you can think of is claimed. Need a cure for cancer? Fulvic acid is the answer says some of its promoters.
     Want super growth for plants? Fulvic acid again is the answer. Go to www.super-grow.biz/fulvicacid.jsp and super-grow plant care will explain and sell it to you. Google “fulvic acid plant growth” and you will find no end to the number of companies touting and selling fulvic acid as the new “miracle grow” for plants. 
Yongye is one of these companies making claims that fulvic acid will result in super growth, except that it sells its product solely in China. Yongye claims crops will grow so much bigger and faster with fulvic acid that customers will make 1000% return from buying their products. That’s right – 1000%.   Yongye claims that internal studies show that for every 1 rmb spent on Yongye’s products, customers will get a return of 10 rmb.   
     There is just one problem. There is no evidence that fulvic acid is a “biostimulant” that causes quicker or increased plant growth. California has banned the use of the term fulvic acid, along with its claims of being a “biostimulant”, as misleading, citing a lack of evidence supporting the claim. Yongye would be prohibited from advertising Shengminsu in California the way it claims it does in China. Oregon also has the same ban.
     How did these unsubstantiated claims for fulvic acid come about? Well, it is commonly accepted that adding organic materials to depleted soils can be very beneficial. No dispute by anyone there. The natural way is composting dead plants, which creates organic material rich in humic acid and fulvic acid. Mixing this organic material with your soil can improve its quality and structure.
     However, in order to short circuit the process, humic substances have been extracted from other substances, such as lignite coal, to be added to the soil for the same effect as composting materials. Some studies have found that humic acid does improve plant growth. However, those studies have not been repeatable. It appears that about half the studies show improvements, half don’t. The studies that appear more rigorous show no improvement. California allows humic acid advertisers to represent only that it may increase plant growth. Even if there is no stimulant effect, adding humic acid may have some benefit to improve the structure and quality of the soil. 
     Fulvic acid is the only active substance in humic acid, so it has been extracted from humic acid, advertised as having greater, more immediate effects, and sold. However, these claims are unsubstantiated.   Many important benefits of humic acid are not present when fulvic acid is extracted. Not only are the benefits of humic acid lost, but the benefits of fulvic acid which exist when still contained in humic acid are lost after it is extracted. Many of the large fertilizer companies either don’t sell fulvic acid, or, if they do, it is a very small fraction of their sales.
     It is unlikely that Yongye is getting experienced, skeptical Chinese farmers to fall for its claims regarding fulvic acid and start purchasing it for their crops. Furthermore, fulvic acid is a commodity product, with many other companies making and selling it for much longer than Yongye, so it would be very unlikely that Yongye would suddenly have extraordinary margins and growth that none of its competitors are sustaining.
 
     There is No Growth like Yongye Growth
     
     Yongye claims to have grown from 200 branded stores on January 1, 2007 to 9100 on January 1, 2010 to 18,700 on June 30, 2010. They call them their branded stores but describe them as independently owned and operated. This growth is simply not possible as described by Yongye.
     Let us just focus on the period from January 1, 2010 to June 30, 2010, during which Yongye claimed to have gone from 9100 branded stores to 18,700 branded stores, an increase of 9600 branded stores. For this six month period, this would be an increase of 52 branded stores a day.
     Assuming Yongye lived up to its earlier representations of a computer for each store, along with training, education and after sales support, what would this involve? It would require, on average, painting 52 stores a day, hanging banners on 52 stores a day, and purchasing and installing 52 computers a day. Furthermore, Yongye would need to continue to provide training, education and after sales support at the previously existing 9100 stores, as well as to a new 52 stores each and every day.
     The size of Yongye’s sales and support staff is simply not sufficient to support these functions. As of January 1, 2010, Yongye reported having 100 sales and support staff but to perform all of these functions would conservatively require about 3000 staff. Regarding adding the stores, if it took only 10 people to add a store very three days that would be over 1500 sales and support staff. Even with that number, it would be virtually impossible because you would first need to convince the new stores at an unbelievable pace, solve a logistical nightmare of getting the people and materials to each store, and do all the physical labor of painting, putting up the banners and installing the computers. 
     Meanwhile, you need a large number of sales and support staff to remain to do the training, education, and after sales support, for which you would conservatively need at least another 1500 employees.  Yongye claimed that each sales manager oversaw 3 to 10 stores at a time. Assume the number is 10 and give each manager 1 assistant; you then have 2 sales and support staff for each store. That would require 1870 sales and support staff for these functions. Of course, that number is unrealistically low. Assuming 20 working days in a month, that gives each sales and support staff only 2 days a month for each store to do training, education and after sales support.
     So, very conservatively, Yongye would need over 3000 sales and support staff to perform the functions they claim at the growth they claim. Perhaps they recruited contractors and distributors to assist. However, Yongye provides no indication in their financial reports or SEC filings that they had anywhere near that number of contractors or distributors assisting with these kinds of tasks. 

Yongye International Claims to Be Selling More Than They Have the Capacity to Produce

     Yongye is its only manufacturer. It does not purchase the product it sells from anyone else. Yongye reported that the capacity of its production line was 10,000 tons per year for its plant product. However, Yongye reported selling more product, over 10,000 tons, in the first half of the year, than it has the capacity to produce in an entire year.
     The excess did not come from a sell of off inventory. Inventory only dropped from $42,033,261 on January 1, 2010 to $41,437,200 on June 30, 2010. This very small drop would not account for selling more than twice the amount that Yongye could make in half of one year. 
     Likewise, Yongye’s report on July 19, 2010 that it recently increased capacity from 10,000 to 15,000 tons per annum would not account for the difference. Putting aside the credibility of this claim for the moment, this increase was evidently not in place as of April 2010, since it the capacity at that time was still listed as 10,000 tons per year in an investor presentation. Thus, any increase in capacity only occurred either at the end of or shortly after June 30, 2010 and had little or no impact. Even if it had occurred earlier, the capacity would still only be 7500 tons for the year, well less than the over 10,000 tons reportedly sold.
     The announcement of the increase in capacity due to streamlined production and updated equipment was quite a surprise, casting some doubt on its credibility. Yongye had, on numerous occasions, indicated that the entire capacity was 10,000 tons per year with that equipment, without every mentioning that it could be increased or was in the process of being increased. No mention of it in the annual report for 2009, in the first quarter report, or in the investor presentations, the latest of which was in April 2010.

Conclusion

     As the CEO, Mr. Wu, puts it when describing his previously failed business career, “dreams are beautiful, reality is harsh”. Yongye International is selling a dream to investors; the intent of this article is to explain the harsh realities. The dream is a miracle product providing returns to customers of 1000%, resulting in sales for the company that is growing at an incredible rate as a result of innovative marketing. The reality is a modern day snake oil product with little chance of anything but ordinary gains in a highly competitive industry with experienced, skeptical customers. The marketing success here is the sales pitch of Yongye to those who buy their story.   

P.S.

There are many problems the article didn’t discuss. Here is a brief summary of some of these problems:
     (1)    The complicated company structure making it difficult to hold anyone liable because Yongye only owns Fullmax, a virgin islands’ company, that only owns Asia Holding, a Hong Kong company, that only owns 90% of the operating entity, Yongye International, in a joint venture with Inner Mongolia Yongye;
     (2)    Yongye’s failure to have positive cash flow from operations in any year it has reported;
     (3)    Yongye’s agreement to buy the manufacturing operations from its predecessor owned in part by Yongye’s CEO, then paying $9 million in goodwill on a total purchase price of $16 million;
     (4)    the accounting firm changing every year – 4 different accounting firms in 3 years;
     (5)     A business that pays in advance and timely to its suppliers but provides terms for its customers to pay 3 to 6 months after receiving the product.

Disclosure: Short YONG.

Disclosure: Short YONG