Wednesday, February 9, 2011

China Agritech: a follow up

THIS POST HAS IMPORTANT QUALIFICATIONS - SEE THE POST SCRIPT.  PLEASE READ THE QUALIFICATIONS AS AN IMPORTANT PART OF THIS POST.

China Agritech is a NASDAQ listed Chinese company that is – according to its SEC filings - in the business of manufacturing and distributing organic fertilizer.

The annual filing lists their capacity as follows:

... annual production capacity as of December 31, 2009 was approximately 13,000 metric tons of organic liquid compound fertilizers whereas ... annual production capacity for granular fertilizers as of December 31, 2009 was approximately 200,000 metric tons, consisting of 100,000 metric tons in Anhui, 50,000 metric tons in Harbin, and 50,000 tons in our newly completed plant in Xinjiang.

In my last blog post I noted that:

(a) A hitherto unknown shortseller (Lucas McGee Research) had released a report that suggested that key plants either did not exist or were entirely incapable of producing at the levels indicated in the annual filings.  Lucas McGee research - as company promoters have been keen to point out - operates out of a virtual office and have a very limited history.

(b). The biggest shareholder is the world's most powerful private equity firm (Carlyle). I did not note – but Carlyle has filed a prospectus to register (and hence sell) their stock.

(c). The company has issued a denial of the shortseller report and claimed that all their plants and distribution centers are as listed in the annual filing.

I have a short position in the stock. I am keen to verify or reject the claims in the short seller report. (If I rejected the claims I would switch and go very long the stock.  The stock is on-face cheap - and it is liquid enough that I could change my position in minutes.)

I wrote to Carlyle – and to Anne Zheng (a staff member of Carlyle and Carlyle's representative on the board of CAGC) – to see if Carlyle would confirm or deny the shortseller report. Alas I got no answer.

That makes research a little harder.  This post is a summary of my research efforts.

The research efforts of course wound up against the normal epistemological problems of proving the existence or non-existence of things.  In this case, if you find the plants and you count the trucks entering and leaving the plants with amounts of fertilizer on them consistent with the company filings you have proved the existence of the company and disproved the short case.

If however you do not find the plants you have not proved the short case - the plants could be somewhere else - or closed for a reason - or you could have the address wrong or any other similar snafu.  It is hard - nay impossible - to prove a negative.

So - if the short case is right - the best I could expect to do is find data consistent with the short case.  I did not expect to be able to prove the fraud.

The key shortseller allegations

Here are the key shortseller allegations as stated by Lucas McGee (the shortseller):

Sinochem (a claimed large customer) has told us that it does not sell any Agritech products 
Government officials in China told us that Agritech does not have a license to manufacture granular fertilizers, which the company claims are its largest product line. 
After visiting Agritech’s reported manufacturing facilities in Beijing, Anhui, Xinjiang, and Harbin, we found virtually no manufacturing underway. The single exception was the facility in Pinggu County on the outskirts of Beijing, where the plant was not in operation on the Friday when we (Lucas McGee) visited but local people told us that it has sporadically produced some liquid fertilizer over the last year. 
Plants in Bengbu, Anhui (supposedly the largest), Harbin, and Xinjiang were completely shuttered.
Obviously these are allegations that go right to the heart of the company.  Instead Lucas McGee suggests that money is being stripped out of the company by inflated rents to related parties.  

If the Lucas McGee allegations are correct then the company will probably trade well under a dollar at some future date.  

The company has categorically denied these allegations. Firstly it has pointed to a contract with Sinochem previously filed with the SEC (I will get to that contract later).  Further the company has photographs of bags of granular fertilizer and some liquid fertilizer. And it has said that “the company and its subsidiaries are operating normally.”

As stated – after repeated requests – Anne Zheng (the Carlyle executive on the China Agritech board) did not confirm or otherwise vouch for the company's position.

Doing the work myself

Given that I could not rely on Carlyle, I employed a lawyer in China to visit the plant and see what they could find. This was made somewhat more difficult than usual because of Chinese New Year celebrations. You would not expect the plant to be operational during the holiday – and hence you could not check the volume of the plant by, say, counting trucks visiting.

The Anhui plant

I chose the China Agritech plant in Anhui because (a) it is listed as the largest plant run by the company – doing 100 thousand tonnes per year of fertilizer, (b) the Lucas McGee report suggested that it was shuttered and (c) it was fairly close to Shanghai and hence possible to visit.

Here is what the shortseller report said about the plant.

In Anhui, which Agritech calls its principal production facility, $400,000 worth of plant and equipment would seem slim for 100,000 tons of production capacity. We visited and found a small plant on a rutted road outside Bengbu, completely deserted.

Lucas McGee give a photograph.





This (surprisingly) was not the plant we found.  We found the plant we photographed  from following SEC filings.  

The annual filing gives the addresses of the plants as follows:




The Anhui plant is giving as  Changzheng East Rd, Gaoxin District, Bangfu City. The plant is (according to this part of the annual filing) large (3,400 square meters) and the rent is USD32,488 per month. (You can calculate the rent per square foot and my knowledgeable China contact suggests that this is high for low end industrial rent in China.)

Changzheng (the street name) translates as “Long March”.

There is another SEC filing (a quarterly) which gives a lease agreement for a plant in Bangfu City.

The address is consistent (1188 Changzheng Road Gaoxin District, Bengbu.)  I am presuming that these are the same plant - as there is only one plant listed as rented in Anhui in the property section of the annual report.  

We have however had problems with this in translation.  Some translations have it as "Long Road" Gaoxin District – rather than “Changzheng Road” or “Long March Road”. You can see that translation in using a Google translation of this 2007 job advert.

The lease gives the space as 1338 meters squared – considerably smaller than the 3400 meters square in the annual report. The rent is also considerably less than the annual report (commensurate with size) but the rent per square foot was higher - and high according to my (knowledgeable) contact.

Anyway my contact visited this site – and it is clearly an industrial site – but there is no large fertiliser plant on the site. The ground floor is held by the Bengbu Yi Machinery Factory and the Bengbu Equipment Factory. These are metalworking shops – and their sign is on the front door.

Here is the photograph.



THERE IS AN IMPORTANT CAVEAT REGARDING THIS PHOTO AT THE END...


There were not a large number of people on site. That was not surprising as it was Chinese New Year. There was however a security guard – and my contact talked to the security guard. He had never heard of China Agritech – or even Anhui Agritech. However it turned out that they did have premises on the second floor of the building – though nothing as large as the amounts indicated in either the lease or the annual.

There were no smells associated with organic fertiliser. Organic fertiliser as most people would know smells somewhat.

Moreover – and this is an obvious point – a fertilizer plant that processes 100 thousand tonnes of fertilizer per year is vanishingly unlikely to be on the second floor. 100 thousand tonnes of fertilizer is 2.5 million 40kg bags of fertilizer.  Moving this requires trucks and loading docks and the like.

The Security Guard said that the Bengbu Equipment Factory moved here approximately 3 months ago. He was not aware of either China Agritech or Anhui Agritech having any other premises. A cursory online check with the Administration of Industry and Commerce database showed Anhui Agritech only at this address. My lawyer-contact in Shanghai noted that it would be breaking the law to be operating from a second address without including that address in the database.

This all sounds consistent with the Lucas McGee report, however I note a glaring inconsistency.  This appears to be a different premise to the one photographed by the shortseller report. 


The shortseller premises are a small plant on a rutted road whereas my contact suggested that this was a more urban plant.  It would be sensible to have a fertiliser plant at an address closer to the outskirts of town, after all fertiliser is a bulk commodity and organic fertiliser smells. Moreover it is used outside towns – so premises on the outskirts of town make more sense than this site.

It is possible then that the premises are different from the ones mentioned in the annual report. However our contact visited the premises in the annual report and they did not find a fertiliser plant capable of producing 100 thousand tonnes per annum.

Moreover - considerable digging on the internet has meant that we have found an advert for a plant lease for 1338 square meters at the same address as the Anhui Agritech lease.  The same address and the same plant size to the square meter suggests that the plant was released.  This is consistent with Bengbu Equipment Factory moving into premises previously occupied by China Agritech - however we have no information that the premises were ever occupied by China Agritech.  The security guard did not know China Agritech...  

The Sinochem contract

China Agritech has claimed Sinochem as a major customer. Lucas McGee says that they talked to Sinochem and Sinochem denied being a customer. The company in their defence has pointed to an SEC filing that details a contract with Sinochem. Here is that filing.

The filing is interesting. It is for liquid fertiliser and in surprisingly small quantity. The contract is for liquid fertiliser in tiny bottles. I quote:


Name

Package Size


Number


Volume (L)


Unit Price (Yuan /L)


Purchase Amount (Yuan)

organic condensed liquid compound fertilizer (Broad Spectrum Type)

15ml *300 packages/piece



5,000



22,500



60



1,350,000

organic condensed liquid compound fertilizer (Broad Spectrum Type)

180ml *50
bottle/piece



100,000



900,000



55



49,500,000

organic condensed liquid compound fertilizer (Anti-disease Type)

20 mil * 300
bag/piece



25,000



150,000



66



9,900,000

Total (RMB)

60,750,000


















Note: the prices above include packaging price, Party B shall pay transportation fee.

These are tiny bottles – sometimes only 15ml and always less than one fifth of a litre. The contracts include packaging.  A 15ml packet is probably enough for one to five shrubs - not a commercial farm.  The instructions (in Chinese on China Agritech's website) suggests that the liquid be diluted 1000 to 1 before watering plants.  A 15ml packet would do a watering can.  

The total contract is for just over a million litres – or just over a thousand tonnes. This is tiny for a company that produces (or claims to produce) over 200 thousand tonnes per year of fertilizer - and indeed the main product appears to be packing and handling.  

This Sinochem contract is probably real (contrary to the suggestions of the shortseller).  But the contract is tiny and unlikely to be financially relevant. 

Moreover, the contract is not agricultural supply (which is done in bulk) rather a packaging contract for the sort of product someone use to fertilize their home flower patch. I might buy a small bottle of fertilizer for my (postage stamp size) backyard.

Moreover this contract is consistent with what the shortseller said about the company – they said that the company produced small quantities of liquid fertiliser at Pinggu County on the outskirts of Beijing. Indeed the contract was signed in Beijing. 


The company's photographic evidence 

The company has presented several photos to prove the plants are there.  The photos show plants but without loading docks or the like.  They also show liquid fertilizer packing.  They show a total of five 40kg bags of mixed organic/NPK fertilizer.

They are however not supportive of the proposition that this company produces 200 thousand tonnes (5 million 40kg bags) of dry fertilizer annually.

Several of the photos are of packaging and distributing very small quantities of liquid fertilizer.  Here is one example.


Summary

I sent a researcher to the company's stated main premise to see if I could find a plant capable of producing 100 thousand tonnes per annum of bulk fertiliser. We did not find that plant.

The company has protested there is one there. The premises appear different from the one the shortseller visited – but I found stuff consistent with what the Lucas McGee report and inconsistent with what the company says.

The Lucas McGee report said that no contract with Sinochem existed. I am satisfied that Lucas McGee is wrong on that point. A small contract for liquid fertiliser for retail use exists – and the company is capable of bottling such a product. However it is entirely possible that no bulk-dry-product contract with Sinochem exists.  The contract in the SEC filings does not support the proposition that Sinochem is a meaningful customer relative to China Agritech’s claimed sales.

China Agritech has produced photos to support the existence of their main business. These photos are alas entirely consistent with the shortseller claims - in that they do not support the proposition that there is a business capable of distributing 5 million bags of fertilizer.  Moreover none of the photos is labelled or geo-tagged in any way that helps verify the existence of the company.

I am staying short.




John

Some people have noticed - that unbeknown to me - my Chinese contact took the photo of the gate from a website.

I have attached the document the Chinese contact sent me.  Here it is

http://www.calameo.com/books/0005679007df8943103d9

I agree the document is IDENTICAL to the one taken from the website.  I instructed him clearly to TAKE photos -

He just says "Here is a picture of the gate".  He never told me he TOOK the picture of the gate.  Though my instructions to him were clearly TAKE PHOTOS.

I will follow up with photos HE TOOK.

----------------

The current state of play is this:  The lawyer in the states had a colleague swing by the factory on her way home.  She was visiting her family in Anhui for Chinese New Year and SHE provided photos including photos of the metalworking.  She also provided the photo of the factory gate - a photo that perplexed me because it was NOT a photo that matched the photos in the Lucas McGee report.

My lawyer in Shanghai cannot explain why the photo came from the website and was not taken on her phone.

He is trying to follow this up.  I will have a further follow up details when available.

31 comments:

But What do I Know? said...

Fascinating. Thanks for publishing this. . .

Potato said...

Still don't have the testicular fortitude to become a short myself, but I love the stories, John.

Someone's going to have to write a novel on these reverse-takeovers and the short-sellers that investigate them, and if Michael Lewis won't do it then I'll have to try to find some time myself ;)

Anonymous said...

Excellent work, John. Really well done.

It seems obvious now - as with CCME - that these are 'real' companies, but that the revenue is highly inflated, esp as all the legit China firms try to keep a lid on revenue and thus taxes.

Anonymous said...

Their CFO was discussed on seekingalpha last year http://seekingalpha.com/article/228395-china-agritech-questioning-management-s-credibility-part-1

The management have been selling out like billy-o,

http://www.gurufocus.com/news.php?id=118599

and there are numerous legal eagles swooping in...from the states. E&Y China were appointed auditors in December.

Everything (but the fertilizer!) about this stinks.

Anonymous said...

You guys are a complete joke. Carlyle calls the shots here, and they have done the due diligence for you.
Lucas McGee's research was completely flawed, the above analysis is not due diligence. You don't have much time left.

Anonymous said...

Outed from SEC 'The plant Party A leases to Party B is located in No. 1188, Changzheng Road, Gaoxin District, Bengbu. The coverage of the plant is 1338 square meters. The type of the plant is the light structure. It is located in the northwest of Anhui Water Resources Industrial Park. ' there is not only one plant in Anhui Water Resources Industrial Park. 'Bangbushi Dongfang Jingcheng Jixie Shebeichang' is also located in Anhui Water Resources Industrial Park. You may get the photo of Dongfang Jingcheng from their website http://www.dfjch.com/info.asp?second_id=1001
see the picture in that website, Bronte Capital copied it and posted in this blog and claimed it was photoed by their contact. Apparently Bronte Capital is scam!

Anonymous said...

now if you were really unbiased and interested in evaluating whether the plant existed (and capabale of meeting production quota), wouldn't you just call the company and ask for directions and a tour?

They can't "bring in" all the fertilizer industrial machinery to "trick you" on a day's notice?

instead you hire a secret spy w/ a camera to lurk around the outside the premises?

really?

Anonymous said...

John, you really should answer that question about the picture. Undeniably, the photos are the same.

Either you got duped by your investigator or you are misrepresenting or you're blog post is misleading.

But the photos are definitely the same.

persistentone said...

What is really frightening about accounts like John's is that not a single analyst is willing to immediately stand up and say "I have visited the facilities at location X,Y,Z and in our due diligence these plants support the level of production in the company's filings."

The implication is that this thing somehow went through a reverse merger and then uplisting without a single analyst being there to validate the company.

You cannot use the investment by Carlyle as evidence of thorough due diligence, because Carlyle may have seen this as a short term speculative investment rather than a long term buy and hold. The registration statementn from Carlyle certainly suggests that they want the option to sell everything quickly, at the moment of their choosing.

Anonymous said...

All is not as it seems with this blog. I thought you were on the up and up but these posts on the "China Fruads" are starting to seem very...constructed rather than the innocuous accounts or musings they purport to be. All the CCME posts with the caveat "I'm not saying anything...", now this apparently mislabled photo (why would the "Chinese Lawyer" go all the way out to the site and not give you his own photos). Seems like just another Citron Reserach or Muddy Waters masquerading as an unbiased source.

persistentone said...

Why are some of you so focused on the fact that his lawyer did not take an original photo. Simply point this out and give him a chance to correct that and get an original photo?

Is this request even a material point? One assumes John will produce the photo. How does it change anything here? It looks like some of you are just grasping for any cheap shot you can make.

Anonymous said...

check this out - more on Mr. Tang

http://webb-site.com/dbpub/positions.asp?p=8175&hide=

He owns a CPA firm, so probably is figurehead for someone else.

Funny thing is.. look here for its client list:
http://www.gcalliance.com.hk/client.html

"Fertilizer manufacturing"

and a few other possible 'fraudcaps' too...

Anonymous said...

"The lawyer in the states had a colleague swing by the factory on her way home."

"My lawyer in Shanghai cannot explain why the photo came from the website and was not taken on her phone."

Is your lawyer in the states or in Shanghai? Get your story straight. It would also help your case if you would identify your him/her as well as any other parties involved.

Goldensun said...

The touts who are boosting this, and the other China scams, seem only to be able to do two things:

1. Make either ad hominem attacks on writers such as Citron, or John.
2. Make arguments to authority, citing Carlyle.

Both are clear and well known examples of logical fallacies. Those arguments are simply invalid.

They also suffer from some of the worst cognitive dissonance I have ever seen. The pain of accepting that they are being scammed is so great, that instead they just believe with ever greater conviction.

This, by the way, is one of the key psychological principals used by cults.

@Potato, there are a great many stories about these types of companies. Look up the old articles by Gary Weiss, Chris Byron and the incomparable Adrian Du Plessis.

Each and every reverse merger onto the BB and Pink Sheet in the US (not some, not most, ALL) features a sucker. Either the sucker is management who got duped into doing a reverse merger to begin with, or the sucker is the guy buying the stock...sometimes both!

John Hempton said...

American lawyer - resident Shanghai.

Hope that satisfys you.

John

Ted K said...

For whatever it's worth to you Mr. Hempton I DO believe you about the photo there (no sarcasm). The only thing that would even make me question that (and I don't really question you on that, I think you're a straight shooter John) is the fact she is American--Chinese and not Chinese--Chinese. Usually it is the Chinese Chinese who want to do things half--ass. If she was born in China and forged her early years there before University in America I would say there is your answer for the net pic (lie). You know what they say John: "You can take the Chinese out of the Liar, but you can't take the Liar out of a Chinese." Believe me I know what I am talking about on that, and you are reaping the words of that cultural (genetic?) disfunction with your shorts.

By the way Mr. Hempton, the only things that will STOP this is when the U.S. exchanges and FINRA get their head out of their ass (and FINRA doesn't want to change this fraud because their broker/dealer MEMBERS make commissions off the fraud), because Chinese have told lies for hundreds of years if not centuries. The last time their society was even in the football stadium of functional was during the TANG dynasty. May it never be forgotten.

persistentone said...

Nicely written Goldensun. Do you have a blog?

Ted K said...

"reaping the rewards " (not "words") I should have typed in my above comment. I stand by the rest, by the way. Anyone who wants to label me a "racist" (which I am not) for the above words, go spend 5+ years in China and then get back to me. Then whatever you say, I'll tell you I still have more experience in China than you.

polit2k said...

CHINA AGRTCH : Robbins Umeda LLP Announces an Investigation of China Agritech, Inc.
02/09/2011 | 07:15 pm
Robbins Umeda LLP, a shareholder rights litigation firm, has commenced an investigation into possible breaches of fiduciary duty and other violations of the law by certain officers and directors at China Agritech, Inc. (NASDAQ GS: CAGC). China Agritech, through its subsidiaries, manufactures and sells organic liquid compound fertilizers, organic granular compound fertilizers, and related agricultural products in the People's Republic of China. The company was founded in 2003 and is headquartered in Beijing, the People's Republic of China.

http://bit.ly/eiTs9S

Goldensun said...

@Persistentone

Thanks for the compliment. Have often thought about a blog, but unsure if I really have the time. Will let you know if it ever happens.

@Ted K

You are absolutely, 100% correct.

Even if the FINRA/SEC/DOJ wanted to do something, which I strongly doubt, they will do nothing. Why? Because they have zero jurisdiction over a company operated by PRC nationals in the PRC. Yet another invitation for PRC companies to commit fraud against foreigners.

Longs and touts want to believe that company management lies, but only to the Chinese government. That management is really "on their side" and would not lie to them.

This is the thinking of many of the Madoff victims, who knew something was fishy, but not with their accounts.

Consider for a moment that the punishment for the practice of certain religions in the PRC is at a minimum imprisonment, at worst death, and the likely harvesting of organs somewhere in between.

The punishment for lying to American investors in the PRC is nothing.

So, to whom will Chinese management lie? The SAIC or the SEC? The constituency with the power to end their lives or the constituency of sheeple, only too happy to trade their money for shares in VIEs and other nonsense.

persistentone said...

Goldensun, do you post on Yahoo or other message boards? What userid and stocks?

Goldensun said...

@persistentone

No, I do not, but thanks to the encouragement of folks like you there should be a little treat for folks at my new blog BuyersStrike!

If people like it, I will keep doing it. If not, its been a fun day working on it.

Makes me respect the work that John, Jeff Matthews, and other quality bloggers do on a regular basis. It is not so easy.

persistentone said...

Goldensun, you need to tell us how to find it first. :)

Goldensun said...

@persistentone,

Click on my username, it should be hyperlinked. Or
buyersstrike.wordpress.com, if John will allow the shameless advert.

Anonymous said...

So your investigation has run into trouble because you didn't have the right guanxi.....

(Said in sympathy!)

Rajnish Sinha said...

Are you buying puts or doing something else ?

Jesse Glickenhaus said...

So, unlike John, I personally actually visited the company. He might say the fact that I asked for a visit means I get a poteken tour al la Steve Martin's Sergent Bilko. However, unlike him, I can tell you I saw the Anhui factory, I counted bags of inputs and outputs, I timed the output, I counted tons on trucks leaving the factory. Not only are the distribution centers and the Anhui factory there, existing, stocked, and running, but the numbers I calculated for production capacity matched what the factory manager told me, and also what the company states in its filings. For a detailed write up of what I found, including lots of pictures that I personally took, look at the report on www.glickenhaus.com

Jesse Glickenhaus of Glickenhaus and Company

James G;ickenhaus said...

http://www.glickenhaus.com/

John Hempton said...

James

Do you think it is possible you were taken to the SOE next door?

Oh, and I have looked at your photos there - of half their production and a reasonable slab of their claimed distribution - say 25 percent of the company.

Do you see 75 million bucks there.

Say after me: "I will no longer fall for Potemkin Villages." CAGC, CCME - the great Potemkin Village scams.

http://en.wikipedia.org/wiki/Potemkin_village

John

Anonymous said...

A airplane ticket from Austria to Shanghai only took less than $1,500.
Why don't you go and have a trip there for a personal check, John?

Anonymous said...

Giving an inaccurate operational estimate to Chinese government officials at the beginning of the year is NOT lying - it is just like requesting for deferral when filing 1040 forms ...

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.