Saturday, February 5, 2011

China Agritech. The "sniff test" and other questions for Anne Zheng and Carlyle

China scams are becoming so - well - yesterday.  There was a lot of it yesterday - hence two long posts in a day.

I barely noticed that Lucas McGee Research had put out a note accusing China Agritech (Nasdaq:CAGC) of being a fraud.

Lucas McGee is a new name for me - but their report is a classic of the genre.  They visited the factories (addresses in the annual filings) and there was nothing there.  These are plants that supposedly generate 50 thousand tonnes of "organic fertilizer" per year.

A truck carries a bit under 20 tonnes fully loaded.  That is 2500 trucks per year - in and out of the plant - so maybe 10 per working day bringing in the "raw material" and taking out the pellets.  You think you might notice some activity - but alas there was none.

All very interesting - but most interesting is that - at least according to China Agritech's annual report -  Carlyle - the most influential private equity firm in the world - have an equity stake in this company and a nominee on the board.  Her name is Anne Wang Zheng - and she is young (33) and a VP of Carlyle Asia Growth.  She works at the Shanghai office.

Now Carlyle - again according to the filings - has actively traded and sold China Agritech stock exercising their options.

I am not going to vouch for the fraud.  I have not visited the factories so I do not know.  (I confess however to being short the stock for the usual accounting-raised-eyebrows-reasons.)

I see five possibilities - though it is possible that readers - or Carlyle - see more.  I have sent an email to Anne Wang Zheng asking for her views but have received no reply.  Here are the five possibilities:

1.  The short-seller allegations are false.  (That is the short's note is a fraud.)

2.  The short-seller allegations are true but Carlyle is not actually represented on the board of China Agritech.  The China Agritech filings that say they are represented are in error (a fraud committed by China Agritech).  It would not be the first time I have seen people named as directors or officers of a fraudulent company when they in fact have nothing to do with the company.  In this case the company is fraudulent but Carlyle/Anne Zheng are honest.

3.  Carlyle is represented on the board of China Agritech - but remain - at least until the publication of the short's note - ignorant of the fraud.  In which case Carlyle/Zheng look incompetent - but not criminal.  Zheng in fact might be competent if the deception conducted by China Agritech were very well executed.  Being actively deceived even in her role as a board member makes her gullible - but being deceived is not a criminal offence and if she took reasonable steps to acquaint herself with the situation but was deceived regardless she does not even have civil liability.

4.  Carlyle is represented on the board - but found out during the time they were represented on the board that it was a fraud and did nothing about it.  In that case either Carlyle or Zheng (or both) are accessories after the fact to fraud.  Also as they sold stock they might be insider traders.

5.  Carlyle and/or Zheng knew that the company is a fraud from inception - and purchased the stock and sold the stock in that knowledge.  It could be that Zheng knows and Carlyle does not in which case Zheng has committed fraud against Carlyle (and its clients).

I have racked my brain as to which of these possibilities is the truth.  I think it is now incumbent on Carlyle to answer - and I will happily reprint their answer.

If you asked me my best guess it would be 3 above.  Zheng was an unwitting board member - and she may have been actively deceived.  I only arrive at that by applying Hanlon's razor:  "never attribute to malice that which is adequately explained by stupidity."

Of course there may be an explanation outside the 5 above.  Billy Bragg sang that "a man can spend a lot of time wondering what was on Jack Ruby's mind".  And he can.

A blogger could spend a lot of time wondering what was on Anne Zheng's mind.  I have - but I figure it is easier to ask.

So I am asking...


PS.  I have refrained from the (obvious) jokes comparing the company's accounts to a crock of the product (fertilizer) because I am not prepared to vouch for the fraud.  I have not wafted my nose in the product - but my guess is that if a plant did actually process tens of thousands of tonnes of chicken s--t pellets and you asked the locals about how active the plant was they would look at you as if you were strange.  Can't you smell it?

Visiting the plants and not being able to smell it would be proof enough.  In this case you should be able to smell fraud (or at least smell the absence of fraud).

If you believe Lucas McGee this one does not pass the "sniff test".

Corrections:  Carlyle did not - as far as I can tell - ever sell any shares - they purchased more - but only through the exercise of options.  I have corrected the post accordingly.  Thanks for the comment.


Second postscript:  The company has decided on 1 above.  I repeat their press release below.  If Anne Zheng wants to confirm this publicly as a director appointed by Carlyle I will happily post:

BEIJING, Feb. 4, 2011 (Nasdaq:CAGC - News) ('China Agritech', or the "Company'), a leading organic compound fertilizer manufacturer and distributor in China, today announced the following statements in response to the short sellers' elaborate article purposefully delivered during the Chinese New Year Holiday.

China Agritech and its subsidiaries are operating normally. A number of analysts, professional investors, industry experts, and the Company's independent accountants have toured the Company's facilities in the past. The Company has never received any challenges regarding either the existence or the scale of production of its facilities. In addition, management has confirmed that the Harbin facility has never been listed for sale.

The sales growth of the Company's organic fertilizers remains robust. In response to the short sellers' allegation that the Company's distribution centers are non-existent, there have already been 10 newly established distribution centers (including a flagship distribution center) in Henan Province alone.

In response to the short sellers' allegation that the Company's subsidiary YiNong does not exist, YiNong in fact is headquartered in Beijing with strong governmental support. In August 2010, the Company announced that it had entered into a strategic agreement with the Beijing Municipal Government to establish within Beijing the headquarters of its nationwide network of distribution centers.

In response to the short sellers' allegation that the Company does not have a license to manufacture granular fertilizer, the government-issued production license number for China Agritech's granular fertilizers is clearly marked on each of our product's packaging.

All distribution partners have signed legitimate and verifiable contracts with the Company. Sales records have been transacted per legal and accounting standards in China. Sales agreements with major distributors such as SinoChem can be viewed on the SEC's website at

Relevant evidence such as government-issued production license number and photos taken during the production process will be made available on the Company's website in the near future.

The Company appreciates shareholders' long-term support and stands ready to defend and uphold shareholders' value.


Nemo Incognito said...

Having seen a bit of the PE world in Asia's idea of diligence close up, stupidity would seem to be a distinct possibility. Most deals are got via guanxi or relationships, as a result many of the on-the-ground analysts suck at, well, being analysts. I left the PE world in Asia and moved over to the HF side for exactly this reason: relationship driven people use the "don't quash my deal, I have the guanxi" basis for running roughshod over analysts in order to get their deal fees and quite possibly line the pockets of friends/associates who receive the $$$. That and the fact that the PE world lives on the 2 and not the 20.

Anonymous said...

When did Carlyle sell?

John Hempton said...

correction posted re Carlyle selling.


Anonymous said...

You should know that Lucas McGee Research is operating out of a virtual office. Their report is hosted on a Wordpress site using an anonymous registrar.

I think #1 is more likely given all the attempts at concealing the identity of the short sellers.

Anonymous said...

Why do you call it Deloittes? I believe the name is Deloitte (at least in the United States it is).

Just wondering...?

John Haskell said...

The important thing is not the facts alleged against China Agritech, but rather the anonymous person who went to the factory and found that there was no factory. We need the whistleblower to step forward so the SEC can beat up on him as they did with Ackman and Einhorn.

Goldensun said...

Longs pointing to Carlye as validation that CCME is legit seem to forget that the firm's Asian offices have a terrible reputation. Remember the story of Peter "King" Chung? Remember this quote?

"I have bankers calling me everyday with opportunties and they pretty much cater to my every whim - you know (golfing events, lavish dinners, a night out clubbing). The guys I work with are also all chilll - I live in the same apt building as my VP and he drives me around in his Porsche (1 of 3 in all of Korea) to work and when we go out. What can I say,.... live is good,... CHUNG is KING of his domain here in Seoul..... "

Saying that because Carlyle is involved the company must be ok is the fallacy of reasoning known as "argument from authority."

Ask the idiots who fell for the China Water (CWDK/HEK) deal!

A company that wants to fool people can, all the way up to the Board of Directors. In fact, most scam companies do, at least for a short while.

Anonymous said...

>>Relevant evidence such as government-issued production license number and photos taken during the production process will be made available on the Company's website in the near future.

Why not now? The whole response comes across as extremely and purposely and unnecessarily vague if all is on the up and up.

Anonymous said...

Problems at another Carlyle China invested firm:
Carlyle China Deal Faces Trouble-China Forestry-WSJ

Doesn't prove anything about CAGC, but may be another indication that Carlyle has at minimum due diligence issues when investing in China?

Anonymous said...

You have forgot one possibility:
Carlyle may be using China Agritech to pay "fees" to China government/comunist party officials ...

Jesse Glickenhaus said...

I personally visited the Anhui factory as well as half a dozen distribution centers. I wrote up what I found, counting bags of inputs and outputs, into a document containing pictures that I took. It can be found at

Jesse Glickenhaus
Glickenhaus and Co

John Hempton said...

Mr Glickenhaus.

You got had.

They took you to the State Owned Enterprise next door.

Go check carefully the address versus the address in the 10K.


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