Last week, an anonymous short seller posted an instablog attacking China Integrated Energy (CBEH) that drove the shares down more than 30% within minutes. Admittedly, I wrote a favorable article about CBEH, based on the valuation I derived from its financial filings, when it was trading just south of $6 per share. I believe that the short term success of this attack on CBEH may be due to recent, though rare successes, of Muddy Waters “hit pieces” on RINO and China MediaExpress Holdings (CCME). I would like to outline a few key differences between what is happening to CBEH and what happened to RINO and CCME as it pertains to CBEH's valuation.
Though it is very early in the storyline for CBEH, there are a few key differences between the successful short attack on CCME and the attack currently taking place on CBEH. CBEH’s short attacker has experienced wild success in the short term unjustifiably due to his timely release of the report in close proximity to a rare succesful short attack CCME. In actuality there are many short attacks happening right now, probably in the realm of 30+, some highly visible, some not. Only two that I can recall in recent history have actually led to auditor resignations or de-listings. Both were from the same author, Muddy Waters Research.
Below I will break down the important differences between CCME via Muddy Water’s successful campaigns, and CBEH’s current short attacker.
First, the short seller behind CBEH is anonymous. CCME’s is not. This should raise some red flags for the short side of the table. The only recent successful short attacks that resulted in de-listings or auditor resignations were both from Muddy Waters Research.
Second, the CBEH report relies entirely on SAIC filings for the basis of its allegations. The successful Muddy Waters reports rely little on these filings, while instead conducting ground work, checking supplier and customer relationships and speaking to a lot of different people on the ground in China.
Many articles have recently been written outlining the fact that short sellers falsely cite SAIC filings as legitimate financial documents. They are not... Per the SAIC own website, its mission is in...
"...maintaining market order and protecting the legitimate rights and interests of businesses and consumers by carrying out regulations in the fields of enterprise registration, competition, consumer protection, trademark protection and combating economic illegalities."
SAIC filings are not audited. They are not used to calculate taxes. They are not meant to be used to analyze company's finances or value. No one except short sellers writing “hit pieces” would use the financial information in SAIC filings to analyze the company’s value. The SAIC office is for distributing business licenses, and its financial filings are simply a complimentary subcomponent to receive a license. The financials filed through the SAIC don’t even have a mandate to be updated by the company. Meanwhile the SAT office in China is responsible for taxation, yet this short seller makes no reference to these more relevant SAT filings.
The fact that this author relies solely on SAIC filings for nearly all these allegations, while doing no customer or supplier checks, should raise some more red flags with would-be-followers of this research.
Muddy Waters actually provides some form of evidence about CCME that its suppliers and customers relationships don’t exist or are inflated. CBEH’s attacker does none of this, but instead relies solely on unreliable SAIC filings.
Third, the CBEH report attacks absolutely everything under the sun, while CCME's attack was focused on its relationships with its customers. When so much is attacked ranging from its profitability in every single segment, to its cash balance, to its M&A deals, to its capital raises, to its old auditor, to its ownership structure, and more, readers should seriously consider the possibility of a biased smear campaign.
Wholesale Segment
CBEH’s short attacker does not even make an attempt to debunk CBEH’s relationship with its suppliers and customers in its wholesale business. Instead it vaguely calls into question the economics of the dealings as unfavorable to Shaanxi Yanchang Group, China Petroleum (SNP) and SINOPEC (SHI), all high profile and visible government owned entities.
“We find it hard to believe that the two largest oil companies would engage in such trading arrangements…” with CBEH.
The line above is the sole basis for claiming fraud on CBEH’s wholesale segment. He provides nothing to say the sales and relationships don’t exist. Instead he provides a vague opinion that the wholesale oil business adds no value to refiners and it shouldn’t exist at all. Of course this is an asinine observation, as there are many oil wholesalers and distributors in China and around the world. It is a viable business segment with a long history.
Given the public nature of CBEH’s suppliers and customers, which are the largest and most visible state owned oil companies in China, it should be much easier to prove those relationships don’t exist than with small, not-visible companies with which Muddy Waters has had to deal. Readers should question why there is no attempt to debunk these relationships.
Biodiesel Segment
This author provides no evidence that the biodiesel segment is not profitable. There are no calculations, no models, and no attempt at any sort of P&L analysis. There is no refuting of CBEH’s relationships with its customers or suppliers in this segment either. There is no evidence presented that the sales don't exist. The only thing this author does is provide purported conversations with Gushan Environmental Energy, another biodiesel producer in China.
“We asked Gushan management whether it was possible to use Chinese Prickly Ash as a feedstock. They only responded saying that they are trying to use jatropha and castor bean oils as feedstocks in small quantities.” (source)
If you read this purported line from Gushan’s management, it doesn’t even support the author’s uneducated claim that you can’t use Chinese Prickly Ash as an input. This author has no education about bioediesel production, and is instead trying to put words in Gushan management's mouth that aren't even supporting his argument.
Additionally, the references to Gushan and another biodiesel producer failing to list CBEH as a competitor is misleading. He is citing a full year 2008 filed 10-k. CBEH has ramped up its biodiesel segment more recently, so why is this author citing a 2008 competitor report?
Beyond what I perceive to be misleading competitor references, the main argument directed toward the biodiesel segment is that CBEH’s margins are far greater than Gushan’s.
This argument is weak for three reasons. One, Gushan shut down several of its plants due to disputes with local tax authorities during 2009 and 2010. It is producing a small fraction of its sales volumes, while depreciation eats away at its margins. You cannot compare CBEH’s margins, a company operating at full capacity, with Gushan’s margins, which hardly operates at all.
Second, Gushan itself-- the very same company he is citing here to argue against biodiesel being a profitable business-- has openly said in recent months that it is planning to reopen its biodiesel plants. Gushan itself said through a recent Q&A with management that I actually conducted, that it expects to be profitable under current market conditions. At the same time this author is claiming biodiesel is not profitable, the source it uses to make this same claim has openly contradicted this sentiment.
Third, this author fails to recognize the differences between GU and CBEH’s production processes, which on top of the fact that GU is not even operating right now, would lead to different margins.
Retail Gas Segment
Without exception, this entire argument is based on SAIC filings from the acquired gas stations. He claims the SAIC filings don’t show as much income as CBEH reports to the SEC.
SAIC filings should not be relied on for financial information. They are not consolidated financial statements, are not used for taxation, are not audited, and are not even updated by the company. Meanwhile, its SEC filings are consolidated filings that are audited by KPMG. This author is using an age old short selling modus operandi of telling readers to assume the SAIC filings are correct, while the SEC filings are wrong.
Of course this makes little sense, as the SAIC filings are not used by any one for financial purposes, while the SEC filings are used exactly for financial purposes while being audited by KPMG for reliance by the investment community.
Summary
This report is nothing new. It uses an age old SAIC versus SEC filings argument as its base, which is very different than Muddy Water and its recent successes. The CBEH provides no customer or supplier checks of any kind, when I would argue-- given the high profile nature of CBEH’s relationships-- this should have been provided as evidence. The fact that someone went to this much trouble and could not debunk CBEH’s customers, suppliers or sales actually gives me slightly more confidence on this topic. I think the timing of this report near a successful CCME report has given it too much credence.
The company has initiated an internal review. In my opinion, this may lead to sell-side analyst suspensions until the review is complete. I believe that so long as KPMG remains on as the auditor, CBEH will enjoy price recovery in the short term. I think it is very early in this process for CBEH and I can’t predict the future, though I do believe this specific short seller report is very weak. It does not provide real investigation or ground work in China, but rather relies solely on SAIC filings that we know are not for financial or valuation purposes.
I have a small position in the company and I am eager to see how it plays out.
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