I don’t spend nearly enough time reading SEC Proxy Statements. Proxies are the bread-and-butter of serious readers of SEC Statements (such as Michelle Leder’s excellent Footnoted). But in the Universal Travel case I have had some fun with proxies.
The proxy is supposed to detail all the ways in which executives are remunerated and all the related party transactions. Here is a link to the latest proxy from UTA. This was filed on the 3rd of September and contained the following statement per related party transactions:
TRANSACTIONS WITH RELATED PERSONS, PROMOTERS AND CERTAIN CONTROL PERSONS
Related parties can include any of our directors or executive officers, certain of our stockholders and their immediate family members. A conflict of interest occurs when an individual’s private interest interferes, or appears to interfere, in any way with the interests of the company as a whole. Our code of ethics establishes requirements of our officers regarding conflicts of interest. Any violation of our code of ethics must be reported to the Company’s chief operating officer or any member of the Company’s Board.
Except for the ownership of our securities, none of the directors, executive officers, holders of more than five percent of the Company’s outstanding common stock, or any member of the immediate family of any such person have, to our knowledge, had a material interest, direct or indirect, in any transaction or proposed transaction, since the beginning of 2009, in which the Company was or is to be a participant and the amount involved exceeds $120,000.
That is as you would expect to see it. There are no related party transactions of any size which is kind of important because the company recently raised $20 million in cold-hard-cash (in a secondary offering) to do acquisitions.
Alas the latest quarterly filing (10Q) which was filed on the 24th of August (that is 10 days earlier) lists in the balance sheet as an asset $6,986,717 which is “due from a related party”. Obviously I wanted to know which related party owed the company nearly $7 million and for what purpose. This is the main disclosure in the 10Q as to what that related transaction is for:
Note 5 – RELATED PARTY TRANSACTIONS
As of June 30, 2010, Due from related party account has balance of $6.99 million, which was an advance for cash payment of two acquisitions in June. The payments were paid by corporate account on June 28, 2010 and the related party returned the same amount on August 10, 2010.
This leaves lots unanswered and I do not feel happy to speculate as to why these transactions exist. However here are a bunch of questions for management. I have forwarded these questions and have received no reply.
1. What acquisition is this balance for?
2. Was this one of the acquisitions for which capital was raised by a secondary offer earlier this year?
3. Why did a related party receive a cash advance for this acquisition? Was this acquisition made from a related party?
4. Why was this relationship not disclosed in either the proxy or the documents for raising the above-mentioned $20 million?
5. Was there any consideration of charging interest on the cash owed by the related party?
6. Was any collateral taken from the related party?
7. Were there also shares paid to a related party?
8. If so have those shares been registered? Are they being sold into the market?
If they answer I promise to report on the blog.
John
Much cooler than reading a finance blog (or poking around on Chinese websites): Go see The Nick Hempton Band at the Zinc Bar (Greenwich Village) tonight...
Wish I could be there.
John
One of the things I promised with this blog was to explore ideas rather than talk my book. I also promised to explore my failures (of which there have been a few). So here goes.
To make real money in tech your company must do three things. Two out these three and the results will be (at best) inadequate.
Of these normally number 3 is the thing that trips up tech companies – they work really hard to get the idea implemented and then someone with less expense – and with the benefit of watching your failures, trials and tribulations – copies the idea (usually slightly better or less clunky) and the margins go to zip. Microsoft is such a fantastic company not because they have the technology right – but because people build on them proprietary software (developers, developers, developers) and that makes people reluctant to change even if the new product is superior.
But a tech company can easily be tripped up on the execution phase as well. (Anyone remember Friendster? Remember when their site took 2 minutes to load a page because they couldn’t get the IT implemented properly? And look how valuable the position they lost is…)
At Bronte we normally don’t own tech stocks unless all the ducks are lined up – that is we want demonstration of execution and we want to understand how they keep the competition out.
This year we broke the rules and paid for it. Our largest losers (cumulatively about 5 percent) are two tech stocks that are having trouble at the execution phase.
One of them is small cap and too painful to mention – the other has some hope – and it is a well known company – possibly the hottest float of 2009. The company is A123 systems and it has one of the first viable nano-batteries. It has yet to scale production to a level which demonstrates execution and even if it can execute we are not sure how well it will keep the competition out.
What is a nano-battery?
A battery works by chemical reactions which liberate electrons which have to travel through circuits (delivering power) to complete the reaction. The chemical reactions work on the surfaces inside the battery (eg the lead plates inside the lead-acid battery in your car).
One of the limits to how much power a battery can produce and how fast it can recharge and the like is the amount of surface area that the reaction can take place on and how much of the chemical can be stored on that surface area. More surface area is good and your car battery has lots of plates to increase surface area to volume ratios.
A nano-battery makes the contact area very large relative to volumes by making all the contacts at a “nano-scale”. Obviously the smaller you make such stuff the larger the surface area to volume ratio.
A123 have produced the first commercially viable nano battery. It is no longer the only one – Toshiba for instance has demonstrated one. The specifications for this battery are a step increase from the past. If the battery can be made cheaply enough (and that is a big if) then it will change the world because it will make mass storage of electricity viable for lots of applications. The obvious applications are cars but also storage of solar energy and management of peak load electricity would come into play. If A123 executes it changes the world.
When we saw the specs – well – frankly we had our doubts. So we wanted to find people who used them. And remember in the early stage these batteries were frighteningly expensive. So we went to a group that we thought would use these batteries to their full potential and be insensitive to the cost. Besides it gave us a chance to pretend we are kids again – because the real enthusiasts never grew up (they still fly model planes). This little demonstration on YouTube translates raw battery specification into something visual.
The video is astonishing but we wish we never saw it because after seeing it we would have crawled over broken glass to buy the stock. This video cost us a lot of money!
Anyway – the demonstration is a 17 pound remote control plane powered by A123 batteries. The owner will enthuse endlessly – and indeed does.
When this film was taken the batteries were so expensive that only a nutcase enthusiast would pay for them. But who cares, or so we thought! Mass production makes everything cheap and this company had a technological edge and patents we thought might keep the competition out for a while.
There was an implicit assumption here – which is that, provided the battery did not contain super expensive materials (ie rare metals at thousands of dollars per kilogram), then mass production would make anything cheap… in other words we assumed away the risk and difficulty of execution.
And alas execution is really difficult – and whilst A123 is struggling to get a product to market at a price low enough to change the world – other competitors are turning up. And they continue to burn cash in the hope of reaching some manufacturing promised land.
Linked is recent article on a new nano-battery technology (and that alas is one of many, many of which look superior to A123). What got us was just how complicated the manufacturing process seems when you read this article. The company talks about “nano-wires” taking in lithium without breaking but the process not being sufficiently mechanically stable. After all things heat up and flex. So the nano-wires are built on thin metal cores that the company likens to steel rebar. Picture this: how small is this rebar? How do you manufacture it? Who builds the machines to make the machines?
The point is that we lost money because the company just can’t get manufacturing costs low enough fast enough to produce the rosy future we saw. We assumed away execution risk and paid the price.
A123 might get there in the end – and the stock is almost certainly a better buy now than when we purchased it – in that they are further developed and the stock is half the price. But we are hardly in a position to judge whether they will execute in the end. And we are already seeing competitive products in development.
The other tech stock where we assumed away execution risk – well that was an even worse outcome. And the pain of loss makes me not even want to talk about it.
John
We should note some informed comment on just how much battery technology has moved in the remote control plane space. A123 might yet get to a desirable cost structure – but it is highly likely there will be lots of competition (at least nearby) when it gets there.
Numerous people have suggested that it doesn’t really matter that you can’t buy tickets on the Universal Travel Group’s website. After all, all you need to do is give a valid Chinese mobile phone number and they will ring you back to conclude the payment. In that view it hardly matters that the company advised the US capital markets that they had an online payment ability.* People even reference this by pointing to Alexa traffic numbers. So I will do so before revealing the fault in that analysis.
Here is the Alexa page for CNUTG. It reveals that CNUTG is the 17,563rd site in the Alexa database and the 2,492nd site in China. If I compare it to www.check-in.com.au (a real, albeit minor, travel company in Australia) it checks out quite nicely. Check-in is the 1,893rd site in Australia. In other words – the bulls argue – www.cnutg.com is a real travel company albeit with a clunky website and lack of a payment mechanism.
There are fallacies in this argument. The main one is about the relevance of the Alexa database. Alexa provides data on global internet use by people using Alexa toolbars (or similar). This makes CNUTG the 2,492nd site in China of people whose Alexa toolbars are reporting data back. Alas Alexa data is notoriously inaccurate in China as the Chinese internet police block data from Alexa toolbars. Alexa toolbars thus bias Chinese sites to Chinese sites visited by non-residents of China. After all it is the Chinese authorities who monitor website usage in China – and they don’t much like other people doing it.
And that gives the game away… we are not tracking Chinese travel visitors. And it is not surprising that, of China sites, CNUTG is popular amongst non-Chinese. The stock is – after all – listed on the NYSE.
The Chinese Alexa
We can do much better – there is a Chinese version of Alexa which produces far more accurate data for China. That site is China Rank. It is in Chinese only – but it allows us to check out the web traffic per million internet users in China for the various travel companies.
Here is a comparison for Elong, CTrip, MangoCity, Qunar and the two main Universal Travel sites CBA-Hotel and CNUTG. Here is the link .
And here is a snapshot of the page in the original Chinese
And after the Google translator -
You are reading this right – the pages get 1 to 2 users per million internet users in China.
There are 420 million internet users in China – so these sites get about a thousand users in total (and presumably far less users daily).
The only problem is that the company has said in conference calls that it gets about 7 thousand to 10 thousand bookings per day. (They have implied but not confirmed that these are primarily through the website. They might be able to do this by not using the internet - but that is not how it sold the stock and is not consistent with the traffic numbers that the company claims for its website.)
The company claims to have taken 2.4 million flight bookings last year and sold 2.3 million hotel room nights. (Those claims were made by the former CFO at the March 2010 China Rising conference.) Presuming this was on the internet (as the company has implied many times) this is an unusual travel business – in that it sells approximately 1000 users 4.5 million individual bookings per year. That – if true – would be a lot of revenue per unique user!
[For reference: the company has stated in SEC filings that in 2006 the CBA-hotel.com site booked 500 thousand rooms on the internet. They have also stated several times that internet bookings have grown substantially since then. They are thus categorical that a large number of these hotel rooms are booked on the internet.]
Alternative explanations
I am racking my brain about alternative explanations. Again I asked the management if they could explain (but without response). The obvious explanation is that the bookings never happened (and hence the revenue of Universal Travel Group is fake).
That would of course be consistent with the other problems. For instance very limited sales is consistent with the dysfunctional website (making it hard to book), the lack of reasonable cookies on the website (which is not supportive of return business), the lack of customer acquisition cost (typically a major cost for such a business) and the lack of interest earned (which is supportive of the notion that the cash balances the company claims are not existent and hence the earnings are not existent).
A top 100 travel companies in China
China Rank also – conveniently – gives us the top 100 travel companies in China. The source is linked and the list is below. None of the Universal Travel Groups sites rank in the top 100.
1 www.ctrip.com
2 www.17u.com
3 www.flights.ctrip.com
4 www.elong.com
5 www.huochepiao.com
6 www.travelsky.com
7 www.ipiao.com.cn
8 www.huoche.com.cn
9 www.piaojia.cn
10 www.tuniu.com
11 www.feeyo.com
12 www.china-sss.com
13 www.mangocity.com
14 www.9tour.cn
15 www.hrs.com
16 www.zhuna.cn
17 www.etpass.com
18 www.homeinns.com
19 www.piaowutong.com
20 www.airasia.com
21 www.china747.com
22 www.piao.com.cn
23 www.szair.cn
24 www.228.com.cn
25 www.goldenholiday.com
26 www.9588.com
27 www.book-hotel.cn
28 www.shangri-la.com
29 www.128uu.com
30 www.ctqcp.com
31 www.china-holiday.com
32 www.cct.cn
33 www.shal63.com
34 www.sh-holiday.com
35 www.go3.icpcn.com
36 www.yuding8.com
37 www.chinahotel.com
38 www.hzwy.com
39 www.oklx.com
40 www.cityhome365.com
41 www.easy-linkholiday.com
42 www.caissa.com.cn
43 www.053500411.com
44 www.51piao.com
45 www.hostelcn.com
46 www.piao.com
47 www.cntour365.com
48 www.cthy.com
49 www.114huoche.com
50 www.chinaonly.cn
51 www.junli.com
52 www.urthebest.com
53 www.quhappy.com
54 www.egpiao.com
55 www.chinapiao.com.cn
56 www.airprice.com
57 www.huilv.com
58 www.hkmohotel.com
59 www.cytsonline.com
60 www.jsj.com.cn
61 www.chinaticket.com
62 www.ehome365.cn
63 www.hxshuncheng.com
64 www.pekfly.com
65 www.cctsol.com
66 www.dalu.com
67 www.piao123.com
68 www.bjthjp.com
69 www.meini99.com
70 www.trip.com
71 www.hotel.com.hk
72 www.shasm.com
73 www.xz123.com
74 www.youcq.com
75 www.hotelhk.com
76 www.fridayol.com
77 www.zdpw.com
78 www.hottickets.cn
79 www.hotelinhongkong.net
80 www.xinyour.com
81 www.89838888.com
82 www.hohoho.com.cn
83 www.babycity.com.cn
84 www.fjp88.com.cn
85 www.kunmingguoji.com
86 www.actrip.com
87 www.010jp.cn
88 www.hn766.com
89 www.365sunny.com
90 www.95160.com
91 www.guilinyangshuo.com
92 www.yanchupiao.com
93 www.365666.cn
94 www.ginhoo.com
95 www.guilinhome.com
96 www.87667777.com
97 www.0532.com
98 www.51order.com
99 www.paio.cn
100 www.suzhoutravel.com
Stating the obvious: if you can’t rank in the top-100 sites you are not a leading online travel company as per the stock promotion.
John
Postscript: The company has irregularly given different traffic numbers in SEC filings. Here is an example (from the last annual filing).
In August 8, 2007, we acquired Shanghai Lanbao Travel Service Company Limited ("SLB") in exchange for 200,000 shares of our Common Stock and interest-free promissory notes in the aggregate principal amount of $2,828,000, payable no later than August 8, 2008. The note has been repaid in full.
SLB was established in 2002 and its core business focus is a centralized real-time booking system providing consumers and travel related businesses with hotel bookings, air ticket and tourism information via the internet and mobile phone text-messaging technology. It owns and manages the award winning China Booking Association website, http://www.cba-hotel.com/, which receives approximately 200,000 visitors daily.
These numbers are about 100 times the Alexa traffic estimate and maybe 200 to 400 times the China Rank estimate of total users for the site.
*I should note that the company has provided some online payment ability since I wrote my initial post. This ability is limited and clunky. Other major problems with the sites remain – for instance the lack of cookies to appropriately manage return customers.
First postscript quantification: China Rank as far as I understand measures users. Alexa measures viewers in a particular day. In both cases however the usage is way too low to sell that many tickets. The distinction here is second order – but if I have glossed over it then I apologize. Whatever – I noted the visitors per day claimed by UTA for CBA-HOTEL (200 thousand) are 100 times Alexa estimates and 200-400 times China Rank estimates. The nuances in definitions of visitor numbers are small compared to these multiples.
In the last few days more than half of the float of Universal Travel Group has turned over. It is clear that the company has made some misleading claims about their website. Some claims are easily falsifiable - in particular the claim (made by press release) that the website offers comprehensive and timely travel information and services, including guaranteed low prices, high visual appeal, map support technology and easy payment functions.
Still – and despite this – people have purchased the stock on mass – perhaps lured by the low single digit stated price to earnings ratio – perhaps lured by the large ($43 million stated) cash balance. These are of course the same lure. If the earnings are not there the cash balances they generated are unlikely to be there (and visa-versa). And if the cash balance is there my short position in the stock is wrong.
So I needed a test of either the earnings or the cash balance. If I could falsify one then any case for owning this stock would evaporate.
I was criticized in the comments for not approaching management with my concerns – so I have asked management (by email) if they have an innocent explanation for what follows. They have not replied.
Interest earned (or the lack thereof)
Cash interest rates in China are between two and three percent. China does not have a zero interest rate policy. [See the amendment at the end of this article for further clarification.]
The company ended the March quarter with a stated cash balance of $37.833 million.
It ended the June quarter with a stated balance of $43.591 million.
It is reasonable to guess an average cash balance of $40 million.
At 2 percent interest yield (a lower bound) the company would be earning $800 thousand per year – or $200 thousand per quarter on that cash.
It reported interest earnings of $17,081.
No, I am not forgetting a zero. The company is reporting less than ten percent of what is a reasonable lower-bound for interest earnings on its cash balance. [It is less than half the interest that would be received using the lowest rate we can find in the official guideline deposit rates – see the post-script.]
Interpretations
I asked management if there was an innocent interpretation of this discrepancy – indeed I gave them a draft copy of this post. I have not received a reply. So I will provide an incomplete list of alternatives.
First guess: It could be that management are so incompetent that they have parked all this cash in a bank account without even asking for a market yield.
Second guess: It could be that someone is stealing the interest by say depositing it somewhere and having the interest shifted to another account.
Third guess: It could be that the accounts are wrong and the interest is being earned – it is just not properly reported by the company.
Fourth guess: It could be that the cash balance does not exist so it is not possible to earn $200 thousand per quarter – and that $17 thousand per quarter in interest is reflective of the real cash balance.
There may be another interpretation – but the company has not helped me. I am again reaching out to the company for help. They can now provide an explanation by press release and/or SEC 8K filing.
My guess
If I were forced to guess I would suggest the most likely explanation is that the cash balance is missing. The company has claimed to earn lots of money on what is a non-functional internet travel company. Its a fair guess – faced with this bit of corroborating evidence – that the earnings are not there and hence the cash balance is not there.
Reasons people are buying the stock
It is now absolutely established that this company does not sell travel in the way that they press released to the US capital markets. Even in Chinese there was no mechanism to allow you to finalize travel on the internet. (There have been some minor changes to the website over the weekend and in some instances you are sent to third party credit card clearing companies.)
This post gives you reason to question the rest of the accounts – to question whether the earnings are there (or indeed if there are any earnings) and whether the cash balance is there.
Still the clear thinking on this blog has not stopped people buying over 10 million shares at over $3 and sometimes over $4 each. Someone has a different interpretation. If they share it I will happily allow it in the comments. But my guess is that the cash and the earnings are not there. The company provided no alternative explanation despite repeated attempts to contact them.
John
First postscript: Official rates in China are above 5 percent. Banks in China are awash in deposits and do not feel compelled in any way to pay official rates.
There are guideline interest rates that one reader pointed me to – which range from 36 bps to a few percent – and are over 1 percent for 7 day call deposits. Large depositors earn more than these rates though how much more is in dispute. (I have looked at several Chinese companies and the 2-3 percent number I used was taken on much advice.)
That said – the company earned $17 thousand in interest in the quarter on average balances likely near $40 million. That is 0.17 percent per annum – or less than half the lowest interest rate in the table. The point is still made – the interest receipts and cash balances appear inconsistent.
There is more to this story than the dysfunctional website and the fact that an internet travel agent pays a lot in commissions (as part of cost of goods sold, not salaries I might add). But for the moment the website is just so funny.
One reader suggested that it was possible to book a return flight with the return date before the departure date. It was not quite possible – but hey – that was because it wasn’t possible to book anything. But I tried that trick… and it was fun. (This video is in high definition so you can see all the text if you want to push the 720HD option and look on full-screen.)
John
