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.
(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.
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:
Unit Price (Yuan /L)
Purchase Amount (Yuan)
organic condensed liquid compound fertilizer (Broad Spectrum Type)
15ml *300 packages/piece
organic condensed liquid compound fertilizer (Broad Spectrum Type)
organic condensed liquid compound fertilizer (Anti-disease Type)
20 mil * 300
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.
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.
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
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.