As I stated in my report dated May 31, 2013, Every Day Is Independence Day For CPAs, Longwei Petroleum is indeed a thriving business that was defamed by short seller Jon Carnes, AKA Fatty Boy Carnes, and his gang at GeoInvest.
A preliminary settlement was reached on 2/9/16 after a costly three year legal battle. Toups, Cole and DeCiccio will pay $1.34M for understating Longwei's assets by $32M, due to an unrecorded investment in a tourism company. Overstating assets, not understating, is fraud. Understating assets is negligence and a bonus to shareholders as it increases equity. Longwei will pay zero, as their sales were correct as filed.
GeoInvest claimed that Longwei overstated their sales by a factor of 800 times. GeoInvest reported the sales of Longwei Economy and Trading, a subsidiary that consists of a few gas stations, and omitted the sales of the main company, Longwei Petroleum. Here is an excerpt from court proceedings:
MR. COSTANTINI (attorney for auditor): One is that a tax official said that the tax filings in China did not match the filings with the SEC. First of all, different company. Didn't say this about Longwei Petroleum, but said it about Longwei Economy & Trade, which is a subsidiary, but there is no explanation of the relationship between the two at any place in the complaint.
More from court proceedings dated April 24, 2014 (See 173 Transcript of proceedings, pages 5-6, from link).
MR. COSTANTINI: What I am going to do is address each 8 of the signs of fraud that your Honor cited in his opinion. 9 One sign of fraud that your Honor cited was that 10 Longwei was more successful than other companies. And you 11 asked me, what is the auditor's duty and obligation to compare 12 how they do vis-a-vis their competitors and other companies, 13 and there is no obligation, nor is there one stated in the 14 complaint. Indeed, other district judges have concluded that 15 there is no obligation. And a number of not only district 16 judges, but the Second Circuit itself in Chill said that this 17 factor, even if true, is not a red flag. That was the first 18 red flag that your Honor pointed to. 19 The second red flag that your Honor pointed to was an 20 undisclosed $32 million investment in a tourism business. But 21 the complaint doesn't allege that the auditors knew of that 22 investment. And it's an off-the-book transaction that's not in 23 the financial statements. Maybe it's something the auditors 24 should have caught. But that would be simple negligence. That 25 would not be a fraud. And, indeed, if it was known, it would SOUTHERN DISTRICT REPORTERS, P.C. (212) 805-0300 Case 1:13-cv-00214-RMB-RLE Document 173 Filed 04/24/14 Page 5 of 27 E4EMLONC 6 1 have inflated the financial statements even more. They would 2 have had a greater balance sheet by adding $32 million in 3 investments. 4 THE COURT: But it wasn't a fraud. 5 MR. COSTANTINI: That's what I'm saying. It could not 6 possibly be a fraud. But even if it was a fraud, there is no 7 allegation that the auditor knew about it. 8 The third point that you make, and I think is the one 9 that requires the most discussion, is the fact there is a short 10 seller report six months after the last audit, the date of the 11 last audited financial statements, and that short sell report 12 suggested that facilities were idle and made other negative 13 statements. And you have to have a basis to go back with that 14 short seller report and say that must have applied when the 15 audits were being conducted.
The current book value of Longwei Petroleum is about $6.50 per share. Their July 2016 Facebook article (see 4, 5 below) indicates that the "government-guaranteed" gross profit margin will not affect their net profits. In fact, net profits may increase as companies buy more oil during times of low prices.
4. Price target of a high-dividend-paying company can be determined by the magnitude of yield, or percentage of annual dividend divided by stock price. A yield between 5% and 7.5% is applicable to Longwei since it has a strong balance sheet, a projected growth rate of 15-20%, and a simple business with government-guaranteed margin.
5. Using a dividend of $0.30 and a yield of 5%, Longwei's upper-bound price would be $6.00 if remained listed. Based upon a dividend of $0.30 and a yield of 7.5%, Longwei's lower-bound price would become $4.00 if remained listed.
The Facebook article states that they have unreported income of over $250M over eleven quarters, as of July 2016. They had planned on paying an annual dividend of $.30, but GeoInvest's article beat them to the punch. After all, put options have a limited shelf life.
Longwei still has this lawsuit, which I understand is back in play.
To top it off, the Geo gang is still short millions of Longwei shares. Frankly, I don't think they have enough money to cover their shares, considering that there are only a few million ADRs in the US. Carnie is hiding out from the US authorities in Canada, but he may now have to move farther into the woods to hide from the broker and financial regulators. When news of the settlement hits, this should get very interesting.
Disclosure: I am/we are long LPIH.