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New Report on RINO International

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Muddy Waters came out with a new report on RINO International this morning, available here. As in ONP, they do an excellent job providing compelling evidence that RINO is fabricating its SEC financial statements. Here is an excerpt of their summary from the first page:

  • RINO’s FGD sales (60% to 75% of revenue) are much lower than it claims. We found that many of its customer relationships do not exist.
  • Chinese regulatory filings show that RINO’s consolidated 2009 revenue was only $11 million, or 94.2% lower than it reported in the US. We show that the Chinese numbers are credible.
  • RINO’s accounting has serious flaws that are clear signs of cooked books.
  • RINO’s management is draining cash from the company for its own business and personal uses. The management is in flagrant breach of its VIE agreements, which require it to pay income to RINO (as opposed to taking it).
  • RINO’s balance sheet has an astonishingly small amount of tangible assets for a manufacturer. Rather, it is filled with low quality “paper” assets that balance out the inflated earnings, and likely hide leakage.
  • RINO is not the industry leader it claims to be in the steel sinter FGD system market. Rather, it is an obscure company in a crowded field, and is best known for its failed projects. Its reported margins are two to three times what they really are. Its technology is sub-par.
  • We are not sanguine about management “borrowing” $3.2 million to purchase a luxury home in Orange County, CA the day that RINO closed its $100.0 million financing.
It’s an excellent report and an example of yet another fraud in the U.S.-listed RTO china space.
Disclosure: short RINO

Written by chinesecompanyanalyst

November 10, 2010 at 1:15 pm

Posted in Uncategorized

China-Biotics: An Investigation of Its Alleged Store Base

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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:

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:

  1. whether a standalone store existed at that location
  2. whether a store-within-a-store existed at that location
  3. whether the company’s products were found at all at the location
  4. 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, and 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

Written by chinesecompanyanalyst

September 10, 2010 at 12:13 am

Posted in Uncategorized

ONP: Its Largest Supplier Is an Empty Shell Owned by the CEO

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This article is about how Orient Paper’s top supplier is either non-operating or very small, and is majority-owned by its CEO. I will also discuss certain suspicious share transfers by this supplier in July 2009.

But first, I want to discuss a recent development last week. Last Tuesday, Orient Paper announced that Loeb & Loeb, the law firm it hired to run its internal fraud investigation, hired Deloitte & Touche Financial Advisory Services Limited to “assist” it with its investigation into the issues raised by Muddy Waters, LLC. Per the press release, “Deloitte will provide support to Loeb & Loeb, which is working with the Company’s audit committee, in connection with the independent review of the accounting aspects of the issues raised and the investigation of the relevant financial transactions and customer relationships.”

Deloitte is not performing an audit. It is merely “assisting” and “providing support” to Loeb in the investigation. Much hinges on what Loeb asks Deloitte to do. I’ve previously written that Loeb is not the right firm to be leading the ONP internal investigation. I do believe that Deloitte is an appropriate financial consulting firm to investigate the fraud. But it’s unclear what Loeb will ask of Deloitte, and whether Deloitte will need to sign off on any aspect of the investigation. As a result, I could certainly see a scenario where the investigation finds no wrongdoing, despite compelling evidence that the company is committing fraud.

Now, let’s move to the new evidence that ONP is falsifying its financial statements.

ONP’S Main Supplier is an Empty Shell Primarily Owned by ONP’s Chairman

According to SEC filings, ONP’s largest supplier is Xushui County Dongfang Trading Co. Ltd. (“Xushui Dongfang”). From 2006 to 2008, Xushui Dongfang is listed as ONP’s largest supplier, supplying $14.6m, $15.9m, $28.5m, and $30.7m of goods in 2006, 2007, 2008 and 2009. See the 10Ks for 2009, 2008 and 2007. Note that “Xushui County” is the same county that ONP is based in.

Yet according to third party reports, Xushui Dongfang is an empty shell company with no reported revenue. Here is a third party credit report from Qingdao Inter-Credit Services Pte Co., Ltd. (“Inter-credit”). Inter-credit is a large independent credit agency that provides a variety of credit-related services for clients. It operates out of 12 branches, and has 200 employees, including lawyers, accountants and debt collectors. It compiles independent reports on Chinese companies, using data from AIC filings and other resources – a sample report can be seen on their website here.

For any readers who doubt the authenticity of Inter-credit reports, here are their reports on China Sunergy (CSUN) and Solarfun (SOLF), both of which I believe are more accurately reflecting themselves in their SEC financial statements than CMFO, CSKI or ONP.

Here is Inter-credit’s report on Xushui Dongfang, as well as the Chinese and English translation of the information received from the Xushui AIC office:

The last year in which Xushui Dongfang reported financial results was 2007. In 2007, ONP claims to have purchased $15.9 million in product from Xushui Dongfang (at the then prevailing exchange rate); however, Xushui Dongfang only reported approximately $200,000 in revenue in 2007 according to AIC reports.

Equally as important, Xushui Dongfang’s majority shareholder is none other than ONP’s Chairman and CEO. Liu Zhenyong owns 70% of Xushui Dongfang, while Li Jianjun owns 30%. Zhenyong has contributed approximately $500,000 (RMB 3.5m) of capital to Dongfang, while Jianjun has contributed approximately $220,000 (RMB 1.5m).

Naturally, ONP made no disclosure in its SEC filings that there were any related parties involved in the purchases from its largest supplier.  This is likely a violation of SEC regulations.

It’s also an obvious sign of fraud. Xushui Dongfang was likely used to generate fake purchase invoices.  By owning Xushui Dongfang, it is likely easier for ONP to generate fake invoices to show the auditors.  Because ONP never disclosed the common shareholder, it is unlikely that ONP’s auditors looked into Xushui Dongfang.  Thus, it seems that Xushui Dongfang was a vehicle to make ONP appear much larger than it is.

This revelation was first made on July 22, 2010 in the Chinese media when the 21st Century Business Herald (which is considered to be the “Wall Street Journal of China”) published an article on the allegations made by Muddy Waters, LLC.  The article was the lead story for the entire newspaper that day – to see a PDF of the newspaper with the article, click here (it’s the article with the headline that contains “AMEX” and “ONP” throughout the text).  The article quoted a local tax bureau official as saying that Xushui Dongfang is “just like a shell company.”

Click here for a full translation of the 21st Century Business Herald Article.

And here is the excerpt that discusses Xushui Dongfang:

In the upstream chain, this reporter discovered that a company named “Xushui County Dongfang Trading Co. Ltd” (henceforth termed Dongfang Trading Co. Ltd), according to ONP’s financial report, this company, with a (Chinese) name similar to the Company’s, has been ONP’s largest raw materials supplier since 2006.

In the three years from 2007 through 2009, this company’s supplier share is at levels of 53%, 50% and 37%, respectively.

Information shows that this company was established in 2001, registered at Xushui County AIC, and its main business is waste material collection. In the application information provided in the early stages of start-up, the company registration address contained five houses located in “Xushui County Nan He Shou Ying Village West”, and it also comes with lease contracts signed with the village committee.

This company’s initial registered capital was 500,000 yuan ($60,500 at the time), with two shareholders. The first shareholder was Liu Zhen Yong, the second was Li Chen. Li Chen once was a Director of ONP but resigned from the post in 2009. In ONP’s published documents, his drawn salary from ONP was US$4,826 in 2008 and US$4,093 in 2009. Li Chen now holds 201,164 ONP shares, which is 1.1% of shares offered.

Not long after Dongfang Trading Co. Ltd was registered, the legal representation was transferred from Li Chen to a man named Li Jian Jun and equity rose to 500,000 yuan. From what this reporter understands, Li Jian Jun is a native of Xushui. Also, Dongfang Trading Co. Ltd and the HBOP factory address are in the same place in Nan He Shou Ying Village.

“Dongfang Trading Co. Ltd in the most recent two years almost doesn’t have any revenue,” the aforementioned tax bureau insider informed me, “It’s just like a shell company.”

July Share Purchases

That’s not all.

Xushui Dongfang also somehow owned 4.4% of ONP’s shares prior to June 2009. We have no idea how it received those shares because there is no disclosure relating to it in the SEC filings prior to its sale of shares.

Click here for the 8K from June 30, 2009. Here is the first paragraph (bold added for emphasis):

“On June 25, 2009 (the “Closing Date”), Orient Paper, Inc., a Nevada corporation (the “Company” or “Orient Paper”), consummated a Purchase and Sale Agreement with Xushui District Dongfang Trading Limited Company (“Xushui Dongfang”), Barron Partners, LP, Fernando Liu and Golden1177 LP (Barron Partners, LP, Fernando Liu and Golden1177 LP collectively, the “Purchasers”). Under the terms of the agreement, Xushui Dongfang agreed to sell to the Purchasers an aggregate of 2,000,000 shares of the Company’s common stock at $.375 per share, for an aggregate purchase price of $750,000. To facilitate payment and receipt of the purchase price, the Company agreed to pay or cause to be paid $500,000 or the Renminbi (Chinese currency) equivalent to Xushui Dongfang, a company organized under the laws of the People’s Republic of China (the “PRC”). In return, $500,000 of the purchase price would be held in escrow for the benefit of the Company and used to pay the Company’s current and past-due legal fees, investor relations expenses, and auditing fees of a Big 10 accounting firm to be appointed by the Company.”

What? Why did ONP’s largest supplier own 2,000,000 shares of Orient Paper, or about 4.4% of Orient Paper’s share count?

In no previous SEC filing had Orient Paper disclosed the sale or contribution of shares to its largest supplier! Xushui Dongfang was unlikely to have bought the shares on the open market, given that this normally requires regulatory approvals.  Foreign equity holdings by PRC nationals and entities require approval by the State Administration of Foreign Exchange (“SAFE”).

But this is beside the point. The question remains: Why does ONP’s largest supplier feature the following?

  1. It had no revenue in 2008 and 2009, and only $200k of revenue in 2007
  2. It Is 70% owned by the CEO of ONP.
  3. It owned 2m shares of ONP prior to July 2009
  4. Why wasn’t the 70% ownership disclosed in SEC filings? The purchase of products from Xushui Dongfang (keep in mind that Xushui Dongfang comprised 30% to 50% of ONP’s cost of goods sold from 2007 to 2009) was certainly a related party transaction by ONP, and a particularly dubious one at that.

The answer to these questions, in my opinion, is that Xushui Dongfang is a shell company with no underlying business that was used as part of CEO Zhenyong Liu’s efforts to falsify Orient Paper’s SEC financial statements. It likely also aided his efforts to fabricate audit-related supporting documents (ie. invoices) to provide to its auditor.

Written by chinesecompanyanalyst

August 9, 2010 at 6:08 pm

Posted in Uncategorized

Orient Paper: Loeb is Not the Right Law Firm for the Investigation

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Last week, Orient Paper announced it would retain Loeb & Loeb to conduct an independent investigation into the issues raised by Muddy Waters LLC.

While I welcome the third-party investigation, Loeb & Loeb is not the right firm for the job. I don’t intend to discredit Loeb & Loeb’s credentials. But given their active involvement in the Chinese Reverse Takeover (RTO) space, they are neither independent nor objective when it comes to whether a Chinese RTO is defrauding investors. Rather, they are firmly entrenched in the “club” of service providers that earn substantial fees from Chinese companies that have listed publicly in the United States through reverse takeovers of U.S. shell companies. A service provider such as Loeb & Loeb is financially incentivized to conclude that Orient Paper is not making up its numbers. Failing confidence in Chinese RTOs could lead to dramatically reduced revenue for the firm’s Chinese securities practice.

I’m not alleging any present or future wrongdoing on the part of Loeb & Loeb. I’m merely saying that Loeb & Loeb is not a genuinely independent party; they are not the appropriate law firm to perform a third party investigation into whether Orient Paper is falsifying its financial statements; and I and other critics are unlikely to be satisfied with an investigation led by Loeb & Loeb that exempts ONP from wrongdoing.

If Orient Paper is serious about having a third party investigate critics’ claims, they should hire a law firm that is not actively involved in the Chinese RTO space, and can act as a more objective investigator. I provide dozens of potential law firms at the bottom of this article.

Loeb & Loeb’s Active Involvement in Chinese RTOs

Loeb & Loeb is one of the leading law firms in providing legal counsel to Chinese companies that undergo RTOs, or merge with SPACs, to become public in the United States. They are also one of the top firms that provide legal counsel to the investment banks and PIPE investors who provide banking services or capital to these companies.

As they write in their website, “In 2009, Loeb & Loeb LLP’s Corporate Securities practice, notable for taking many of the first private Chinese companies public on U.S. stock exchanges, completed 33 major transactions totaling approximately $2.1 billion in 2009”. For press releases from Loeb & Loeb discussing their strength in Chinese RTOs, see here and here.

Loeb & Loeb is a sponsor of many conferences that focus on Chinese RTOs. They sponsored CCG’s China Rising Conference this year and last year. They are sponsoring the Roth China Conference this year, and sponsored the 2009 and 2008 Roth conferences as well. They sponsored The Dealflow Reverse Merger 2010 Conference in June.

The lead partner of the China practice, Mitch Nussbaum, is a regular on the China RTO circuit. He speaks on panels regularly with other key service providers of Chinese RTOs – see here, here and here. In this link, for instance, Nussbaum speaks at a 2:15pm panel sponsored by Crocker Coulson, ONP’s investor relations representative. Two hours earlier, ONP board member Drew Bernstein gave his own speech at the event.

It’s difficult to imagine a scenario where Loeb & Loeb turns around and accuses ONP of fraud, when Bernstein has called the allegations “categorically false and without merit” and Coulson has been coordinating ONP’s public responses to the charges of fraud.

Nor has Loeb been able to sidestep some of the controversies among Chinese RTOs. For the September equity offering for China Natural Gas, which was alleged to be a fraud by the blog “Worthless Pennies”, Loeb & Loeb was legal counsel to the underwriters. For the April equity offering for Lihua International, which has been flagged by Chimin Sang and Steve Chapski as potentially falsifying its financial statements, Loeb & Loeb was legal adviser to the company.

A Genuinely Independent Third Party should Be Picked Instead

I don’t think Loeb & Loeb should be chosen to investigate the serious allegations of fraud that have been charged against Orient Paper. A law firm with a Chinese office that is not actively involved with Chinese RTOs should be selected to conduct the investigation. Loeb & Loeb is not sufficiently independent. They generate substantial fees from Chinese companies that have undertaken RTOs to become publicly listed in the United States. They have a vested financial interest in seeing that Chinese RTOs are cleared of wrongdoing, generally speaking.

Here is a list of the top 25 foreign firms in the “Corporate/M&A” practice in China, as selected by “The Legal 500”.

Baker & McKenzie
Clifford Chance LLP
Freshfields Bruckhaus Deringer
O’Melveny & Myers LLP
Shearman & Sterling LLP
Skadden, Arps, Slate, Meagher & Flom LLP
Allen & Overy LLP
DLA Piper
Gide Loyrette Nouel A.A.R.P.I.
Herbert Smith LLP
Paul, Hastings, Janofsky & Walker LLP
Paul, Weiss, Rifkind, Wharton & Garrison LLP
Sidley Austin LLP
Simpson Thacher & Bartlett LLP
Sullivan & Cromwell LLP
Weil, Gotshal & Manges
Davis Polk & Wardwell
Dechert LLP (Beijing Representative Office)
Jones Day
Latham & Watkins LLP
Lovells LLP
Mallesons Stephen Jaques
Morrison & Foerster

Some of these firms, like DLA Piper, also play active roles in Chinese RTOs. But many in this list do not. ONP should select a law firm from this list that is not regularly involved in Chinese RTOs to conduct the investigation.

Disclosure: short ONP

Written by chinesecompanyanalyst

July 21, 2010 at 3:16 pm

Posted in Uncategorized

China Marine Food: There’s Something Fishy Going On

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Please read the disclosures at the bottom of this article.

In my previous two articles, I’ve written about how several Seeking Alpha contributors have used locally filed Chinese financial statements to provide compelling evidence that certain U.S.-listed Chinese companies may be frauds.

All foreign-invested enterprises must file financial statements with the State Administration for Industry and Commerce branch of the Chinese government. These documents are not available electronically; rather, a local Chinese citizen must go to the appropriate local branch to access these documents. Fortunately, certain third-party credit agencies provide this service to foreigners for a fee.

In previous articles, I compared the SAIC and SEC financial statements of YUII, CSKI and LIWA. The numbers for YUII matched, whereas they did not for CSKI and LIWA.

In this post, I compare the SAIC and SEC financial statements for China Marine Food Group Limited (CMFO). The numbers do not match.

This provides evidence that China Marine Food Group Limited may be a fraud. In addition, I note additional data points that raise questions about whether CMFO’s financial statements accurately represent the financial condition of the underlying business.

I also present the response of the chief financial officer of CMFO to a question on why the SAIC and SEC documents don’t match, and provide my opinion on his response.

Organizational Structure

Before discussing CMFO’s SAIC statements, let’s discuss the legal organizational structure of CMFO. This is important because each subsidiary files separate SAIC financial statements. Chinese GAAP does not consolidate subsidiaries, and therefore it’s important to determine which subsidiary generates most of the company’s revenue. We can then compare the SAIC financial statements of this main operating subsidiary with the SEC filings.

Here is CMFO’s legal organizational structure, from an annual report. We use the 2008 org structure, because we are comparing their 2006, 2007 and 2008 financials.

The U.S.-based, publicly listed entity is China Marine Food Group Limited. Nice Enterprise Trading H.K. Co., Limited, its subsidiary, is based out of Hong Kong. Nice Enterprise has one subsidiary, Shishi Rixiang Marine Foods Co., Ltd (“Rixiang”), which is based out of China. Rixiang is a foreign invested enterprise that owns two other subsidiaries: (1) Shishi Huabao Mingxiang Foods Co., Ltd. (“Mingxiang”)and (2) Shishi Huabao Jixiang Water Products Co. Ltd (“Jixiang”).

Where are the operations primarily held? Rixiang. We know this by the following disclosures in the 10K:

“With effect from January 1, 2005, Rixiang acquired the business operations of Mingxiang, which subsequently became a property holding company. Rixiang was incorporated as a FIE and was granted the tax incentives for FIEs, and was exempted from income tax for 2005 and 2006… Jixiang is also a property holding company and is not subject to tax.”

Elsewhere throughout the report, the Company also makes clear that Rixiang generates all of the Company’s operating revenue, such as “All of our production is undertaken by our subsidiary, Rixiang” in the “Our Products” section.

From the above disclosure, we also know that Rixiang is an FIE. As an FIE, Rixiang must file accurate annual financial statements with the Administration for Industry and Commerce branch of the Chinese government.

SAIC vs. SEC financial statements

I have had a local third-party credit agency go to the local AIC office in Rixiang’s jurisdiction and photocopy their financial statements.

They are here, in Chinese. And here, in English.

The figures above are in Remnimbi. In the chart below, we convert the Remnimbi to US dollars, and compare key financial line items with CMFO’s SEC financials:

As we can see, CMFO reports much higher numbers in its SEC filings than its SAIC filings. In its SAIC filings, the company generated only $2mm of revenue in 2007 and $7mm in 2008. In its SEC filings, it allegedly generated $36mm in 2007 and $49mm in 2008.

Compare that with Yuhe, which generated $21mm and $34mm of revenue in 2007 and 2008 in its SAIC filings, compared to $22mm and $36mm of revenue in 2007 and 2008 in its SEC filings.

As we discussed earlier, Rixiang is the primary operating subsidiary of CMFO. It is also an FIE. As a result, Rixiang’s financial statements should accurately reflect CMFO’s actual operating results.

But they don’t.

The CMFO’s response to the discrepancies is the following, based on an email:

“It’s a formality in China to file the operating figures with SAIC on an annual basis. We used to hire an independent agent firm to do the filing on our behalf as the process itself is quite tedious though. Guess the agent firm has used kinds of outdated figures to do the filing and thus discrepancies appeared as a result.

Since there won’t be any anticipated influence or harm over those inaccurate historical figures with SAIC, we don’t believe it’s necessary to re-file the statements. That said, we will switch to another sizeable agent firm to do the 2009 filing and will make sure the numbers so filed are consistent with our book record going forward.”

We’ve been down this road with CSKI. The CFO of CSKI said a similar thing in 2008 when asked why CSKI’s SAIC numbers didn’t match the SEC numbers. He promised that 2009 numbers would match. But in more recent discussions, he has revealed they will not.

What is actually going on? My belief is that CMFO is fabricating its SEC financial statements. FIEs in China must file accurate audited financial statements. I’ve spoken with dozens of accountants and CFOs of verifiably legitimate Chinese companies, and they have all confirmed this. It’s understandable to have small differences between SAIC and SEC filings, due to subsidiary consolidation and Chinese vs US GAAP. But CMFO’s 2008 SAIC revenue was 85% lower than its 2008 SEC revenue. That’s not due to GAAP accounting differences.

In my opinion, fraudulent Chinese companies like CSKI, LIWA and CMFO are making up numbers out of thin air. To fool their accountants, the companies are using sophisticated and undisclosed related party and off-balance sheet transactions to inflate financial statements. They are using phony bank statements to fake cash. It’s unclear how exactly they are doing it. But the differences between the SAIC and SEC numbers provides compelling evidence that they are finding a way to do it. After all, there is a lot of money to be made – companies like CSKI, LIWA and CMFO have raised $25mm+ each in secondary equity offerings or private placements, all for dubious purposes. If they are indeed fraudulent, these funds are likely being siphoned to a large degree to personal bank accounts.

These are shocking allegations, yes. But the world of Chinese reverse-merger smallcaps is a shocking one, and given the very low valuation multiples, it’s clear that many other investors suspect similar wrongdoings.

Other Signs that CMFO is a Fraud

The main thrust of our argument that CMFO is a fraud is that the Company’s SAIC and SEC filings don’t match. But as we did with our last two posts on YUII, CSKI and LIWA, we’re going to highlight other signs that make us concerned about trusting CMFO’s SEC financial statements.

Again, we’ll compare CMFO with YUII.

Audit history

In our last post, we explained that Yuhe’s attempt to upgrade to Grant Thornton was a welcome contrast to the audit history of many other Chinese companies that have gone public via reverse mergers.

CMFO’s auditor, ZYCPA Company Ltd., is equally as questionable as LIWA’s and CSKI’s auditors. It is not listed in the top 100 global audit firms. It has 2 partners and 25 personnel, per its web site. Given that CMFO alleges to have generated $70mm of revenue and $15mm of net income in 2009, ZYCPA appears to be a woefully inadequate auditor for the company.

But if CMFO is making up its numbers, it would certainly find an easier time defrauding one of the two partners at ZYCPA than a top-5 audit firm like Grant Thornton.

Capital Raise

As we discussed in our last post, a key thing to monitor when examining whether reverse-merger Chinese companies are frauds is to see how much capital they’ve raised via secondary private placements and equity offerings.

Naturally, we have no issue with capital raises. Companies need to raise funds to grow. But with Chinese companies that have gone public through reverse mergers, we see a tendency to raise large sums of money at large discounts to current stock prices, with dilutive warrants attached, and for dubious purposes. Indeed, if a company is fraudulent, a capital raise is the primary goal of creating a China-based fraud in the first place. The funds are taken from U.S. investors and deposited in the personal bank accounts of the scam artists.

With Yuhe, we have not seen any dilutive and/or unnecessary secondary offerings thus far.

With CMFO, we saw a $30mm private placement on January 20, 2010. The purpose was: “The Company intends to use the net proceeds from this offering for working capital and general corporate purposes.” From its SEC filings, the company allegedly had $7mm of cash at December 31, 2009 and has generated positive free cash flow (measured by cash flow from operations less capital expenditures) for each of the past three years. It’s unclear why the company needed additional cash.

The dilution was not especially egregious though, and the new shares were issued at only a 9% discount to the prior 10-day trading average and a 12% discount to the prior 30-day trading average.


At the time of writing, I and affiliated entities have a short position in CMFO and a long position in YUII. I intend to trade in these securities subsequent to this post within the next three days. I may also initiate positions in other stocks mentioned in this article, including CSKI and LIWA.

In no part of this post do I attempt to provide false or misleading information. All facts presented in this post are true to the best of my knowledge.  All opinions presented on this website are my own and accurately reflect my actual opinion on the relevant subject being discussed. To the extent you believe I have provided false or misleading information, please list your concerns in the comments section and I will address it.

Written by chinesecompanyanalyst

June 1, 2010 at 9:28 am

FUQI: SAIC vs SEC comparison

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FUQI International, Inc. (FUQI) has been one of the more talked-about stocks within the U.S.-listed Chinese smallcap space over the past few months. The main reason is because the company announced accounting irregularities on March 17, sending the stock down ~40% over the subsequent few days. The stock remains 50% below its March 16th closing price.

For anyone who can read a cash flow statement, FUQI has had suspiciously large working capital usages since the company went public. The Company had -$22mm, -$8mm and -$22mm of cash flow from operations in 2007, 2008 and the nine months ended 9/30/09, which equates to a cumulative -$52mm of cash flow from operations during that period. And yet its net income was $14mm, $28mm and $38mm in 2007, 2008 and the nine months ended 9/30/09, summing to a cumulative positive $80mm of net income during that period. The accounting never made sense to me, and it’s no surprise that FUQI “identified certain accounting errors that are expected to have a material impact on the previously issued quarterly financial statements… the cost of sales for each of the periods were understated and gross profit and net income, as a result, were accordingly overstated”.

If FUQI was indeed inflating its net income through aggressive accounting, it was at least cooking its books the old-fashioned way. In this brief post, I intend to compare FUQI’s SEC and SAIC filings. Unlike CSKI, where the SAIC-reported 2007 revenue is 95% lower than its SEC-reported revenue, FUQI’s SEC and SAIC numbers are in the same ballpark. As a result, we can be confident that FUQI has some sort of real, and probably valuable, business behind the murky set of financial statements that it provides to investors. The same cannot necessarily be said for CSKI.

Here are FUQI’s financial statements in Chinese.
Here are FUQI’s financial statements in English.

Here is the financial comparison for FUQI.

Compare that to CSKI:

Naturally, FUQI’s SAIC and SEC filings do not match exactly. SAIC filings are done in Chinese GAAP, whereas SEC filings use US GAAP. Chinese GAAP treats a variety of items differently than US GAAP, including capital expenditures, depreciation, etc. It also does not consolidate subsidiaries, whereas US GAAP does.

For our purposes, we are merely trying to see if the SAIC filings show a real business of some respectable size. For FUQI, the SAIC filings demonstrate that a real company generating a material amount of revenue exists in China. For CSKI, the SAIC filings indicate the opposite.

The CFO of CSKI has claimed that SAIC filings don’t need to be accurate. That doesn’t jive with my discussions with lawyers, accountants and CFO’s of verifiable Chinese companies, who claim that Chinese Foreign Invested Enterprises must provide reasonably accurate and audited financial statements in their SAIC filings. And from looking at FUQI’s numbers, I question why FUQI would provide SAIC financial statements that show revenue and total assets that are of the same magnitude as the items reported in their SEC filings, if it didn’t need to.

The more correct story, in my opinion, is that CSKI reports SAIC revenue that is 95%+ lower than its SEC revenue because its actual revenue is indeed 95%+ lower than its SEC revenue.

Disclosure: I have no position in either FUQI or CSKI. I may initiate a position subsequent to writing this post.

Written by chinesecompanyanalyst

May 26, 2010 at 1:00 pm

Posted in Uncategorized