China-Biotics: An Investigation of Its Alleged Store Base
On August 31, China-Biotics released the addresses of its alleged store base, in response to allegations of fraud from Citron Research. Citron asked a simple question: if CHBT is reporting accurate financial statements in its SEC filings, it should be able to provide the addresses to its 100+ stores, which contributed more than 25% of revenue in Fiscal Year 2009.
After the company released its locations, a colleague and I hired local investigators to visit a majority of the disclosed locations to determine whether the the stores in fact exist.
We’ve published our findings on the following website: www.therealchbt.com
The company’s list of locations provided 80 locations. One of these locations is a repetition of a previous location, leaving 79 independent locations. We visited 43 of these locations. A China-Biotics store was found at only 2 of these 43 locations. The remainder of the addresses were supermarkets, hotels, office buildings and empty lots. There were no smaller CHBT stores-within-a-store or kiosks at any of the locations.
On our website, we have included a tab that lists all of the locations for which we have sent an investigator to, with information on:
- whether a standalone store existed at that location
- whether a store-within-a-store existed at that location
- whether the company’s products were found at all at the location
- if the product was found, where it was located.
By clicking on any given address in the stores tab, such as here, you can see further information about what our investigators found when they inspected the location, as well as pictures of the address and outside of the store, as well as a picture of any products available at the store.
The only standalone stores that we found are essentially the same ones that showed up when we searched for the chinese characters of the company’s stores (“益生有益” or click here if your browser doesn’t support Chinese fonts) in http://map.baidu.com/, http://shanghai.aibang.com/, and http://www.mapbar.com/. These search sites only yield 6-7 CHBT locations. Many of the locations released by the company referred to supermarkets like Tesco or Carrefour. Some of these supermarkets carried the company’s products on their shelves. Some didn’t. None had “stores within stores”.
The conclusion, in my opinion, is simple. The company claimed to have 100+ stores. Based on our simple visits to a majority of the addresses provided by the company, I believe that’s a blatant lie.
In my opinion, their misrepresentation of their store base is one of many pieces of false information that the company has provided in its SEC filings.
Did the Company ever specifically claim it had stores?
Yes, the company has historically claimed that it owned 100+ stores.
Here is disclosure from their 2010 10K. The company says:
“We intend to expand the sale of our retail products to the other metropolitan cities in China through a combination of traditional distribution channels and dedicated Shining outlets. We have a total of 111 outlets as of March 31, 2010.”
The company makes a specific distinction between “traditional distribution channels” and “dedicated Shining outlets”. I don’t think shelf space at a Tesco supermarket is what investors typically have in mind when they read “dedicated Shining outlets”. Elsewhere, the company refers to its outlets as stores. See this press release from third quarter 2010, where the company announces the opening of “four new retail stores”. Or here, where they claim that in 2008, they “opened 51 new Shining-branded retail outlets, bringing the total number of stores to 60”.
Even in the press release announcing their investor day, the company promises visitors a “tour visiting China-Biotics’ retail stores”. A more accurate statement would be a “tour visiting China-Biotics’ shelf space”.
Are the stores a material part of the company’s business?
Yes, the stores have historically been a material part of the company’s alleged business.
Here is a breakdown of the company’s alleged sales based on distributors versus “retail outlets” for 2008, 2009 and 2010, according to its SEC disclosure.
The company generated more than a quarter of its sales from its retail outlets in 2009. Click here for the relevant disclosures from the 2008, 2009 and 2010 10Ks discussing the company’s share of sales from distributors, as compared to “retail outlets”.
Note that the company doesn’t specify whether distributors refer to distributors for only the retail operations, or for both the retail and bulk additives operations. In the above table, we’ve given the company the benefit of the doubt, and assumed an interpretation of the company’s SEC filings that minimizes the company’s sales from retail outlets.
Further Fabrications in SEC Filings
Our store investigation demonstrates that the company likely only owns 6-7 standalone stores. That means that the company is fabricating other aspects of their SEC filings, in my opinion.
First, the company, as I see it, is fabricating information about its employees. Here is disclosure from the 10K, where the company lists 232 full-time employees at its retail outlets.
Our investigators did not see any full-time China-Biotics employees manning the Shining Golden Essence shelves at Carrefour. It certainly doesn’t take 232 employees to operate 6-7 small retail outlets.
Second, the company has, as I see it, fabricated portions of its Management’s Discussion & Analysis in prior SEC filings. See the following disclosure in its 2008 10K, which I’ve also attached here:
“Selling expenses were $6,869,109 or 16.2% of net sales for the fiscal year ended March 31, 2008 compared with $4,502,687 or 14.7% of net sales for the fiscal year ended March 31, 2007. The operating costs of the retail stores are included as selling expenses. This increase in selling expenses was primarily caused by the roll out of retail stores. As of March 31, 2008, we had a total of 60 retail stores in operation (as of March 31, 2007, we had 9 retail stores).“
As discussed, the company doesn’t appear to have anywhere close to 60 retail stores.
Third, the company is fabricating its lease expense, in my opinion. The company reported $3.4m and $3.9m of lease expense in fiscal years 2009 and 2010 (see here). After excluding the $74k of lease expense for its Pudong facility (the company disclosed that it has no recurring lease expense for its Qingpu facility), that leaves $3.3m and $3.8m of lease expense for its store base.
$3.8m of lease expense for 6-7 stores would imply annual rent of $550k per store. Small stores such as those shown here and here are more likely to incur annual rent expense of $20k to $50k per store. As a result, I believe that the $3.9m of total lease expense in the 2010 10K is, like much of the rest of the company’s SEC filings, carefully crafted fiction.
Disclosure: I am short CHBT