The Similarities Between Madoff and Harbin Electric

,

This past week, a new film documentary premiered entitled “Chasing Madoff”. 

http://movies.yahoo.com/movie/1810207107/video/26380206

It chronicles now famed whistleblower Harry Markopolos, whose longstanding battle to get the SEC to take action against the massive Ponzi scheme perpetrated by Madoff & Co. had been documented for years. 

To this day, Markopolos’s letter to the SEC in 2005 (which wasn’t his first, his first formal complaint to the SEC was made in early 2000), remains a classic in common sense insight for investors.  Citron believes it should be required reading for every market participant, legislator and regulator.

http://online.wsj.com/documents/Madoff_SECdocs_20081217.pdf

After recently re-reading “No One Would Listen”, this writer couldn’t help but see the similarities between Madoff and Harbin Electric.  Before you dismiss this as a stretch … consider a few points.

   Similarities between Madoff and Harbin: 

 

1)  Off-the-charts financial results that defy independent verification

Madoff reported earning 12% or more almost every year, while never disclosing how he did it.

Harbin has doubled revenue each of the last two years, to a run rate of over $500 million per year, meanwhile claiming net margins besting peer competitors by orders of magnitude.  Yet it does not disclose a single verifiable large customer or large scale order with a verifiable counterparty. Its major customers from prior years’ filings state little or no business conducted with Harbin.

2)  Investors who know something fishy is going on, but stay involved

Many of Madoff’s investors suspected he was doing something “wrong” (i.e. frontrunning orders), but invested anyway, because they figured he was on their side — as long as they could profit from his cheating, then cheating was OK.

Harbin investors have submitted hundreds of emails to Citron.  But not a single one has ever credibly defended the company’s business.  Instead, they all assert the theme of “who cares if there is a business or not….we are getting taken over.”

3)  Investors focus on credentials and not business

Madoff derived credibility because he was Chairman of the Board of Directors and a member of Board of Governors of the NASD.

Harbin’s Chairman Tianfu Yang derives credibility because he is a Deputy in the National People’s Congress.

4)  Professional Industry counterparties keep their distance

Many qualified market participants concluded Madoff was a fraud.  But while Madoff's wealth management business grew into a multi-billion-dollar operation, none of the major derivatives firms would trade with him because they concluded his numbers and his strategy were fictional.

Even though Harbin Electric has engaged numerous experts in its going-private process, the major firm analysts are all mute, large firm arb desks aren’t taking the “easy money” bait, and short-sellers can’t even short the stock because the borrow is so tight, all while the stock trades at 2/3rds of the takeout price. 

5)  Family members in key positions of trust

Madoff’s right hand man was his brother Peter Madoff who served as Chief Compliance Officer for 20 years.

Tianfu Yang’s right hand man is his brother Tianli Yang, who is Vice President of Harbin Electric and a director of subsidiaries.

6)  The low credibility auditor

Despite being surrounded by white shoe pedigree peers, Madoff’s auditor was Friehling & Horowitz, a little known accounting firm that has since been sued and put out of business.

Despite its going private documents festooned with pedigree white shoe names (every one of which explicitly disclaims any actual due diligence), Harbin’s auditors are Frazer Frost, a now disbanded and disgraced auditing firm which has been sued by the SEC and whose client list is the poster child for China stock fraud.

7)  Constantly raising expensive money despite claiming wildly profitable operations

Madoff continued to pay large acquisition fees to feeder funds, despite a business that purported to be massively profitable. 

Harbin’s Chairman Yang had to pledge the majority of his stock for an expensive $50 million loan.  The company also is indebted to a patchwork of banks, pledging various assets, while the company claims nearly $100 million in cash on the balance sheet, and hugely profitable operations, that never relieves its insatiable needs for cash.

   …But … One Major Difference

 

When Madoff’s fraud was finally exposed, there were consequences … serious consequences, as in a 150 year jail term, and asset seizure.

Citron believes the Harbin Electric deal is likely to “fall apart” at the last minute due to unexplained circumstances, which will likely be conveniently blamed on “regulators” and “short sellers”. 

But when it goes south, nobody at Harbin will be accountable, either legally or financially.  The utter lack of civil or criminal jurisdiction over the principals in China assures that shareholders will have zero recourse. 

Although there have been dozens of China RTO frauds exposed, not one penny has been recovered for shareholders by legal action, and not a single indictment of a culpable party has been executed.

    Conclusion

Citron alerts investors that, as currently structured, and absent regulatory intervention, this purported buyout can proceed all the way to the altar with not a single dollar escrowed to protect investors from being jilted at the last minute. 

The impressive-sounding white shoe names on the documents have all indemnified themselves with broad disclaimers.

For those following the case of CHBT, a China RTO fraud stock tracked by Citron for nearly a year, the real liquidity only poured into the stock in the final weeks immediately prior to the deadline for its audited annual report.

The entire Harbin take-private transaction depends on massive bank financing from one of China’s state financing agencies, an entity which customarily underwrites massive infrastructure development projects for widespread social benefit, not leveraged private equity deals to profit selected Hong Kong fund operators.  It remains utterly unclear how far this bank will deviate from their clearly stated policies of state and social interest to underwrite this dubious transaction.

Investors need look no further than the recent cases of Sino Forest and Longtop, whose stocks had no floor when the music stopped.  Billions in investor assets simply disappeared into the mists.

 

Cautious investing to all.

 

Harbin Electric: The Black Hole of Information

,

Whether a company’s stock trades in the US, Shanghai, Hong Kong or Shenzen, all investors want the same thing:  transparency.  The problem with Harbin (NASDAQ:HRBN) is not the short-sellers, as the company so vehemently stated on its last conference call.  The problem is the company has been violating every principle of transparency over recent years, which only intensifies as the company ramps up its claims of an upcoming $24 a share private takeover.

Investors have nothing to judge an actual business, absent a buyout offer, except a 2010 audit by defunct auditor Frazer Frost, which was has become the poster child for auditor negligence in the Chinese RTO space.  Meanwhile, Harbin Electric’s stock is being propped on the promise of a going-private transaction at $24 per share, a make-good for any possible operational problem the company has or any inconsistency in its financial reporting.  The story has not wavered in the face of:

  • industrial slowdowns both worldwide and in China
  • increasing gross margin pressure on the entire Chinese industrial sector — in both labor and materials
  • wave after wave of exposures of fraud among China RTO’s
  • the specific corruption being investigated among China’s rail industry after the recent fatal crash
  • bank / state credit tightening in China

… just to name a few headwinds.

The operations of the company, as well as the going-private promises, are perched to an extraordinary degree, on the representations and obfuscations of just one man, Chairman Tianfu Yang.

The going private transaction filings are already replete with Chairman Yang’s refusal to provide transparency into his company.  Thwarting Morgan Stanley's buyer search, Chairman Yang’s was unwilling to share sufficient information with any parties trying to value the company.  Its language we've never seen before in a public company document.  (See link below to "no disclosure to suitors". )  

Further, despite having hired the world’s pre-eminent investment bank, Goldman Sachs to advise him personally, the bank financing essential to the company’s going-private transaction has been negotiated by just one man, Tianfu Yang.  Outside confirmation of the “bankability” of this loan commitment has been reduced to just one single disclosed conference call among the parties.  All of the nameplate advisors have explicitly disclaimed any independent verification of material company information, or the responsibility to acquire any, beyond what the company has disclosed to them.

And still the financials for this company are no better than those provided by the disgraced audit firm Frazer Frost, which is actually not in business any longer, its own merger-formed company torn apart by SEC sanctions for shoddy work practices ( http://www.sec.gov/litigation/admin/2010/33-9166.pdf ) and failure to detect fraud at RINO.

   Where is Harbin’s Real Business?

 

Here is a glaringly simple question, yet one which shareholders are willing to overlook in the hopes of a buyout.  Who are Harbin’s customers?  The linear and micro motor division creates custom motor solutions.  Therefore the company should have a portfolio  of customers with large-scale production orders.   Harbin’s revenue growth claims are enormous – it claims it is now doing more business in its most recent quarter than it did in the entire year 2008 — a 400% increase in just over 2 years — and at very high margins.   But not a single customer of significant size can be independently confirmed.  With a $500 million a year run rate, it should be possible to find at least a few customers doing $25, or $15 or even $10 million a year in verifiable revenues with Harbin.  But there simply are not.

This is why Citron’s findings published two weeks ago here  http://www.citronresearch.com/index.php/2011/08/03/harbin-electric-completely-exposed/   are so disturbing.  Harbin stopped disclosing customer concentration identities and percentages in 2010.  But its claimed 2009 and 2008 large customers do not check out, and are easily disproven.  Harbin’s largest purported customer in 2008 (and #2 in 2009), Jiangsu Liyang Car Seat Adjuster, simply does not manufacture or offer for sale electric seat adjusters (after a brief attempt to expand into that product line), and states it buys no electric motors. 

So who are the customers?  To make matters worse, the company was not willing to disclose or discuss customers even with a possible suitor, who was brought to the table by Morgan Stanley, as evidenced by comments in the fairness opinion. 

See page 2:  no disclosure to suitors

Instead of issuing Press Releases attacking short sellers, if Chairman Yang were interested in building the value of his company, rather than manipulating the price of his company’s stock, he simply needs to make his company transparent to investors.  With millions spent on “advisors”, not one dime has been spent to remedy the lack of a reliable audit.  Why has Harbin published at least 5 PR’s in the last year attacking shortsellers, and 7 others about the going-private transaction, yet only one identifying a single design win leading to a new piece of business with a disclosed party.  Citron has made a simple chart that shows the communications from Harbin to Wall Street.  In the past 2 years, Harbin has only disclosed one customer order (and we do not even know the value of the order) in December in 2010.  Besides that….nothing.

HRBN PR survey

 

   How do you explain this land transaction?

It has been a common tactic of China fraud stocks to announce fraudulent asset purchases to offset claims of fraudulent revenue.  The problem is, if you announce huge fictitious gross and net revenues, how do you account for the fact that your cash never goes up?  You have to offset the fake profits with fake asset purchases.  PUDA, YONG and BORN are just a few of the firms that have gone this route.

So it raised a few eyebrows when Harbin abruptly announced with its most recent “record” quarter, that it was putting down a $23 million deposit on land rights for a new factory.   This transaction was never disclosed in a press release, nor was the need for these 80 acres was ever previosuly disclosed in a conference call or investor presentation.  It just suddenly appeared in a filing last quarter’s 10-Q.  (It is just a coincidence that the purchase price is almost exactly Harbin’s pretax net income reported for the quarter?)

 

"On June 10, 2011, Simo Motor entered into a land use agreement (the “Simo Land Use Agreement”) with Xi’an Lintong Tourism and Business Development Management Commission (“Xi’an Lintong”) with respect to Simo Motor’s use of 500 Chinese Mu of land (approximately 82.4 acres or 333,500 square meters) located at Daixin Industrial Development Zone in Xi’an Lintong (the “New Site”). Pursuant to the Simo Land Use Agreement, the New Site will be used for construction of a new manufacturing facility that will produce electric equipment and machinery and related products as part of a capacity expansion project at Xi’an Simo. The term of the Simo Land Use Agreement is 50 years and the aggregate amount that Simo Motor shall pay to Xi’an Lintong is approximately $38.8 million (RMB 250 million). The Company made a pre-payment of $23.0 million (RMB 150 million) as of June 30, 2011 and will pay in full upon receipt of the land use license to be issued by the government."

 

The price Harbin paid for the most recent land transaction comes out to be 500 thousand RMB per Mu.  This price appears seriously inflated after some online research and review of corresponding land bureau records. 

  1. http://studio.e696.com/stock/InvestContent.aspx?stockid=600302&reviewid=254914173250

The link above shows the purchase of 242.85 Mu of industrial use land in the exact same industrial park, dated 2008.  The purchase price then was a mere 70 thousand RMB per Mu, 14% of what Harbin is paying. While Chinese land price appreciation has been steep since 2008, a 700% appreciation is not credible.

  1. http://www.dc88.com.cn/gyyq/police.asp?id=709

The link above is a policy document that shows the purchase price of the industrial park. While the date of the info is unclear, the purchase price comes to between 30 thousand to 60 thousand per Mu, roughly in line with the 2008 purchase record.

  1. http://www.xainvest.gov.cn/baozhang/tzbz.asp

The link above contains information about industrial land purchase prices during 2009 and 2010, in the city of Lintong, where Harbin’s land purchase is located.  We see prices of 112 thousand per Mu, less than 1/4th the 500 thousand per Mu Harbin paid for its land.

  1. http://maps.google.com/maps/ms?msa=0&ie=UTF8&ll=34.250406,108.998108&spn=0.503433,0.891953&z=11&msid=212302640873797248115.0004aa40c7b347d4bd0cc

The link above shows transactions and comparable land purchase data pulled from Xi’an land bureau. Harbin’s land purchase price simply doesn’t make sense when benchmarked against the recent transaction data and it most likely grossly overstated the price it paid for the land acquisition.  Further, this price would amount to more than double the entire land use rights the entire company shows on its balance sheet! 

Yet, not only did the company not state its intention to commit to this size land rights purchase, it didn't even put out a PR when it closed the deal.  Can this transaction stand independent scrutiny?  

   Xi’an 

Citron thought the following article, on the wild-west state of stock peddling in China, with epicenter in Xi’an, which happens to be where Harbin Ximo Motor is domiciled and where the “funky” land transaction occurred.  What makes this article interesting is it shows that even local Chinese are not immune to RTO scams and the epicenter of the problems is in the backyard of Harbin.

http://www.bloomberg.com/news/2011-08-18/chinese-protest-5-billion-losses-tied-to-u-s-reverse-mergers.html

 

   Is This the Price of a Payoff??

In Harbin’s most recent filings, we read an interesting disclosure, which management was recently asked to explain.  

In February 2011, the Company entered into a consulting service agreement with a third party which agreed to provide advisory and consulting services to obtain financing in Chinese Capital Market for a period of 5 years from 2011 to 2015. The service fee is non-refundable and amounted to $3 million.”  

Of the $3 million, over 2.9 million has already been paid to this undisclosed party … in cash.  Now while Citron does not believe that $3 million is enough to secure a $450 million loan that cannot get paid back, we do believe that it is more than enough to secure loan documents.  Why we believe this to be true is twofold.

  1. If there is one thing Harbin can do without consultants is raise money.  The company has multiple bank loans, relationships with the largest investment bankers in the world, and a purported deep-rooted relationship with one of the largest banks in China. 
  2. In normal fundraising situations, companies pay investment bankers a percentage after the money has been raised.  The upfront money to this undisclosed entity that was given the same month that all parties walked away from a possible takeover transaction is the type of business done by companies on the brink of bankruptcy, not ones about to be taken over.
  3. Most importantly, what makes this relevant now is that management had an opportunity to respond to the question of to whom and why they gave this money.  But management chose doubletalk and subterfuge, offering us this response:

$3 million consultant explanation

   The Black Swan

 

Citron, like many other investors, has taken a position that the lack of transparency about this company, and its operating history, create a significant risk that this deal is just a charade and can never close on the terms disclosed.  Investors will have to take their chances on a binary event – either the going private deal is funded and closes, or it does not, and the stock falls to low single digits.  There is really no other outcome.

This has nothing whatsoever to do with the fiction of "forcing down the company's stock price" the fiction management keeps trumpeting.   Based on mountains of due diligence, only the summary of which can be effectively reported in a blog, it is Citron’s belief that Harbin Electric cannot possibly pass an audit with a real accounting firm, or justify an enterprise value of $750+ million.  Further, without the going-private deal, its stock is worth no more than $2 or $3 on the Nasdaq market.   Meanwhile, Harbin has never responded to any of the substantive disclosure failures raised by Citron with verifiable  answers about the business, rather just more defense of the buyout.  Their story, and their stock, is propped by hope – the light at the end of the tunnel — without ever disclosing the dangers lurking for investors if that light is not reached.

However, what Citron cannot control is whether the political and economic situation in China is so corrupt that a bank can be influenced to make a low interest $400 million dollar loan that makes no business or economic sense, and that has no chance of ever being repaid.   If Tianfu Yang is able to use his influence and power to effect lending of a state owned bank on a stack of material misrepresentations, then the shorts are dealt a black swan situation. That is a question that no independent research or investment banking firm can handicap.

If this is the case, however, the current price of Harbin’s stock should be of no consequence whatsoever to Chairman Yang.  In fact, the lower it trades, the more “easy money” can be earned by his minions by simply waiting for this "sure thing" deal to close.  His preoccupation with the short positions and the option positions is all just noise.  The shareholder vote is a foregone conclusion; every shareholder wants the “easy profit” of the $24 payout.  The only question is whether this deal is real or not, period. 

   Conclusion

Citron expects that there will be private buyouts of a few Chinese companies in the next year.  But these will be at very modest prices, after the fraudulent inflated claims wash out.  The transparency risks of companies operating in China have been made very very clear to the market, and are now increasingly being priced in.

Meanwhile, Citron has published ample evidence that Harbin Electric closely resembles the raft of other China RTO’s that have collapsed under the weight of their material misstatements to the US market.  Consider:

  • Extreme revenue growth, but an absence of verifiable customers
  • 50-year old main manufacturing facility
  • Its unlikely cash position inconsistent with its patchwork of loans and financings
  • Quarter after quarter of purported “record profits”, but keeps needing financing
  • Hasty and apparently fabricated land rights transaction
  • Unnecessary cash-up-front “Fees” to undisclosed parties
  • No legal or financial accountability from the many paid advisors and consultants to the deal

If this buyout deal should hit a “last minute snag”, in Q1, 2012, China Development Bank’s financing commitment is set to expire, just days before the company faces its March 15, 2012 audited 10-K filing date with no “plan B”.  Without audited financials, Harbin then faces delisting proceedings. 

It is Citron’s belief that the company cannot pass a real audit, and the only way an unaffiliated banking entity would finance a $400 million dollar loan for this company is with the application of substantial “guanxi”, which is not a balance sheet item.

Meanwhile, the regulatory risk remains very high.  Harbin trades despite its obviously deficient 2010 audit, and its failure to satisfy Nasdaq independent audit committee requirements, which it was notified about in 2009.  It is obvious from prior Citron reports that Audit Committee Chair Boyd Plowman is not and was never "independent", due to his undisclosed director's role at various Abax entities. 

Meanwhile, if unchallenged by regulators, the proliferation of other “Chairman led” buyouts flying in the face of due diligence, (latest example PUDA) is an obvious consequence for the US markets.

 

PS   If the deal doesn’t close, don’t expect the deal terms to provide consequences that protect shareholders.  No purchase money is escrowed in this deal structure.  90% of the termination fee would be due from Chairman Yang himself.  And as Chairman, it would be his responsibility to collect it …. from himself.  Now that’s a payment that would take some “guanxi”…! 

 

Cautious Investing to All

 

 

 

 

 

 

 

Whether a company’s stock trades in the US, Shanghai, Hong Kong or Shenzen, all investors want the same thing:  transparency.  The problem with Harbin is not the short-sellers, as the company so vehemently stated on its last conference call.  The problem is the company has been violating every principle of transparency over recent years, which only intensifies as the company ramps up its claims of an upcoming $24 a share private takeover.

 

Investors have nothing to judge an actual business, absent a buyout offer, except a 2010 audit by defunct auditor Frazer Frost, which was has become the poster child for auditor negligence in the Chinese RTO space.  Meanwhile, Harbin Electric’s stock is being propped on the promise of a going-private transaction at $24 per share, a make-good for any possible operational problem the company has or any inconsistency in its financial reporting.  The story has not wavered in the face of industrial slowdowns both worldwide and in China, increasing gross margin pressure on the entire Chinese industrial sector, wave after wave of exposures of fraud among China RTO’s, the specific corruption being investigated among China’s rail industry, or bank / state credit tightening in China, just to name a few headwinds.

 

The operations of the company, as well as the going-private promises, are perched to an extraordinary degree, on the representations and obfuscations of just one man, Chairman Tianfu Yang.

 

The going private transaction filings are already replete with Chairman Yang’s refusal to provide transparency into his company.  Thwarting Morgan Stanley buyer search, Chairman Yang’s was unwilling to share sufficient information with any parties trying to value the company.    (From filings:  “Management, with the support of the board, was unwilling to share information.” and “It’s difficult to conduct [due] diligence without CEO support.”  [ Link ]

 

Further, despite having hired the world’s pre-eminent investment bank, Goldman Sachs to advise him, the bank financing on which the company’s going-private transaction depends has been negotiated by just one man, Tianfu Yang.  Outside confirmation of the “bankability” of this loan commitment has been reduced to just one single disclosed conference call among the parties.  All of the nameplate advisors have explicitly disclaimed any independent verification of material company information, or the responsibility to acquire any, beyond what the company has disclosed to them.

 

And still the financials for this company are no better than those provided by the disgraced audit firm Frazer Frost, which is actually not in business any larger, its own merger-formed company torn apart by SEC sanctions for shoddy work practices and failure to detect fraud at RINO.

 

Where is Harbin’s Real Business?

 

Here is a glaringly simple question, yet one which shareholders are willing to overlook in the hopes of a buyout.  Who are Harbin’s customers?  The linear and micro motor division creates custom motor solutions.  Therefore the company should have a handful of customers with large-scale orders.   Harbin’s revenue growth claims are enormous – it claims it is now doing more business in its most recent quarter than it did in the entire year 2008 — a 400% increase in just over 2 years.   But not a single customer of significant size can be independently confirmed.  With a $500 million a year run rate, it should be possible to find at least a few customers doing $25, or $15 or even $10 million a year in verifiable revenues with Harbin.  But there simply are not.

 

This is why Citron’s findings published two weeks ago here [ Link ] are so disturbing.  Harbin stopped disclosing customer concentration identity and percentage in 2010.  But its claimed 2009 and 2008 large customers do not check out, and are easily disproven.  Harbin’s largest purported customer in 2008 (and #2 in 2009), Jiangsu Liyang Car Seat Adjuster, simply does not manufacture or offer for sale electric seat adjusters (after a brief attempt to expand into that product line), and states it buys no electric motors. 

 

Who are the customers?  To make matters worse, the company was not willing to disclose or discuss customers even with a possible suitor, who was brought to the table by Morgan Stanley, as evidenced by comments in the fairness opinion. 

 

[ Link ]   (insert no disclosure to suitors)

 

Instead of issuing Press Releases attacking short sellers, if Chairman Yang were interested in building the value of his company, rather than manipulating the price of his company’s stock, he simply needs to make his company transparent to investors.  With millions spent on “advisors”, not one dime has been spent to remedy the lack of a reliable audit.  Why has Harbin published at least 5 PR’s in the last year attacking shortsellers, and 7 others about the going-private transaction, yet only one identifying a single design win leading to a new piece of business with a disclosed party.  Citron has made a simple chart that will show the flow of information to Wall Street.  In the past 2 years, Harbin has only disclosed one customer order (and we do not even know the value of the order) in December in 2010.  Besides that….nothing.

 

(insert press release chart)

 

 

 

How do you explain this land transaction?

 

It has been a common tactic of China fraud stocks to announce fraudulent asset purchases to offset claims of fraudulent revenue.  The problem is, if you announce huge fictitious gross and net revenues, how do you account for the fact that your cash never goes up?  You have to offset the fake profits with fake asset purchases.  PUDA, YONG and BORN are just a few of the firms that have gone this route.

 

So it raised a few eyebrows when Harbin abruptly announced with its most recent “record” quarter, that it was putting down a $23 million deposit on land rights for a new factory.   This transaction was never disclosed in a press release, and was the need for these 80 acres was never disclosed in a conference call or investor presentation.  It just suddenly appeared in a filing last quarter’s 10-Q.  (It is just a coincidence that the purchase price is almost exactly Harbin’s pretax net income reported for the quarter?)

 

On June 10, 2011, Simo Motor entered into a land use agreement (the “Simo Land Use Agreement”) with Xi’an Lintong Tourism and Business Development Management Commission (“Xi’an Lintong”) with respect to Simo Motor’s use of 500 Chinese Mu of land (approximately 82.4 acres or 333,500 square meters) located at Daixin Industrial Development Zone in Xi’an Lintong (the “New Site”). Pursuant to the Simo Land Use Agreement, the New Site will be used for construction of a new manufacturing facility that will produce electric equipment and machinery and related products as part of a capacity expansion project at Xi’an Simo. The term of the Simo Land Use Agreement is 50 years and the aggregate amount that Simo Motor shall pay to Xi’an Lintong is approximately $38.8 million (RMB 250 million). The Company made a pre-payment of $23.0 million (RMB 150 million) as of June 30, 2011 and will pay in full upon receipt of the land use license to be issued by the government.

 

The price Harbin paid for the most recent land transaction comes out to be 500 thousand RMB per Mu.  This price appears seriously inflated after some online research and review of corresponding land bureau records. 

1.       http://studio.e696.com/stock/InvestContent.aspx?stockid=600302&reviewid=254914173250

The link above shows the purchase of 242.85 Mu of industrial use land in the exact same industrial park, dated 2008.  The purchase price then was a mere 70 thousand RMB per Mu, 14% of what Harbin is paying. While Chinese land price appreciation has been steep since 2008, a 700% appreciation is not credible.

2.       http://www.dc88.com.cn/gyyq/police.asp?id=709

The link above is a policy document that shows the purchase price of the industrial park. While the date of the info is unclear, the purchase price comes to between 30 thousand to 60 thousand per Mu, roughly in line with the 2008 purchase record.

3.       http://www.xainvest.gov.cn/baozhang/tzbz.asp

The link above contains information about industrial land purchase prices during 2009 and 2010, in the city of Lintong, where Harbin’s land purchase is located.  We see prices of 112 thousand per Mu, less than 1/4th the 500 thousand per Mu Harbin paid for its land.

4.       http://maps.google.com/maps/ms?msa=0&ie=UTF8&ll=34.250406,108.998108&spn=0.503433,0.891953&z=11&msid=212302640873797248115.0004aa40c7b347d4bd0cc

The link above shows transactions and comparable land purchase data pulled from Xi’an land bureau. Harbin’s land purchase price simply doesn’t make sense when benchmarked against the recent transaction data and it most likely grossly overstated the price it paid for the land acquisition.

 

Xi’an 

Citron thought the following article, on the wild-west state of stock peddling in China, with epicenter in Xi’an, which happens to be where Harbin Ximo Motor is domiciled and where the “funky” land transaction occurred.  What makes this article interesting is it shows that even local Chinese are not immune to RTO scams and the epicenter of the problems is in the backyard of Harbin.

http://www.bloomberg.com/news/2011-08-18/chinese-protest-5-billion-losses-tied-to-u-s-reverse-mergers.html

 

 

Is This the Price of a Payoff??

In Harbin’s most recent filings, we read an interesting disclosure that was finally put to management.

 

In February 2011, the Company entered into a consulting service agreement with a third party which agreed to provide advisory and consulting services to obtain financing in Chinese Capital Market for a period of 5 years from 2011 to 2015. The service fee is non-refundable and amounted to $3 million.”  

 

Of the $3 million, over 2.9 million has already been paid to this undisclosed party.  Now while Citron does not believe that $3 million is enough to secure a $450 million loan that cannot get paid back, we do believe that it is more than enough to secure loan documents.  Why we believe this to be true is twofold.

 

1.      If there is one thing Harbin can do without consultants is raise money.  The company has multiple bank loans, relationships with the largest investment bankers in the world, and a purported deep-rooted relationship with one of the largest banks in China. 

2.      In normal fundraising situations, companies pay investment bankers a percentage after the money has been raised.  The upfront money to this undisclosed entity that was given the same month that all parties walked away from a possible takeover transaction is the type of business done by companies on the brink of bankruptcy, not ones about to be taken over.

3.      Most importantly, what makes this relevant now is that management had an opportunity to respond to the question of to whom and why they gave this money.  But management chose doubletalk and subterfuge, offering us this response:

 

[ LINK ]

 

The Black Swan

 

Citron, like many other short sellers, has taken a position that the lack of transparency about this company, and its operating history, create a significant risk that this deal is just a charade and can never close on the terms disclosed.  Investors will have to take their chances on a binary event – either the going private deal is funded and closes, or it does not, and the stock falls to low single digits.  There is really no other outcome.

 

Based on mountains of due diligence, only the summary of which can be effectively reported in a blog, it is Citron’s belief that Harbin Electric cannot possibly pass an audit with a real accounting firm, or justify an enterprise value of $750 million.  Further, without the going-private deal, its stock is worth no more than $2 on the Nasdaq market.  Harbin has never responded to any of the substantive disclosure failures raised by Citron with hard answers about the business, rather just more defense of the buyout.  Their story, and their stock, is propped by hope – the light at the end of the tunnel — without ever disclosing the dangers lurking for investors if that light is not reached.

 

However, what Citron cannot control is whether the political and economic situation in China is so corrupt that a bank can be influenced to make a $400 million dollar loan that makes no business or economic sense, and that has no chance of ever being repaid.   If Tianfu Yang is able to use influence and power to effect lending of a state owned bank on misrepresentations, then the shorts are dealt a black swan situation. That is a question that no independent research or investment banking firm can handicap.

 

If this is the case, however, the current price of Harbin’s stock should be of no consequence whatsoever to Chairman Yang.  In fact, the lower it trades, the more “easy money” could be earned by his minions by simply waiting for the deal to close.  His preoccupation with the short positions and the option positions is all just noise.  The shareholder vote is a foregone conclusion; every shareholder wants the “easy profit” of the $24 payout.  The only question is whether this deal is real or not, period. 

 

Conclusion

 

Citron does not doubt that there will be private takeouts of a few Chinese companies in the next year.  But these will be at very modest prices, after the worms have come out of the woodwork.   The transparency risks of companies operating in China have been made very very clear to the market, and are now being priced in.

 

Meanwhile, Citron has published ample evidence that Harbin Electric closely resembles the raft of other China RTO’s that have collapsed under the weight of their material misstatements to the US market.  Consider:

·         Extreme revenue growth, but an absence of verifiable customers

·         50-year old main manufacturing facility

·         Its unlikely cash position inconsistent with its patchwork of loans and financings

·         Quarter after quarter of purported “record profits”, but keeps needing financing

·         Hasty and apparently fabricated land rights transaction

·         Unnecessary cash-up-front “Fees” to undisclosed parties

·         No legal or financial accountability from the many paid advisors and consultants to the deal

·         .. and the shady past dealings of its Chairman and his brother

 

If this buyout deal should hit a “last minute snag”, in Q1, 2012, China Development Bank’s financing commitment is set to expire, just days before the company faces its March 15, 2012 audited 10-K filing date with no “plan B”. 

 

It is Citron’s belief that the company cannot pass a real audit, and the only way an unaffiliated banking entity would finance a $400 million dollar loan for this company is with the application of substantial “guanxi”, which is not a balance sheet item.

 

Meanwhile, the regulatory risk remains very high.  Harbin trades despite its obviously deficient 2010 audit.  If unchallenged, the proliferation of other “Chairman led” buyouts flying in the face of due diligence (latest example PUDA) is an obvious consequence.

 

PS   If the deal doesn’t close, don’t expect the deal terms to provide consequences that protect shareholders.  No purchase money is escrowed in this deal structure.  90% of the termination fee would be due from Chairman Yang himself.  And as Chairman, it would be his responsibility to collect it …. from himself.  Now that’s a payment that would take some “guanxi”…! 

 

Cautious Investing to All

 

 

Harbin Electric – Completely Exposed

,

   Introduction

In 2010, the Chinese RTO space was thrown on its head when once high flying Rino International was exposed as a fraud and its customer/contractee list was shown to be fraudulent.  At the same time the CEO was taking money out of the company, the company was misrepresenting its stature in its industry to US investors.  All of this transpired under the eyes of their trouble-plagued auditor Frazer Frost. 

It was only a month earlier that Harbin Electric (NASDAQ:HRBN) prevented itself from becoming another RINO by announcing a takeover bid by its Chairman/CEO Tianfu Yang.  But that time has now come.  Citron will prove that Harbin is just as bad as RINO:  fabricated customers, management taking money from the company, undisclosed insider dealings, and the worst accounting disclosures that either Citron or any forensic accountant has ever seen.

As for a buyout?   Not happening!   This report, if printed in its entirety, would span over 100 pages.  A team of attorneys and investigators has been gathering this data for months. 

Overview

This report examines in significant depth Harbin’s purported operations and the deal documents to explore the following questions:

  1. Harbin has grossly overstated revenues from its three disclosed (largest) customers.
  2. Harbin has grossly overstated its export revenue. 
  3. Harbin is guilty of multiple securities violations
  4. Harbin's largest division has disclosed material control weaknesses in every principal aspect of its business. 

Note:  Throughout the report we will refer to a thorough investigation into Harbin conducted by a private investigative firm in China.  In order to protect our sources, Citron redacts the name of the firm,  replacing it with “X” in appropriate documents.  The executive who headed the report is a Certified Fraud Examiner with a specialty in China who has curriculum vitae more extensive than any investigator we have ever worked with.  The full report, including the redacted names, will be available to the SEC or through legal due process with Citron Research.

   Grossly Overstated "Largest Customer" Revenues

Harbin’s current 10-K (fiscal yr 2010, filed March 16, 2011) states:

“No customer accounted for more than 10% of the total revenues for the fiscal year ended December 31, 2010. Two major customers accounted for approximately 22% of the net revenue for the fiscal year ended December 31, 2009, individually accounting for 12% (DXT) and 10% (Jiangsu Liyang Car Seat Adjuster Factory), respectively. Three major customers accounted for 43% of the net revenue for the fiscal year ended December 31, 2008, with each customer individually accounting for 16% (Jiangsu Liyang Car Seat Adjuster Factory), 15% (DXT) and 12% (Guiyang Putian Logistic Co., Ltd.), respectively.”

It is the opinion of Citron that Harbin is materially misrepresenting its revenue to the investing public and thereby committing fraud on the marketplace.  Here we will review the 3 stated major customers of Harbin and the results of our investigation.

Customer #1: Jiangsu Liyang Car Seat Adjuster

The clearest sign of fraud at HRBN is seen in the interview with the purchasing agent at Jiangsu Liyang.  Jiangsu Liyang (JLA) was reported to be Harbin's 2nd largest customer in 2009 (10% of revenues), and its largest in 2008 (16% of revenues).
The customer's Vice General Manager states unequivocally that not only has his firm not ordered a fraction of what Harbin has reported, worse, their customers predominantly order manual seat adjustors, not motorized ones.

This interview is definitive and draws a clear path to fraud — more than sufficient to trigger the Material Adverse Effect clause of the bank's loan document draft. 

[  Liyang Car Seat Adjuster Manager Interview  ]

Analysis of JLA revenues per HRBN disclosures:

Year

HRBN Reported Revenues (USD mil)

%
from
JLA

Revenues attrib to JLA
(USD mil)

Avg
RMB / USD conversion rate FY

Revenues attrib to JLA
(RMB mil)

Revenues as reported by JLA (RMB mil)

Revenue % over-stated

 

2009

223.23

10%

22.32

6.8311

152.49

0.32

     98 %

2008

120.82

16%

19.33

6.9483

134.32

0.32

     98 %

 

According to JLA's SAIC filings and presentation, which are consistent with its published business model, HRBN’s claimed sales to JLA were 114% of JLA’s total 2009 revenues, and 148% of JLA’s 2009 operating costs.  See the documents linked below for verification. 

[ JIANGSU LIYANG AUTOMOBILE SEAT ANGLE-CONTROLLER Credit Report and SAIC filing ]

[ Liyang 2011 Business Plan

**  Interesting note:  JLA has no difficulty making public statements consistent with its SAIC documents – which is not the case with HRBN … or many other of the Chinese RTO’s.

Customer #2:  Daqing Xinchengtai Technology  (DXT)

The reported largest customer of Harbin in 2009 (and #2 in 2008) was challenging to obtain financial information from.  That is because they are not a manufacturer themselves, but rather a middleman, supplying pumps to the government funded Daqing Oilfield.  While the SAIC docs retrieved were light on information because of the “Intermediary” nature of DXT's business, the interviews were conclusive.

All of Citron’s research, including interviews, confirmed that Harbin grossly overstated revenues recognized from DXT.  It is Citron’s assessment that HRBN overstated its 2009 and 2008 sales to DXT at least by 365% and 247% respectively. 

Below is the supporting documentation:

[ Daqing Interviews ]

[ DXT SAIC ]

Customer #3:  Guiyang Putian Logistic

The last of HRBN’s “top 3” customers is Guiyang Putian Logistic (GPL), responsible for 12% of Harbin’s revenues for 2008.  ( The Chinese character name for GPL is:

贵阳普天物流技术股份有限公司

It is the opinion of Citron Research that Harbin has greatly exaggerated its sales to GPL.  As stated in the 10-K,  GPL was 12% of 2008 Net Revenue of $120,802,302. Obtaining these records was more burdensome because Guiynag is located in the Guizhou Province, a third level province in China with inferior corporate record keeping.

HRBN reported sales to GPL that would be 85% of GPL’s total revenues.  This is obviously unrealistic as validated by the purchaser for GPL.  Our source documents appear below:

[ GPL_Interview ]

[  GPL SAIC English  ]

This is what our research revealed for the only three customers ever identified in Harbin's SEC filings.  We can only imagine what the rest of the revenue book looks like.

   Grossly Overstated Exports

From 2010 10-K:

“Our automobile specialty micro-motors are purchased by customers who are first-tier suppliers to the automobile industry. We supply these products to domestic customers and also export them to OEM suppliers in North America.”

In the same 10-K they state that international sales are $20,410,902 for the year ending 2010.  Noting all of the subsidiaries of Harbin as presented in this corporate structure on their website:

 

Citron has completed an exhaustive analysis of product imports as published in Datamyne, and finds a mere fraction of the amount of imports to North America Harbin claims to be exporting. 

It is the opinion of Citron that Harbin has exaggerated their export data by a factor of multiples.  Linked here is a worksheet with our findings.   Our research shows HRBN exports of less than $4 million in 2010, compared to their reported $20+ million.

[ Harbin Exports from Datamyne ]

For all those who think that Harbin is immune to criticism because of its purported pending buyout, be advised that this company is under the scrutiny of the SEC until the moment the deal is completed.  The company is at risk of being forced to announce non-reliance on its filed financial statements at any time.  The Material Adverse Events clauses of the various deal agreements therefore hang in the balance. 

   Material Adverse Events

Even though Citron has provided strong evidence that HRBN has been fabricating revenues in its SEC filings, we are sure that many investors will say, “Who cares if the company is being bought?” 

Besides the obvious regulatory risk involved, there are critical contingencies defined in the loan docs that give the bank an out for material misstatements by the company in its reported financials.  In particular, the loan documents state:

 18.12   Original Financial Statements   

 

(a)

The Original Financial Statements were prepared in accordance with the Applicable GAAP consistently applied unless expressly disclosed to the Lender in writing to the contrary before the date of this Agreement.

 

(b)

The Original Financial Statements give a true and fair view of the Target’s consolidated financial condition and results of operations during the relevant financial year.

 

(c)

There has been no material adverse change in the Target’s assets, business or financial condition since the date of Original Financial Statements.

 

(d)

The Group’s most recent financial statements delivered pursuant to Clause 19.1 (Financial Statements):

 

(i)

have been prepared in accordance with the Applicable GAAP as applied to the Original Financial Statements; and

 

(ii)

give a true and fair view of (if audited) or fairly present (if unaudited) its financial condition as at the end of, and results of operations for, the period to which they relate (consolidated where applicable).

 

(e)

Since the date of the most recent financial statements delivered pursuant to Clause 19.1 (Financial Statements) there has been no material adverse change in the business, assets or financial condition of the Group.

 

Securities Law Violation/Conflict of Interest 
– Part 1: Tianfu Yang’s personal loan from Harbin

 

In the 10-K we read an interesting disclosure: 

"On December 28, 2010, the Company made an advance of $1,517,000 to Tai Fu Industrial Co., Ltd., an entity owned by Tianfu Yang, the Company’s Chairman. The purpose of the advance was to accommodate an urgent cash need of a transaction for this related entity under a guarantee to repay the Company within a few days.  As of December 31, 2010, the money was repaid in full."

This disclosure brings up several issues that should be troubling to all investors:

  • Why does another entity belonging to the CEO have an “urgent cash need”?
  • Why does Tianfu Yang not have $1.5 million in cash to give to the other entity?  Isn’t that odd for someone proposing to sign personally for a $400 million loan?
  • This transaction appears to be a clear violation of Sarbanes Oxley.  As clearly stated in section 402 from Sarbanes Oxley:

SEC. 402. ENHANCED CONFLICT OF INTEREST PROVISIONS.

(a) PROHIBITION ON PERSONAL LOANS TO EXECUTIVES.—Section 13 of the Securities Exchange Act of 1934 (15 U.S.C. 78m), as amended by this Act, is amended by adding at the end the following:

‘‘(k) PROHIBITION ON PERSONAL LOANS TO EXECUTIVES.—

‘‘(1) IN GENERAL.—It shall be unlawful for any issuer (as defined in section 2 of the Sarbanes-Oxley Act of 2002),  directly or indirectly, including through any subsidiary, to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of that issuer.

.

Was the loan actually repaid?  Is it odd to take an "urgent cash need" loan out on Tuesday, only to pay it back on a Friday?  Who accounted for the reconciliation of the loan?  Was it paid back in full in cash on that stated date?  Or was this a postdated transaction that involved an “in kind” repayment at a later date so the company did not have to take the charge before the quarter ended ?  Or are we supposed to believe the repayment just coincidentally fell on the last day of the quarter?

Additionally, it was previously reported on by Citron that in the past that CEO Tianfu Yan and his brother Harbin Vice President Tianli Yang were previously obligated to make a civil settlement of a charge of misappropriation of funds and falsification of a bank loan document at a prior company.  While these facts do not prove fraud in Harbin, it does go to character.    

Harbin responded to this finding, not by disproving or even denying their legal wrongdoings, but rather by claiming that Tianli Yang is not a director of Harbin as Citron stated.  Just to prove the thoroughness of the work, here is a document that proves in fact that Tianli Yang is on record as a director of Harbin.

[ SAIC Filing with Tianli Yang Director ]

 Securities Law Violation/Conflict of Interest – Part 2: 
Boyd Plowman’s role in Abax and the Harbin Special Committee

 

 

Aside from Harbin’s CEO, the most important man in this process has become Boyd Plowman.  Mr. Plowman is both head of the audit committee of Harbin, as well as the appointed head of the special committee to take the company private.  This committee is at the center of the requirement that the interests of shareholders be defended.  It is under his watch that we are to trust both Harbin’s financials, and the fairness of the process by which the “takeover” transaction proceeds. 

However, the July 13, 2011 proxy statement filing is the first time investors are informed of the following :

“Shortly after Abax filed a Schedule 13G with the SEC on December 9, 2010 announcing its greater than 5% ownership of the Company common stock, Mr. Plowman, the Special Committee Chair, brought to the attention of the other members of Special Committee, as well as to Gibson Dunn, the fact that he was then serving as a director of several Abax-controlled entities including Abax Global Opportunities Fund, Abax Arhat Fund, Abax Claremont Ltd., Abax Jade Ltd., Abax Emerald Ltd., Abax Lotus Ltd., Abax Nai Xin A Ltd., and Abax Nai Xin B Ltd. (the “Abax Companies”).

This relationship presents many conflicts of interest among shareholders / Harbin / Boyd Plowman that the SEC cannot ignore. 

  1. #1.  On July 29, 2010, just before all the buyout drama began, Abax Emerald loaned Harbin $15 million at a 10% interest rate.  This would be a related party transaction, since the head of the audit committee is a director of Abax Emerald.  Worse, you would think the head of the audit committee would know better than to fail to  disclose this relationship.  The above-market interest rate alone gives rise to the question of whether preference was granted to a related party.
  2. #2.  Reading the language in the filing, we are to believe that no one on the special committee ever knew that Plowman was associated with Abax?   Does this pass the smell test?
  3. #3.   It has never been disclosed how much financial interest Plowman has in Abax.  Nor have been disclosed other relationships with directors of Abax, such as this investment company we found called Kilometre Growth, where Plowman is a director along with other Abax directors.  Why are these matters undisclosed in HRBN's SEC filings?

http://www.formds.com/issuers/kilometre-growth-asia-fund

Citron is amazed that Gibson Dunn did not find conflict in this relationship and that the SEC can authorize this deal without greater transparency of the Abax/Plowman relationship.  This might be the first time in the history of takeovers that the head of the special committee formed to oversee the sale of a company is actually a director of the acquiring entity.

Citron also notes the numerous times Plowman’s bio appears in Harbin’s filings; yet not once does it mention his directorship in Abax funds; this despite Abax’s high profile in the China investment scene following Morgan Stanley’s major stake in the fund in 2007. 

   Disclosures that the SEC Cannot Ignore

While the Special Committee was busy talking to the white shoe lawyers and bankers about a deal, the most reprehensible disclosures we have even seen in a public company were filed in the HRBN 10-K.  The disclosures are regarding Simo Motor, the largest subsidiary of HRBN, purchased in 2009 and "restructured" in 2010, at a cost of over $25 million, to integrate it into Harbin just last year.  We note that these disclosures did not exist when HRBN purchased Simo. 

“We and our independent registered public accounting firm, in connection with management's assessment of and the audit of our internal control over financial reporting as of December 31, 2010, identified five material weaknesses in our internal control over financial reporting…

Control activities related to bank reconciliationAt Xi’an Simo, the bank reconciliation for various bank accounts were not prepared accurately, which impacted the valuation and existence of the cash in bank as of December 31, 2010.

Control activities related to the reconciliation and classification of notes receivable – At Xi’an Simo, notes receivables endorsed as payment to third parties were not properly recorded, resulting in a discrepancy between the physical notes receivables on hand and the general ledger. Additionally, the improper classifications of transactions has impacted the completeness, and valuation of accounts payable / advance to suppliers and notes receivable balances at the year ended December 31, 2010 at Xi’an Simo

Control activities related to the calculation of provision of income tax – At Xi’an Simo, due to ambiguities in the PRC tax rules, the temporary and permanent differences in tax amounts were not properly identified

Control activities related to valuation of inventory allowance – At Xi’an Simo, slow moving inventories that had not been used over a year were not properly evaluated for inventory allowance.

Control activities related to inventory recording –– At Xi’an Simo, inventory movement between manufacturing facilities and sales entities were not timely and properly recorded on the general ledger.

It is especially astonishing how Simo Motors, Harbin's largest and highest visibility acquisition, has severe management control problems in every single verifiable part of this business:  cash reconciliation, tax filings, payables, receivables, and inventory valuation.  And as has been previously documented in text and video ( view here if you haven't seen it already), Simo Motors main physical plant is an antiquated 50 year old facility, with severe lack of automation of its manufacturing capabilities, requiring tens of millions of dollars in retooling and capital improvements required to to be competitive in its space.

With all the money being spent on consultants, why wouldn’t Goldman Sachs, Morgan Stanley, or Lazard recommend a new, independent forensic accountant to run these material weaknesses to ground before any deal closes? 

   Forensic Analysis

Because we knew that HRBN directors would not hire a forensic accountant to go through their current operations, we hired one ourselves to present a financial analysis of HRBN.  As noted, every potential financial acquirer walked away from this deal…maybe they saw what our forensic accountant projected.

[ HRBN Independent Forensic Acounting Report ]

   Cannot be Said Too Many Times:  Frazer Frost

Anyone following the China RTO drama is well aware of the notorious audit firm Frazer Frost, which occupies a unique spot in the history of this sector.  After all, Frazer Frost is the only auditor sued by the SEC during this entire China RTO fiasco.  Citron is actually in competition with Frazer Frost — they have as many halts as we do over the past 7 months.

http://www.theprogressiveaccountant.com/news/sec-suspends-california-audit-partner.html

“Moore Stephens Wurth Frazer Torbet, LLP and Frost, PLLC are moving to resume operations as separate entities, as existed prior to their combination in January 2010. The combined firm, Frazer Frost, LLP, will continue to exist as a legal entity until the separation has been completed. It continues to be the policy of both firms not to comment publicly on client, personnel, or other internal matters.”

“Frazer Frost”, the auditor of record for Harbin’s 10-K, doesn’t actually exist any more. (Citron especially appreciates this website.  http://www.frazerfrost.com/ )  This is what investors will see if anyone ever tries to hold the auditor accountable for the annual financial report on which this purported 3/4ths of a billion dollar transaction is based. 

Formed of a merger in early 2010, Frazer Frost was dissolved in the wake of the SEC suit for having accepted management’s assurances in lieu of its own verification in the case of China Energy Savings Technology.  Then came the exposure and delisting of RINO, whose management admitted it had fabricated revenues based on non-existent contractual relationships with large customers, again assumed valid by the same audit firm.  

With all the firepower of assembled consultants for this deal :  Goldman Sachs, Morgan Stanley, Ernst & Young, Lazard, Skadden Arps, Gibson Dunn,  and White & Case, all with their hand in the till for the deal, nobody has demanded the hiring of a forensic auditor to finally lay out a full and fair accounting of the entire company for all investors to see what’s going on.  The only numbers available are Frazer Frost’s.

   A 500 Page Proxy Statement, but
Nobody Has Done Their Homework

 

Lets see what all these high-priced consultants didn’t do.

Morgan Stanley:

“In arriving at its opinion, Morgan Stanley assumed and relied upon, without independent verification, the accuracy and completeness of the information that was publicly available or supplied or otherwise made available to Morgan Stanley by the Company, and formed a substantial basis for its opinion. With respect to the April 2011 Case, Morgan Stanley assumed that they had been reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of the Company of the future financial performance of the Company.”

Lazard:

“Lazard assumed and relied upon the accuracy and completeness of the foregoing information, without independent verification of such information. Lazard did not conduct any independent valuation or appraisal of any of the assets or liabilities (contingent or otherwise) of the Company, or concerning the solvency or fair value of the Company, and Lazard was not furnished with any such valuation or appraisal.”

Goldman:

Mr. Tianfu Yang did not request, and Goldman Sachs did not provide, at any time, any opinion to the parties as to the fairness of the $24.00 offer price or as to any valuation of the Company for the purpose of assessing the fairness of such offer price. Goldman Sachs was not requested to, and did not, recommend at any time the specific consideration payable in the proposed merger, which $24.00 consideration was communicated by Mr. Tianfu Yang to Goldman Sachs and subsequently was determined by negotiations between the Special Committee and Mr. Tianfu Yang and Abax, and as a result, the Company’s decision to enter into the merger agreement was solely that of the Special Committee and the Company’s board of directors.

(Goldman apparently did not assist Tianfu Yang in the negotiations for a $400 million dollar bank loan either.) 

Audit Committee:

“Members of the Audit Committee rely without independent verification on the information provided to them and on the representations made by management and the independent accountants. Accordingly, the Audit Committee’s oversight does not provide an independent basis to determine that management has maintained appropriate accounting and financial reporting principles or appropriate internal control and procedures designed to assure compliance with accounting standards and applicable laws and regulations. Furthermore, the Audit Committee’s consideration and discussions referred to above do not assure that the audit of the Company’s financial statements has been carried out in accordance with generally accepted accounting principles or that the Company’s auditors are in fact “independent”.”

And finally, Citron notes that all the negotiations with China Development Bank were conducted personally by Tianfu Yang, despite his having retained the world's pre-eminent investment banker as his personal advisor. 

    The Silence of the Buyers is Overwhelming

This company was left at the altar by Barings.  Worse, they were left at the altar by 73 potential strategic and financial bidders, who were offered a look at this company.   Only 3 bothered to execute an NDA, and not one offered a competing bid.


The industry has spoken.  The lack of enthusiasm for this deal speaks volumes. Initially the deal was to be funded by Goldman Sachs and Barings.  After they walked away, Morgan Stanley shopped for buyers.  Of the 73 potential bidders they bought to the table (41were strategic), only 3 strategic ones even asked for an NDA. 

For a company who is supposed to be a leader in the Chinese motor industry it is obvious that their industry does not even find them significant enough to sign an NDA.  The complete lack of interest in the deal from all parties that were brought to the table by Goldman Sachs and Morgan Stanley affirms to ridiculous nature of this alleged buyout.  This demonstrates that not only does Citron view Harbin with skepticism, but it has no credibility with any serious competitor in the space.

   Breaking Up Is Hard to Do

Deals of this size typically have breakup fees attached.  These are intended to provide a measure of assurance to investors, who have the most to lose if it fails, or the spurned buyer, for all their wasted expense and effort if a better suitor comes along. 

But like every aspect of this proposed deal, the breakup fees are a story of their own. 

Consider:

  • If the company breaks up the merger, it owes the buyer group, 90% of which is Chairman Tianfu Yang $22.5 million.
  • If the buyers group fails to conclude the merger, the buyer group jointly (but not jointly and severally) is obligated to pay the company a $30 million breakup fee.

Since, in neither of these cases, is any cash pledged to back these guarantees, these failsafe provisions, customarily structured to protect the unaffiliated security holders from a broken deal, result only in scenarios where the Chairman has to sue his company or the company has to sue its Chairman, for enforcement of the "guarantee". 

   The Significance of the SEC in this process

The entire proxy and Form 13E-3 is now submitted and under review by the SEC for comments and questions.  At a time when both US officials and Chinese officials are working towards the goal of reliable and transparent disclosures from Chinese listed companies, this filing is a major step in the wrong direction. 

The next step in this process is an anticipated set of questions and comments from the SEC, due within 30 days of the SC 13E3 filing date, July 13, 2011.  This report will shed light on numerous issues that should be of substantial concern to the SEC, as noted in the next section.

Where the market has done an efficient job in flushing out Chinese RTOs and other equities with unreliable accounting, the notion of hiring a team of lawyers to prop of a company with questionable financials, reconciled by non existent auditing firm is a dangerous blueprint for other Chinese companies to inflate their stock while management could possibly be selling stock into a bidding market.  Chinese nationals in management positions, insulated as they are from any enforcement of US securities law can easily orchestrate the whole process.  Therefore the SEC is a gatekeeper on a set of market integrity concerns which stretch far beyond the current Harbin drama.

   Proof that Tianfu Yang has NO INTENTION of Concluding the Proposed $24 Buyout of Harbin Electric

 

It's really quite simple.  If Tianfu Yang wanted to buy Harbin Electric he would have taken a different path.  He knew Simo's cash couldn't be reconciled.  He knew his gross margins from his antiquated factories couldn't possibly be double or triple any of his competitors.  He knew the sales to disclosed major customers were false.  More than anyone, he knows that the company keeps consuming cash, despite the profitable financial statements and projections.

ALL he had to do was declare non-reliance on the filed audited financial reports.  He would have disclosed all the internal weaknesses in the company, and gone through restatements.  He would have hired a forensic auditor, and would be able to buy the entire company for possibly under $5.00 a share.  He knew all of this and knows it today.  

For less than 25% of the pricetag of the financing he's purportedly arranged, he and a group of colleagues could have bought 100% control of the business completely legally and swiftly.  In fact, as his advisors, Goldman Sachs would have been remiss to the point of negligence had they not so advised.  Why has nobody advised calling in a forensic accountant? 

Caveat emptor.

   Conclusion

In reviewing the preponderance of evidence presented in this and previous Citron reports on Harbin, it is the unequivocal opinion of this writer that CEO Tianfu Yang does not want this deal to go through.  He alone knows what his company is truly worth, and he knows about the overstatement of revenues.  The last thing he wants is to be on the hook for a $400 million loan for a company that only made .16 cents last quarter, even considering its highly suspect accounting.  Mr. Yang was able to procure a boilerplate loan doc; Citron believes it was competently prepared, but it will never be executed.