Feb 25, 2019 5:07 pm
Summary
Kandi Technologies Group has a colorful past riddled with alleged and proven stock manipulation and fraud. One case bears a striking resemblance to current events.
The recent approval of Kandi's vehicles by the NHTSA has been massively misunderstood. The NHTSA does not approve vehicles for importation.
Kandi's grandiose plans for their American operation consists of one small ATV wholesaler based in Garland Texas. They have nothing in the form of distribution channels.
While all eyes are on the future of their US endeavors, Kandi has exhibited appalling results in China utilizing a mere 3.7% of their manufacturing capabilities.
The complicated corporate structure hides the fact that much of their revenue is generated from selling back to themselves in an elaborate circle.
The exciting new industry of electric vehicles has taken the world by storm, attracting retail investors by the droves flocking to catch a piece of the action. But unfortunately, often times where you find money, you also find greed.
Kandi Technologies (KNDI) has a long history of alleged and proven stock manipulation and fraud. There have been six well-documented cases dating from 2009 to 2016 all worthy of a raised eyebrow, and as the news of recent developments rattles the investment community that surrounds the stock, I urge investors to look carefully at the company's past and tread lightly.
After taking a deep look into Kandi's colorful history, we'll examine why this recent news of NHTSA approval bares a very close resemblance to previously alleged nefarious intentions. We'll take a look at the company's performance in China and line it up against popular U.S. electric vehicles to see if success is plausible for the newcomer.
As Warren Buffet once said, "Be Fearful when others are greedy, and greedy when others are fearful."
A Nefarious Past
The past of Kandi Technologies is stained with many accounts of alleged and convicted stock manipulation and fraud. Starting in 2009, the CEO (still current CEO) issued 350,000 shares to Roger Lockhart and George Tazbaz for the purposes of compensating stock promoters in the US. The alleged agreement was to manipulate the stock to $3 per share by the end of 2009. The SEC convicted Lockhart and Tazbaz of stock manipulation and fraud but did not take enforcement action against the company or CEO. This will prove to be a common theme in the years to come.
Moving to 2012, Kandi made an all-stock acquisition of a company called KO NGA Investment Limited. Under the terms of the agreement, Kandi was to issue 2.35 million shares as compensation representing a purchase price of $8 million. Kandi reported that KO NGA was owned by 7 unrelated shareholders.
Source: KO NGA INVESTMENT LIMITED
The Panama Papers Leak provided incriminating evidence that the sole shareholder of KO NGA was, in fact, Kandi's CEO Hu Xiaoming. This is another brazen case of securities fraud by management. Again, no enforcement action was taken by the SEC against the company or CEO.
Kandi has made several of these stock-based purchases that I believe could be considered suspicious. A recent acquisition made in January of 2017 had the company dole out $33 million in compensation for Jinhua An Kao; a business that had been turning a loss. Kandi received only 5.5 million in net tangible assets but booked $24 million in goodwill from the transaction. The company maintains in their filing with the SEC that "The Transferor has no relationship to the Company other than in connection with this transaction." I would like to point out the oddity of a stock-based transaction of $33 million on a wildly volatile small-cap stock… But I digress.
In June of 2013:
Source
After the announcement of approval by the Chinese government for sales and subsidies of their cars, Sharesleuth reports that a number of accounts on Twitter and Yahoo Finance began posting about the company. These promoters were also seen on the message boards of GM (NYSE:GM) and Tesla (NASDAQ:TSLA) "issuing baseless price targets, predicting an imminent short squeeze, and suggesting that Kandi was a buyout target."
The posts were then promptly deleted, but Sharesleuth managed to capture screenshots of the alleged manipulation:
Source: Sharesleuth report
A week later, the reason became clear as Kandi announced a private placement of 4.4 million new shares at a price of $6.03 a share which raised $26.4 million before expenses. Shareholders were diluted by over 15% and the stock crashed back down to earth.
We can draw some incredible parallels to present day action as the stock soars high on a similar 'approval' in the U.S. It's worth noting that Kandi currently sits with a largely untouched $300 million mixed shelf offering, meaning that management is fully capable of massive dilution. Take that as you will.
These are only the highlights in a much longer list. The company has been accused and investigated for subsidies fraud in China, which led to a full withdrawal of subsidies for an extended period. Kandi's financial auditor was banned by the PCAOB for malpractice. Numerous "accounting issues" led to an investigation of falsely inflated revenue numbers after a third-party's financial statements showed an $80 million discrepancy. Lawsuits are still in progress.
Throughout this extensive list, no charges have ever been laid against the CEO or any of Kandi's management. In their SEC filings, the following disclaimer says it all:
Investors may experience difficulties in effecting service of legal process, enforcing judgements or bringing original actions based on United States or foreign laws against us or our management. The legal system in China cannot provide investors with the same level of protection as in the U.S. The Company is governed by laws and regulations generally applicable to local enterprises in China. Many of these laws and regulations were recently introduced and remain experimental in nature and subject to changes and refinements. Interpretation, implementation and enforcement of the existing laws and regulations can be uncertain and unpredictable and therefore may restrict the legal protections available to foreign investors.
Against that background, let's investigate the recent news through a clearer lens.
The Facts Behind the Hype
The whole reason for the recent hysteria was an "approval" by the National Highway Traffic Safety Administration (NHTSA) for the sale of Kandi's model K22 and EX3 cars. This is an astounding obfuscation of reality as The NHTSA doesn't approve cars in the United States but instead leaves it up to manufacturers to meet their requirements. This quote was taken directly from the NHTSA website:
The National Highway Traffic Safety Administration (NHTSA) is authorized under Title 49, Chapter 301 of the U.S. Code to issue Federal Motor Vehicle Safety Standards for new motor vehicles and new items of motor vehicle equipment. NHTSA, however, does not approve motor vehicles or motor vehicle equipment, nor do we endorse any commercial products or conduct pre-sale testing of any commercial products. Instead, Chapter 301 establishes a "self-certification" process under which each manufacturer is responsible for certifying that its products meet all applicable safety standards.
The following steps are how manufacturers go about importing their vehicles to the United States:
The NHTSA requires that manufacturers send them the general vehicle specifications for self-certification and reporting purposes
The manufacturer must designate a U.S. agent for service of process who will act as their primary contact in the event of a safety issue
NHTSA sends a 3-digit VIN to be used in the process of manufacturing for identification of the manufacturer
Vehicles are then manufactured and individually identified using the manufacturers VIN as part of a larger 8 digit code
The federal agencies that regulate the importation of vehicles are the DOT and US Customs upon arrival in the United States
Kandi's press release has used this 3-digit VIN as proof of approval from the NHTSA, but, in truth, manufacturers are only required to send in their vehicles' specifications in order to receive a VIN.
The Plan for Distribution
Also somewhat misleading is the company's plan to distribute its vehicles throughout the United States. It would be reasonable to think that with all the attention Kandi has garnered in the last few days, they would have a firmly established distribution channel already in place for their 'approved' vehicles.
Kandi has stated that it plans to sell its vehicles through their wholly-owned subsidiary SC Autosports LLC. The company was acquired in June of last year in an all-stock acquisition (sound familiar?) totaling $10 million. $1 million was to be paid up front and the other $9 million was based on the company's performance over the next 3 years.
Upon further digging, it turns out that SC Autosports is comprised of one building in the small town of Garland Texas.
Source: Google Maps
The acquired company (previously Sportsman Country) was a wholesaler of ATVs and had been in operation for a mere 18 months prior to the acquisition. They reported a grand total of 1 million in revenue for 2017. Sportsman Country's net assets recorded by Kandi were $823,000, leaving a gigantic portion paid over and above to be booked as goodwill.
Conveniently, the stock price fell substantially after the acquisition announcement allowing goodwill to be recorded as $5.2 million instead of $9.2 million. Calculated at the current day price per share for the remaining shares held in escrow, the total acquisition cost is close to $15 million. I would argue that an 18-month old ATV wholesale operation booking $1 million in revenue does not carry a fair value near $10 million.
However, Kandi's 8-K filing contains the familiar statement maintaining that "the transferors have no connection with the company other than in connection with this transaction."
So, the Company's grandiose plan to launch an American operation stems from a small building in Garland Texas. What about their infrastructure and success on home soil?
Current Car Sales and Manufacturing Capabilities
Illuminati Investments does a fantastic job of laying out Kandi's extremely poor results. Promoters of the stock have boasted of factories capable of producing 300,000 cars per year. An additional new factory that was completed last year will add 100,000 cars to that capacity. At the same time, the company only sold 11,400 units in Fiscal 2017 and 10,100 units in 2016 as per their latest 10-K. This represents a 3.7% utilization of manufacturing capacity. Keep in mind that there are current lawsuits alleging over-inflated numbers on previous financial statements.
On top of this, a significant portion of sales can be attributed to a subsidiary of the company that operates a "ride share" program, so, in essence, their largest customer is themselves.
Kandi's "car share" program: Taken from Illuminati Investments article
Illuminati Investments alleges that the company was massively defrauding the Chinese government in collecting subsidies on the sale of cars back to themselves through an elaborate scheme.
But even taking their numbers as gospel, in the best of cases, they look truly pathetic when compared to the competition. Tesla has a max capacity of 300,000 cars per year and sold just under 250,000 cars in 2018. Promoters of the stock could argue that the company hasn't had a chance to build up to optimal sales, but Kandi has been approved and capable of selling EVs for the last 6 years. Being that China is by far the largest EV market making up 51% of global sales, I fail to see how Kandi has managed to underperform so severely.
Something is amiss here, whether it be demand for the vehicles or the stated max capacity. Either way, I don't believe that the significantly smaller U.S. market will contribute in any way to remedying these discrepancies. When you add this to the fact that their planned entry into the U.S. market is an ATV wholesaler in a small Texas town, it seems all too obvious that investors have ubiquitously misunderstood the situation.
The EV Industry Comparative
Even with all that said, maybe there will be demand in the U.S. With such largely under-utilized manufacturing capability, Kandi could do well if consumers are willing to buy them. I'll let you decide if that's remotely plausible.
Source: Zhejiang Kandi Vehicle - Page 2 - China Car Forums
Meet the K22. The car that Kandi's CEO says "is competitive in price and quality with advanced tech features that are in demand by American consumers." What are these advanced features you might ask? The car vaunts a top speed of 64 miles per hour, a whopping 66 horsepower, and an 83-mile range per charge. This is how it holds up against the competition:
While the K22 will assuredly be one of the cheapest cars on the market, I have my doubts about whether consumers will be flocking to buy this relatively unknown foreign brand. With specs that place it substantially below the competition, I wonder if there will be any market whatsoever.
In addition to the K22, Kandi will be releasing the EX3 for a yet undetermined price. This version will contain a much larger battery but lacks in performance just the same.
What are you Buying When you Buy Kandi Stock?
I'd like to finish my article with a question, partly because I'm not entirely sure what the answer is. What are you buying when you purchase this stock?
Source: latest 10-Q
The image above taken from Kandi's SEC filings depicts the company's opaque corporate structure. Everything below the thick black line represents The JV Company, of which Kandi is a 50% shareholder. Because of the partial ownership, net profit/loss is recorded separately from Kandi's financials under the equity section of the income statement. In this way, all expenses of The JV Company are largely hidden from SEC filings.
90% of Kandi's revenue comes from the sale of batteries and parts to The JV Company (in essence selling to themselves). In return, a large portion of cars manufactured by The JV Company is then sold back to a Kandi subsidiary ride-share program. This means that the majority of their reported revenue and activity is really just the transferring of assets from one subsidiary to another.
It is known that Kandi's CEO also sits on the board of directors for The JV Company, but my digging turned up no mention of how much compensation board members receive. The barrier of partial ownership leaves the inner workings and expenses concealed. All we've seen come out of The JV Company is substantial losses recorded separately for the last few years.
This obscure corporate structure seems to run the gambit of elusive behavior as the company cycles through revenue by selling to itself. What do you get when you buy Kandi shares? After endless hours of research, I still couldn't give you a clear answer.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in KNDI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
