Good morning. Here is an interesting cautionary tale on Chinese stocks that a good friend sent me.
Wall Street Scion Lost in China Agritech as Shorts Cry ‘Scam’
By James Sterngold - Apr 26, 2011
Jesse Glickenhaus learned about investing in China the hard way: The first shares he bought, in an organic fertilizer company, lost half their value in four months after short-sellers questioned the firm’s credibility.
When Glickenhaus, 29, joined his family’s New York asset- management company in October, he wanted to bring its stock picking into the era of global warming. That led to a $4 million investment in China Agritech Inc. (CAGC), a Beijing-based firm listed on the Nasdaq Stock Exchange and 22 percent owned by Carlyle Group. It was, Glickenhaus said, a way to profit from the need to feed China in an environmentally responsible way.
Or so it seemed. The same week in November that Glickenhaus & Co. bought most of its 326,130 shares, China Agritech replaced its auditor. Three months later, investors who had bet against the stock attacked the firm as a scam with no real operations. Shares tumbled to $6.88 on March 14, when trading was halted for failure to file financial data, from $15.87 on Nov. 8.
“It would be easy to walk away at this point,” said Glickenhaus, whose family company has $1.3 billion under management. “It’s not nothing, but it’s not a big deal for us financially. The real reason we’re fighting is because we believe someone blatantly lied to short the stock.”
The experience has provided Glickenhaus, who has a master’s degree in global affairs from New York University, with a quick education in reverse mergers by foreign companies, such as the one executed by China Agritech. It has also vexed his grandfather, Seth Glickenhaus, 97, who founded his first company in 1938, still comes to the office most days and said he had “certainly never run into a problem like this.”
‘Backdoor Registrations’
In a reverse merger, a closely held corporation buys a publicly traded shell company and retains its U.S. listing. China Agritech came into being after China Tailong Holdings Co., a fertilizer maker founded in 1993 by Yu Chang, merged in 2005 with Basic Empire Corp., a shell company that began life in Nevada in 1925 as Argyle Mining Co. and no longer had any business operations, according to a China Agritech filing.
Companies that get listings on U.S. markets by reverse mergers aren’t subject to the same scrutiny as those that make initial public offerings, Luis Aguilar, a commissioner at the U.S. Securities and Exchange Commission, said in an April 4 speech. More than 600 such “backdoor registrations” have been done since 2007, including about 150 by firms based in China, and a “growing number” of those companies “are proving to have significant accounting deficiencies,” he said.
SEC Probe
The SEC set up a task force to look for fraud in overseas companies traded on U.S. exchanges, with particular interest in Chinese reverse mergers, and began a probe last year asking auditors for information on the firms. China Green Agriculture Inc. (CGA) in Xi’an and Rino International Corp. (RINO), a Dalian-based maker of water-treatment equipment, said they have received inquiries from the agency.
China Agritech hasn’t disclosed whether it’s a target, and Shiwei Yin, a New York-based executive at Grayling, the company’s investor-relations firm, said he couldn’t comment. John Nester, an SEC spokesman, said the agency neither confirms nor denies investigations.
Glickenhaus said he didn’t check how China Agritech obtained its U.S. listing and focused instead on the fundamentals of the company, its new drought-resistant products and the role of Carlyle, the Washington-based private-equity firm that bought a stake in 2009. His confidence in China Agritech remains unshaken, he said, even though it has fired two auditors in four months, is late in filing 2010 financial data and announced on April 18 that Nasdaq was planning to delist it.
Frayed Khakis
“I’m not going to say you shouldn’t invest in China,” said Glickenhaus, sitting in the company’s midtown Manhattan office, dressed in frayed khaki pants and a rumpled shirt. “In the future, if I find a company in China, I’ll probably stick to those that have had a major, well-known auditor for several years. I learned it’s not that difficult to manipulate the market in a small-cap, publicly traded Chinese company.”
On Feb. 3, a report titled “China Agritech: A Scam” was published on the website of Lucas McGee Research. The 16-page paper, whose authors were identified only as holders of short positions, or bets against the company, said China Agritech “has no valuable technology, intellectual property, customer relationships or capital assets.”
Site Visits
Site visits to company facilities “found each one empty, idle and without production equipment,” with the exception of one plant in Beijing, the report said. Financial data supplied to Chinese regulators and obtained by “legal agents” who weren’t identified, showed that China Agritech had 2009 revenue of $7.6 million. While the company said it had almost $46 million of cash on its books and unaudited 2010 revenue of $119 million, the report concluded that revenue last year couldn’t have exceeded $7.5 million.
Lucas McGee is described on the website as an investor with more than 10 years’ experience in Asia. There was no response to e-mails or messages left at a Hong Kong number on the website. McGee isn’t registered as an analyst with Hong Kong’s Securities and Futures Commission.
The report ricocheted on blogs, including Seeking Alpha and Bronte Capital, and was cited by Bloomberg News. Shares fell 9 percent on Feb. 3. Three lawsuits citing the report and seeking class-action status claimed shareholders had been defrauded.
YouTube Rebuttal
Glickenhaus, who teaches a course at NYU called “The Effect of Climate Change on the Global Environment,” decided to see for himself. He flew to China on March 4 and visited several fertilizer plants and retail outlets with company executives. He posted his own report on the Glickenhaus & Co. website on March 24 and a video on YouTube showing busy factories to refute the short-sellers, whom he accused of being “negligent in their disregard for the truth.”
That only led to further attacks. John Hempton, chief investment officer of Bronte Capital, a Sydney-based fund manager who had a short position in China Agritech, wrote in blog posts and e-mails to Glickenhaus that the New York investor had been duped. Glickenhaus was taken to a state-owned fertilizer-bagging plant at an address different from one listed in China Agritech filings, Hempton said in an interview.
“I had a lawyer resident in Shanghai stake out their facilities,” Hempton said in a telephone interview. “There was no evidence of operations.”
Glickenhaus said he arranged his trip through China Agritech. He also said he hadn’t spoken with any customers or contacted the firm’s banks to check on its finances.
Beijing Factory
At a China Agritech factory in the Pinggu district of Beijing, a two-story building about the size of two football fields with the company’s name displayed outside, Bloomberg News observed about a dozen workers leaving by bicycle at 5 p.m. on April 18 as four guards stood at a security gate.
At another facility about a mile (1.6 kilometers) away, identified in filings as a research and development site, only an outline of the company’s name appeared outside. A lone guard, who identified himself as Mr. Qin, said operations had ceased about a month and a half earlier. Eddie Fan, a spokesman for China Agritech in Beijing, said the firm had moved its research operations to another location closer to the factory and would disclose the address when it files its annual accounts.
On March 13, four days after Glickenhaus returned to New York, China Agritech said in an SEC filing that it was involved in a dispute with Ernst & Young Hua Ming, the auditing firm it hired in November to replace Crowe Horwath LLP. Ernst & Young had asked for “an independent investigation in order to verify certain transactions and balances recorded on the company’s financial statements and records” for 2010 and that the accounting firm had determined “it may not be able to rely on management’s representations,” according to the filing.
Trading Halt
China Agritech said it had fired Ernst & Young and begun an investigation. It also said Zheng Wang, a Carlyle executive who sat on the company’s board, had resigned.
Christopher Ullman, a Carlyle spokesman, declined to comment, as did Charles Perkins, a spokesman for Ernst & Young.
Trading in the shares was halted March 14 and hasn’t resumed. China Agritech disclosed on April 18 that it received a letter from Nasdaq saying the exchange intended to delist the company, a decision the fertilizer maker has appealed. Wayne Lee, a spokesman for Nasdaq in New York, declined to comment.
New Auditor
The company has retained TroyGould PC, a Los Angeles law firm, and BDO China Li Xin Da Hua Certified Public Accountants Co. to conduct an investigation. On April 12, it hired a new auditor, Simon & Edward LLP, a Los Angeles affiliate of BDO International, a network of accounting firms. The company hasn’t said when it will release its 2010 financial statements.
Zhang Min, China Agritech’s board secretary, said at the company’s headquarters on the third floor of a Beijing commercial complex on April 7 that she couldn’t comment beyond statements the firm had already made.
Rodman & Renshaw LLC, a New York-based brokerage that underwrote a $23 million share offering for China Agritech last April, said it was confident the documents it issued in connection with the sale were accurate.
“Rodman stands by its due diligence procedures,” said Erik Knettel, a company spokesman.
James Glickenhaus, 60, Jesse’s father and Glickenhaus & Co.’s general partner, blamed inept China Agritech executives for mishandling the situation.
“Management has acted incompetently, there’s no question about that,” he said, referring to the firing of the auditors. $4 Million Ferrari
He also said short-sellers were trafficking in misinformation. Short positions in China Agritech increased to more than 2.9 million shares in March, or 23 percent of the shares publicly available, from about 2.3 million at the beginning of November, according to data compiled by Bloomberg.
“We have a long history of standing up to this kind of thing, and we’re not going to lie down now,” said James Glickenhaus, who owns a custom P4/5 Ferrari that he said cost $4 million and has produced several Hollywood action movies, including “The Exterminator,” a 1980 film about a Vietnam veteran turned vigilante.
For James Glickenhaus, China Agritech is the start of a long tutorial for his son, “like sending him to business school,” he said. For Jesse Glickenhaus, who has since bought 300,000 shares in another agriculture company, CVR Partners LP, a Sugar Land, Texas-based maker of nitrogen fertilizers that had an IPO April 7, China Agritech has already paid off.
“I went into this with an open mind,” Glickenhaus said. “I didn’t expect to enjoy it as much as I have.”
To contact the reporter on this story: James Sterngold in New York at jsterngold2@bloomberg.net
To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net
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