Thursday, August 4, 2011

So that makes it alright then...

China Media Express (now defunct and exposed as a fraud) was once the highest conviction and highest stakes short-versus-stock-and-stock-promoter battle on Wall Street.

That mantle has now shifted to Harbin Electric a company which makes (or is that purports to make) large numbers of high-tech electric motors. The Harbin battle has become special for its vitriol and today's 15% plunge and recovery in the stock is just the latest salvo.

Harbin Electric is subject to a proposed management buyout involving the CEO (Mr Tianfu Yang) and Abax Capital (an Asian based private equity fund sometimes associated with Morgan Stanley). The proposed buyout price is $24 and the stock is trading at $17.50 so if the deal goes through holders should make 37% returns. As the deal is meant to close in three months this is an unbelievable 350 percent annualized return. Bulls point to reputable parties involved in this deal including Goldman Sachs and China Development Bank.

Citron's case is that the company is a fraud and the deal is a fraud. The company is worth something close to zero, the deal will not close and the stock will collapse to low single digits. Citron (and other shortsellers) argue the deal is a ruse to suck in unsuspecting arb funds and dumb shareholders and that - absent the deal - Harbin would have collapsed like just about every other Chinese reverse merger.

I am not going to go through the background: all I want to point to is the latest "hit-piece" from Citron Research and Harbin's response.

Harbin alleges criminal behavior by people associated with Citron:

The Company believes that Citron used doctored SAIC reports. The Company has recently reconciled its PRC tax filings on a consolidated basis with its financial statements reported in its SEC filings for fiscal year 2009 and has not found any inconsistency in any material respect. Its SAIC filings are largely in line with its tax filings in the PRC.

Suffice to say that at there is a criminal conspiracy here - either Citron and associates are knowingly peddling lies or Harbin Electric is knowingly peddling lies.  

I don't have access to the original documents and so I don't want to add to that debate. I want to focus on director conflict of interest and Boyd Plowman - the "independent director" charged with assessing the Chairman's take-private bid for the company.

The role of Boyd Plowman

When the management of a company attempt to take it private the role of non-management directors is crucial. After all non-management directors are there to protect against management stealing the company or at least buying it on the cheap.

So typically the board will set up a "special committee" of non-associated directors to assess "the deal". 

Harbin did that.

And the chair of that is Boyd Plowman.

Here is what Citron said about Boyd Plowman's independence:
Mr. Plowman is both head of the audit committee of Harbin, as well as the appointed head of the special committee to take the company private.  This committee is at the center of the requirement that the interests of shareholders be defended.  It is under his watch that we are to trust both Harbin’s financials, and the fairness of the process by which the “takeover” transaction proceeds.  
However, the July 13, 2011 proxy statement filing is the first time investors are informed of the following :
  • “Shortly after Abax filed a Schedule 13G with the SEC on December 9, 2010 announcing its greater than 5% ownership of the Company common stock, Mr. Plowman, the Special Committee Chair, brought to the attention of the other members of Special Committee, as well as to Gibson Dunn, the fact that he was then serving as a director of several Abax-controlled entities including Abax Global Opportunities Fund, Abax Arhat Fund, Abax Claremont Ltd., Abax Jade Ltd., Abax Emerald Ltd., Abax Lotus Ltd., Abax Nai Xin A Ltd., and Abax Nai Xin B Ltd. (the “Abax Companies”).”

Citron then made obvious comments about whether this relationship was appropriate or not. 

Harbin replied:

The allegation that Mr. Boyd Plowman is a Director of Abax is simply not correct. Mr. Plowman resigned as a Director of Abax on December 16, 2010, just a few days after Abax acquired 5% of the Company on December 9, 2010. This information has been disclosed in the preliminary proxy statement filed with SEC on July 13, 2011. Mr. Boyd Plowman confirm that he is not a director of Kilometre Growth either as alleged by the Report.
So that makes it alright then?

Seriously though it took from 9 December 2010 to 13 July 2011 to disclose that to the public.

That is 216 days.

But it was disclosed, and I guess within the letter of the law that does make it alright then.

The only problem is that Abax and Harbin have been dealing for some time. For instance the last 10K provides this disclosure:

On July 28, 2010, the Company entered into a Loan Agreement, dated July 28, 2010 (the “Loan Agreement”) with Abax Emerald Ltd., a Cayman Islands limited company (“Abax”), pursuant to which Abax agreed to provide the Company with up to $15,000,000 in loans (“Abax Loan”). The Abax Loan was to be  made pursuant to one or more borrowings (each, an “Advance”) from time to time from the Closing Date (July 28, 2010) to the date falling on the expiration of five (5) months after the Closing Date upon delivering a notice from us to Abax. In lieu of payment of interest in cash on each Advance, the outstanding principal amount thereof  accreted in value for the period commencing on the Borrowing Date (the date on which any Advance is made from us to Abax) for such Advance and ending on the day on which such Advance is repaid, at a rate equal to 10% per annum, computed as described in the Agreement. The Loan Agreement provided that we could  voluntarily prepay any Advance (or portion thereof in an integral multiple of $100,000) at its accreted value at any time upon written notice to Abax. On the Maturity Date (six months after the date of the Agreement), we were obligated to  repay the remaining outstanding loan not theretofore paid, together with all fees and other amounts payable under the Loan. On July 29, 2010, the Company received the $15 million loan from Abax. The Abax Loan was used to pay down certain debt and to support our capital expenditures and working capital.
So the company borrowed at 10% from Abax. Nowhere in the annual filing is this disclosed as a related party transaction. Management were (as we are now told) informed by Plowman that he was a director Abax entities on 9 December 2010 - three months before the 10K was filed.

I guess that would be sort-of-OK if Harbin really needed the money. But Harbin claim to have had almost 100 million of cash sitting on the balance sheet the whole time that they borrowed 15 million from Abax.

This is very perplexing. Harbin borrowed from an undisclosed related party at a high interest rate whilst sitting on lots of cash.

And Harbin disclosed the fact that it was a related party 216 days after management were informed of the conflict.  And they did not disclose it in the 10K.

But it is now disclosed. And we know that that makes it alright then.



Nemo Incognito said...

And as a further aside, HRBN's original deal with Citadel was done by Chris Hsu's team who was formerly a partner of Abax.

Asia is small, but not that small.

Tom said...

I especially like the part in HRBN's rebuttal that (1) complains about short-sellers ruining the value of a company (2) encourages shareholders to call up their broker and instruct them not to lend out their shares.

All this, for a company that is guaranteed to be worth $24 per share in three months to any shareholders who hangs on. And yet, for some reason, HRBN is worried about the present price of the stock, and feels the need to encourage a short squeeze.

Sometimes these things are so transparent that you wonder who's actually getting fooled by this sort of thing. Are they all robo-traders?

draghkhar said...

Looks like the SEC is getting involved with HRBN:

As chairman Tianfu Yang said: "attacks on the credibility of the Company would continue, and may even increase, in order to drive its share price down for the benefit of short sellers." Now including the SEC? Is that how they plan to close the US budget deficit?! :-)

Anonymous said...

Talking about the apparent smallness of Asia, Xiang Dong Yang, the founding partner and President of Abax Global Capital, is also a director of China Natural Gas (NASDAQ:CHNG).
Just like HRBN, CHNG is also in the process of being 'taken private' by its CEO. This time with the assistance of Themes Investment Partners, and for a much more modest $4.25.
CHNG last traded for $2.61

Anonymous said...

Hi - anyone concerned thought that the deal will be consummated as part of some larger (fraudulent) scheme we don't understand, yet?

Chip said...

Maybe a crazy idea, but say they take a loan and complete the takeover. They may then relist in HK and raise capital to pay off the original loan.

Anonymous said...

You do very good work.

Anonymous said...

The plots thickens. HRBN just flat out denied that they are under any sort of SEC investigation.

I wish I had a free hour today to get on the phone with the SEC to confirm or deny...

WelRed said...

Tom has it exactly correct. Well done sir.

Now just to find some cheap(ish) puts.

Nemo Incognito said...

Too funny viz CHNG - Frank Yu didn't last long at Och Ziff and is good friends with Donald Yang. He was a bit of a goose and was an MD in banking at GS, wonder if he was on the Longtop deal team?

Anonymous said...

Under what conditions would it makes sense for a private equity firm to grossly overpay for a diseased target?

Nemo Incognito said...

Anon @ 2:46am, not many but if you thought diseased target going down could get you in serious trouble you just might. All you have to do is do enough diligence to make a negligence case not stand up while not uncovering the problem you already know about.

kristiina said...


Yves at NC linked to this article mentioning you. And then today NC ran an article by James Galbraith on fraud, and in the comments this article was brought up and also Michael Lewis got a mention, so i read his take on the greek situation: beware of Greeks with bonds in Vanity Fair.

Yes, fraud is the name of the game, and those exposing fraud are being treated as nasty destroyers of value. How can anyone be so mean that they blow up the fortunes of perfectly respectable investors? As a spectator, it is absolutely stunning to watch what rapists do when they are being raped. It seems they think it is wrong when it is done to them. I wish i knew what to make of this - where will this lead?

Just wanted to say (again) that i respect and admire what you are doing. If i ever had money to invest (though with my disposition, chances for that are about zero) i'd vote for you with it. They used to say about Göring's brother that he was a moral man in an immoral time, as he did his best to save people from nazis. Strangely, in these times it seems it is even harder to be moral, and there are even less moral men. But you are one of them.

Anonymous said...

Nemo Incognito- good observation on the personnel at Abax. Most people were generally surprised (I know I was!) when Chris Hsu founded Abax and got the big commitment from MS. Anyone on the HF sell side in Asia knows all about Chris' experience, reputation... And remember, MS was on its ill-advised Mack-inspired "chase risk and catch Goldmans" splurge where it bought subprime originators, seeded HFs, ramped up fixed income risk etc etc all at the top. I'm with Citron on this one.
- KC

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