Kandi Technologies: Concerns Over Recent 10Q Have No Merit
Jul. 23, 2014 11:48 PM ET | About: Kandi Technologies, Corp (KNDI)
Disclosure: The author is long KNDI. (More...)
Summary
KNDI is not creating an “illusion” of rapid company sales via increased EV Parts sales.
EV Parts sales in Q1 was a natural precursor to increased electric vehicle sales from their JV in Q2.
The Carshare program is not an inventory buildup vehicle. It is a customer that provides economic benefit to KNDI.
JV sales in Q2 of 4,114 electric vehicles implies strong sales growth with their customers, including the Carshare project.
KNDI is not gaming the system to maximize government subsidies. The Company receives subsidies because they provide EVs to consumers which helps alleviate China's air pollution problem.
Introduction
I felt the need to respond to Mr. Rabizadeh's recent short article on KNDI because I believe it is filled with numerous misinterpretations of KNDI's business and SEC filings. First, I will discuss why Mr. Rabizadeh's puzzling assertion that increasing EV Parts sales create an "illusion" of growth is not accurate. Next, I will discuss why Mr. Rabizadeh's is incorrect in his claim that the Carshare project is a subsidiary of KNDI. Then, I will refute his claim that there is no way for investors to meaningfully gauge performance of EV sales to the Carshare project and that current sales are merely "inventory buildup". Finally, I will discuss why Mr. Rabizadeh's is incorrect in his belief that KNDI is receiving government subsidies through disingenuous methods such as inflating sales via inventory buildup tactics at their subsidiaries.
Growth in EV Parts Business an Indication of Growth, Not an "Illusion"
In Mr. Rabizadeh's article, he states the following:
The 10-Q also states that 60% of EV Sales were to KNDI subsidiaries ("Kandi Electric Vehicles (Shanghai)" and "Kandi Electric Vehicles (Changxing)")…The more concerning part is how KNDI spun this to boast 174% revenue growth from $14.7M to $40.2M. Without this questionable tactic, revenue growth would have been roughly flat.
Mr. Rabizadeh is basically saying that KNDI is artificially inflating their results by propping up their sales with an EV Parts business which sells products at a loss. These statements are very misleading because it does not take into full context the relationship between KNDI's EV Parts business and the KNDI-Geely JV.
Before discussing the relationship between KNDI's EV Parts sales and their JV, it would be helpful to first have another look at KNDI's organizational chart which I have pasted below.
(click to enlarge)
As you can see, KNDI owns 50% of "Kandi Electric Vehicles Group". This JV was established with Geely for the production and sales of electric vehicles. As part of the JV agreement, KNDI agreed to contribute their EV manufacturing plant in Changxing and Geely agreed to contribute their manufacturing operations in Shanghai.
Following the contribution of these assets, the JV became a 100% owner of KNDI's manufacturing operations in Changxing ("Kandi Electric Vehicles (Changxing)") and Geely's manufacturing operations in Shanghai ("Kandi Electric Vehicles (Shanghai)"). This is clearly illustrated in the organizational chart above.
The latest 10Q provides the following breakout of KNDI's sales to their JV:
(click to enlarge)
As can be seen, in Q1 2014, KNDI had over $24mm of sales to their JV via purchases from the JV's Changxing and Shanghai subsidiaries. The latest 10Q makes it clear that the manufacturing operations in Changxing and Shanghai are for the production of electric vehicles. Consider the following statement in the 10Q:
In March 2013, Kandi Vehicles formed Kandi Electric Vehicles (Changxing) Co., Ltd. ("Kandi Changxing") in the Changxing (National) Economic and Technological Development Zone. Kandi Changxing is engaged in the production of EVs….Kandi Vehicles transferred 100% of its ownership in Kandi Changxing to the JV Company
Thus, it is a logical conclusion that of the $25mm of EV Parts sales that KNDI reported in Q1, the vast majority of these sales ($24mm out of $25mm) were to supply EV parts to the JV's manufacturing subsidiaries in Changxing and Shanghai. The EV parts that KNDI is selling to the JV are used by the JV's manufacturing subsidiaries to produce electric vehicles.
KNDI's sourcing of EV parts for the JV business is a legitimate business transaction that they must report in their financial statements. These parts will used by the JV to manufacture electric vehicles that the JV will then sell to customers, like the Carshare project, with the profits being split 50/50 by KNDI and Geely. KNDI did not get into the EV business to profit off of sales of EV parts, so the fact that KNDI makes little to no money from this business as of now is not a concern. The management team knows that the real profits are in the actual sale of electric vehicles.
So what does this all mean? Well, it means that Mr. Rabizadeh's assertions that KNDI is misleading investors by inflating their EV Parts sales does not make much logical sense. I think a more sensible conclusion from all of this is the following:
KNDI is providing EV parts to their JV. KNDI sources most of these parts from third parties and also manufacturers a small percentage of these parts.
The KNDI-Geely JV uses these parts at their manufacturing operations in Changxing and Shanghai to provide electric vehicles
In Q1 2014, KNDI's JV purchased a meaningful amount of EV parts from KNDI in order to ramp-up of production of electric vehicles in anticipation of a large increase in EV sales in Q2 2014
In Q2 2014, KNDI's JV sold 4,114 electric vehicles which was a large increase from the prior quarter and provides confirmation that the purchase of EV Parts from KNDI was demand related and not inventory buildup / channel stuffing.
So, while it is true that KNDI's EV Parts sales are not profitable (essentially breakeven) and are attributable to increased sales from their JV subsidiary, investors should view this as a positive. Increased parts sales are an indication that the JV expects strong demand for their electric vehicles. The EV Parts business, right now, is essentially a pass-through item for KNDI. The real profits for the KNDI's EV business will come from the sales of electric vehicles through their JV. Thus, Mr. Rabizadeh's claim that KNDI is using "questionable tactics" by intentionally inflating sales via their EV Parts business does not hold water. His argument that KNDI is merely stuffing the channel and building up inventory might have a leg to stand-on if EV sales at the JV declined or remained stagnant. However, this is clearly not the case given the JV's sale of 4,114 electric vehicles in Q2 2014.
KNDI is Currently Benefiting and Will Continue to Benefit from the Carshare Project
The statements in Mr. Rabizadeh's article that I felt were the most off-base were his comments on the Carshare project. Consider the following quotes in his short article:
The Carshare project does sound promising as it seems to be rapidly growing. The problem is, it's not clear how much economic benefit KNDI will get from the rental revenue….Without any other information about the Carshare project, we have to assume that KNDI only has a 9.5% economic interest in the Carshare project (remember, it's 50% of 19% since it's a JV with Geely).
However, thanks to their creative organizational setup and carefully worded press releases, KNDI is creating the impression that sales are exploding -- when, in fact, all that is exploding is the buildout of inventory from one KNDI subsidiary to another.
Importantly, we have no idea how the Carshare project is actually doing. KNDI has only released data to date on sales of EVs to the Carshare project. For all we know, actual rental revenue is not growing or not operating profitably.
So, lets discuss some of these comments one-by-one. First, I will discuss Mr. Rabizadeh's comment that it is not clear how much economic benefit KNDI will receive from the Carshare program's rental revenue. Well, this is true, but it is ultimately an empty statement. The primary economic benefit to KNDI from the Carshare program is from the sale of electric vehicles from KNDI's JV to the Carshare program, NOT from the rental revenue. This is clear when reading the description of "EV Products" sales in the latest 10Q:
During the three months ended March 31, 2014, our revenues from the sale of EV products increased by $6,641,054, or 384.5%, as a result of a 105.3% increase in unit sales and a 136.0% increase in the average unit price compared to the same period of last year. The significant increase was mainly attributable to the newly-added EV model -Kandi Brand SMA7000BEV, a five-door and five-seat vehicle, and SMA7001BEV, an improved model of electric vehicle, both of which are sold at a significantly higher prices. The increased unit sales were driven by sales to Hangzhou Public EV Sharing System (the "Carshare" Project).
KNDI effectively owns 9.5% of the Carshare project, so the incremental rental revenue that they will receive from that small stake will be a nice added bonus. Ultimately, however, KNDI has and continues to expect to make the majority of their profits from the JV's sale of EVs to the Carshare program.
Next, I will discuss Mr. Rabizadeh's assertion that "KNDI is creating the impression that sales are exploding -- when, in fact, all that is exploding is the buildout of inventory from one KNDI subsidiary to another." What he seems to be implying is that KNDI is essentially selling to themselves by transferring inventory from their JV (of which KNDI owns 50%) to the Carshare program (of which KNDI owns 9.5%). This is completely false. Just because KNDI's JV owns a small stake in the Carshare program does not mean that they are essentially selling to themselves. It is not very complicated or confusing, the JV sells electric vehicles to the Carshare program and receives money (at a profit) for the vehicles that they sell to the program.
Think about it this way…Let's say that I owned 1 share of Microsoft. At the same time, assume that I coded a piece of software that I sold to Microsoft for $1 million. So, because I own 1 share of Microsoft, does that mean that I am essentially selling to myself for no economic benefit? Of course not! I am pretty sure I would still receive $1 million. The same concept applies to the electric vehicle sales of KNDI's JV to the Carshare program.
Finally, in regards to Mr. Rabizadeh's comment that "we have no idea how the Carshare project is actually doing". Well, this one is a fairly easy statement to refute. First, let me repost the following quote from the 10Q which I referenced earlier:
During the three months ended March 31, 2014, our revenues from the sale of EV products increased by $6,641,054, or 384.5%, as a result of a 105.3% increase in unit sales and a 136.0% increase in the average unit price compared to the same period of last year. The significant increase was mainly attributable to the newly-added EV model -Kandi Brand SMA7000BEV, a five-door and five-seat vehicle, and SMA7001BEV, an improved model of electric vehicle, both of which are sold at a significantly higher prices. The increased unit sales were driven by sales to Hangzhou Public EV Sharing System (the "Carshare" Project).
The Company explicitly states that the growth in EV products was due primarily to the Carshare program. In regards to Q2 2014, as I also mentioned previously, the Company just issued a press release which stated that EV sales in Q2 totaled 4,114. Although KNDI has not reported a breakdown of sales by customer, this explosive growth in EV sales implies strong growth at most of the JV's customers, including the Carshare program. So, I believe we do in fact have a pretty good indication of how the Carshare project is doing. It seems to be doing exceptionally well in fact. Also, at the end of the day, regardless of what customers are providing this growth, the fact is KNDI's JV is growing at a strong rate. This is the most important fact that an investor in KNDI should consider.
KNDI Has Strong Support from the Chinese Government
The last point that I would like to refute from Mr. Rabizadeh's short article is his claims that KNDI is gaming the subsidy system by employing tactics that "helps them qualify for the maximum amount of government subsidies, thus making KNDI a viable and profitable business model." Does it really make sense that the Chinese government would support a company that simply exists for its own benefit by collecting incentives by inflating sales through internal inventory buildup. Somehow, I don't think the Chinese government is that stupid. This allegation is really out of line. The more logical conclusion would be that KNDI receives subsidies because they have been successful in selling electric vehicles to real consumers, not fake sales through internal buildup.
Conclusion
In conclusion, I disagree with all of the key points in Mr. Rabizadeh's recent short article. KNDI is not misleading investors by artificially inflating EV Parts sales. Instead, the growth in EV Parts sales in Q1 2014 was a natural precursor to increased electric vehicle sales from their JV in Q2 2014. KNDI is NOT receiving limited economic benefit from the Carshare program. In fact, KNDI receives a great deal of benefit via the sale of electric vehicles from their JV to the Carshare program. Based on KNDI's recently reported electric vehicle sales of 4,114 in Q2, the JV is exceeding expectations and will most likely continue to provide tremendous benefit to KNDI and its shareholders. Finally, as a result of their continued success, KNDI should continue to receive strong incentive support from the Chinese government. Thus, I believe that the recent correction in KNDI's stock price represents an attractive entry point for a long investor.
