China Agritech: PIPE Dream
Board: Value Hounds
Chinese reverse mergers are under scrutiny and rightly so.
I have looked at 3 in the last 3 weeks and been the unhappy owner of Bodisen Biotech. So far, I see several common characteristics:
• The owner of the acquired active business becomes the CEO of the new foreign owned entity and the process puts a lot of wealth in his/her pocket compared to what could have been realized by remaining a PRC company
• The financing used is some of the most deleterious and diluting for shareholders: PIPE’s, warrants and constant issuance of shares for cash
• Weak cash flow and poor management of working capital
• Incomplete information on filings that would make an investor’s job easier.
Two pieces of advice when looking at any of these:
• Follow the money
• Look at several in the same segment if possible to get some indication of standards for margins, utilization and pricing.
China Agritech is a company I looked at a couple of years ago. I did not think they were good enough to buy. Trading was halted in March 2010, as they were unable to file the 10K. They lost their auditor and hired a new small not big 4 auditor--
The Company could not complete the filing of its Annual Report on Form 10-K for the year ended December 31, 2010 due to a delay in obtaining and compiling information required to be included in the Company's Form 10-K, which delay could not be eliminated by the Company without unreasonable effort and expense. In addition, the Company has dismissed its auditors and is in the process of finding a new independent registered public accounting firm to audit the financial statements for the year ended December 31, 2010.
BTW late filings are a way of life at CAGC.
The new auditor is not one of the red flag auditors like Kabani and Moore Stephens, but they are not big 4. That is not to say the Big 4 don’t ever get caught on the wrong side of malfeasance, but it is less likely
On April 6, 2011, the board of directors (the "Board") of China Agritech, Inc. (the "Company"), based on the recommendation of the audit committee of the Board, approved Simon & Edward, LLP to serve as the Company's independent registered public accounting firm, effective April 6, 2011.
Yongye and China Green have provided some data that can be used to make comparisons to yet another humic acid based fertilizer company.
So far we have seen high revenue for tons sold at YONG and extraordinarily high margins at CGA. What will CAGC tell us? We do have a company in CAGC that has the very real threat of fraud in every SEC document. Their production, revenue and margins might help point us the way to some truth about YONG and CAGC if we look hard…or not
These companies are a snake pit and in saying that we risk legal action from snakes for defamation of character
Remember all the fun we had reading the J Capital attack on CGA?
If not and if you are interested in vats of vitriol, here is the link:
CGA then spent a fair amount of time and effort refuting the report. That was in a shareholder letter here:
Initially, you might have been tempted to believe the J Capital report, but the short sellers are not coming off as any more believable than the companies.
The very same scenario has been evolving at China Agritech.
A small time blogger issued a research report
And of course China Agritech issued a detailed indignant reply:
There may be some small mustard seed of truth in either of these short seller attacks, but on the whole these short research reports do not ring of the whole truth and nothing but the truth. The rebuttals tend to lend some credence to several points in each research report.
Questions on CGA’s margins have merit as do related party transactions
L M appears to have looked at the Chinese filing for CAGC and seen discrepancies—could be true. Potential inflated revenue seems possible.
The PR rebuttals from the company tend to dignify the attacks in my opinion. They should not have taken it point by point, but simply dismissed it. They doth protest too much maybe. Makes me consider that some of the attacks hit close to home.
There is the share price to consider and the dropping price in all these companies cramps their ability to raise cash, as the issue of shares is one of the perks of being a US registered corporation. These companies have a big incentive to do whatever they can to keep the share prices high. After the press release refuting L M Research’s attack, CAGC did rise briefly.
Another Shell Game RTO
Third time is a charm. YONG, CGA and CAGC all started life as something else. YONG was a sun tan oil shell, CGA was a failed takeover of Arby’s/Mexican restaurant venture and CAGC was a mining company called Argyle.
As usual, shells are devoid of cash so a holding company is formed. Tailong gathered cash via Tailong shareholders, the nascent CAGC issued 10.6 million shares to Tailong and it became a wholly owned subsidiary and the name was changed to China Agritech. There were also PIPE’s involved in this reverse merger. CAGC sold 590K shares to private investors for $1 million.
And of course what reverse merger would be complete without a round trip? Mr. Yu Chang was the owner of Pacific Dragon acquired in 2004 by Tailong. When Tailong became the wholly owned subsidiary of CAGC, Mr. Yu Chnag was installed as CEO. Tailong got 10.6 million shares in the exchange.
Mr Chang’s path to riches is slightly more convoluted than straight sale of a private company to the foreign RTO
Pacific Dragon was the PRC company that had a fertilizer business with 5,000 ton capacity. Tailong is the holding company that bought it
However, Pacific Dragon was 10% owned by another company in entirely unrelated businesses called Yinlong. Stay with me here, Mr. Chang owned 85% of Yinlong. The acquisition of Pacific Dragon required shares to be issued to Yinlong. As Mr Chang was an 85% owner of Yinlong, he was entitled to those shares also.
What we are looking for here is big payouts that don’t reveal themselves to casual observation. Mr Chang’s salary is small by western standards--$120K initially and in 2009 around $90K. But don’t feel to bad for him. He started with nearly 11 million shares and over 50% ownership of CAGC. He was down to around 7 million shares by the last 10K filed in April 2010—loss of nearly 4 million shares. Some of those sales do not even have to show up in filing as massive dumping. In 2009, as majority owner of CAGC, he was able to endorse the purchase by China Agritech of his shares held by Yinlong business. CAGC bought him and Ms Teng out for $8 million. There was a million dollar cash payout and issuance of shares for cash to cover the rest.
Ms Teng is another insider that has done very well on this reverse merger. Ms Teng was CFO several years ago and has also made millions from shares. She was moved to director
Shares have been diluted over the years. Obscuring all the dilution is a 1:4 reverse split Sept 2009 and then a 2:1 forward stock split February 2009. Shares are at 17 million and nearly doubled since the end of 2006 when they stood at 9.6 million.
The company has used every method in its quest for cash. They have taken PIPEs money, issued warrants and issued and sold shares. Warrants are currently at 1.9 million outstanding underlying shares.
July 3, 2007-- a private placement of 5,556,000 shares of stock to 20 investors for approximately $15 million
January 13, 2006--- private placement of 4,800,000 shares to 22 investors for a total of $12,000,000.
February 3, 2005—private placement of 590,283 shares at a price of $1.6941 per share to two accredited investors, Chinamerica Fund, LLP and Gary Evans, for a total of $1,000,000.
Shares sweetened with warrants to Carlyle
Caryle is a big investor in CAGC
October 19, 2009 -- issued 2,785,536 shares and warrants to purchase up to 1,857,024 shares at an initial exercise price of approximately $5.38 per share for a purchase price of $15,000,000.
The Company met the net income target for 2009 and the exercise price of the warrants issued to the Carlyle remained at $5.38 per share with no additional issues
Carlyle Investors has a one-year right of participation in future offerings for shares of stock, debt or equity securities convertible, exercisable or exchangeable into common stock, or debt securities. The amount is for no less than $5 million and no more than $10 million. Carlyle gets to put one of their own on the board -- Zheng “Anne” Wang.
China Green and Yongye raised a few questions.
Unfortunately not much about China Agritech helps answer the questions.
Yongye reported revenue that is significantly higher than the competition and on less production. Let’s start there.
Reported revenue and production
Yongye apparently is able to sell its liquid fertilizer for significantly higher prices than either CGA or CAGC. There is no difference in the fulvic acid product. Concentrations are close and in some instances YONG has stated requirements for application needing 3X the amount of product as CGA does. But each flavor of fertilizer may have slightly different dilutions. Facts point to YONG being either nearly equivalent or quite a bit more dilute. CAGC sells a concentrated fertilizer that requires 1000 ml to 15 to 180 ml of product. No coverage is given.
With all the variations in reporting, we can look at revenue/tons to get some idea of revenue generated per ton. Since the figures are far apart it should suffice
YONG recently reported $214 million in revenue on 18,500 tons of sales.
In 2010 CGA reported $52 million in revenue and produced 22,000 tons of liquid fulvic acid fertilizer.This is prior to Gufeng.
CAGC is a little harder. They do not give the tons of liquid they produce. They started as a company with no granular and 5,000 tons of capacity for liquid. They added 8,000 tons of liquid capacity. They also went heavily in to granular fertilizer starting in 2008 and now have 2000,000 tons of capacity in granular.
Add to the problems, failure to file 2010 documents and we are making some assumptions on unproved numbers, but lets go with it. Sales of the new granular product increased 80% over 2009. Granular was $29 million in 2009. An 80% increase is $52 million in revenue
Total revenue reported unaudited in 2010 is $119 million leaving $67 million for liquid fertilizer revenue.
Since capacity is 13,000 tons and revenue is increasing I am assuming they are close to capacity as it has been 13,000 for three years
I am still convinced that YONG is one of two scenarios:
They are getting those prices, but it can’t last as competition increases. Nothing can return this much profit and stay a secret in such a competitive niche. There are hundreds of companies making this product.
They are inflating revenue.
According to business decisions by CAGC and CGA moving both of those companies heavily into lower margin granular fertilizers and away from the liquids I am going to go out on a limb and conclude the liquid market may not be all the PR says it is. Actions speak louder than words.
CAGC had margins below both YONG and CGA even before they started meaningful granular fertilizer production in 2009. As with CGA, granular fertilizers are lowering margins substantially. This indicates that liquid fertilizer growth is not sufficient and that in spite of lowering margins, they need to diversify their products
[See post for tables]
The negative CFFO in 2006 and 2007 was partially due to receivables and inventory. In 2009 prepaid expenses were terrible and you have to wonder why the company’s credit appears to have evaporated.
There are inconsistencies from company to company that can’t be resolved by looking at the filings.
Why does YONG get so much more cash for its products?
Why are CGA and CAGC going heavily into lower margin product?
Is the humic acid based fertilizer market a good place to be?
Are any of these filings reliable?
Do we believe shareholders interests matter to management based on the dilution and enrichment of insiders we see across these three companies?
CAGC has not even issued the 2010 filings, has changed auditors frequently, and trading has been halted until resolution. They are the worst of the three by far.