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The Forensic Factor On The "Most Preposterous Chinese Reverse Merger Yet": AutoChina (AUTC), Sees 50% Price Drop

Tyler Durden's picture





 

Our friends at The Forensic Factor have been busy. After exposing one after another alleged Chinese fraud reverse merger, and forcing management teams to address investors about numerous allegations of impropriety, the small research boutique has come out with a report exposing what it dubs "the most preposterous Chinese reverse merger yet." As usual, in a world of shady transatlantic backdoor dealings, and cash strapped US exchanges willing to list anyone and everyone, regardless of whether their financials are even remotely valid, we believe it is our duty (without intent to profit) to expose companies that may or may not be fraudulent, particularly now that it is obvious that the SEC is fully endorsing the ponzi scheme of US capital markets. Quote TFF: "after a deep dive into AutoChina (Nasdaq: AUTC), The Forensic Factor ("TFF") has concluded that AutoChina is potentially the most dangerous Chinese reverse merger that we have examined. As the AutoChina story gets exposed, we would expect a significant share decline of at least 50% and a material increase in the short interest (incredibly, less than 1% of the shares are short - a true rarity among the Chinese reverse mergers). TFF believes investors would be prudent to avoid AutoChina at all costs. At the same time, we implore regulators to protect the investing public and launch an investigation into AutoChina."

TFF highlights the following bullets with regard to possible impropriety at AUTC.

  • An extensive use of the same gain-on-sale accounting that led to the entire sub-prime industry blowing up. As we will discuss, AutoChina's accounting methods were dubbed "Crack Cocaine Accounting" by Bloomberg in a story on the sub-prime lenders
  • A mockery of U.S. GAAP accounting, resulting in massively overstated revenue and earnings that should not be relied upon by investors
  • A harrowing $450 million discrepancy between operating cash flow and net income over the past six quarters
  • A labyrinthine org structure and a reliance on related party debt that has become the primary funding source for the core business
  • The largest funding source for the company's auto loans appears to be a related party operator of grocery stores called Beiguo Commercial Building Limited
  • The most dilutive, and shareholder unfriendly, earnout that we have ever seen. The perverse earnout has potentially incentivized management to use logic-defying accounting to drive specious revenues and earnings
  • A misunderstood market capitalization based upon future earnout shares that do NOT appear to be included in sellside models
  • Massive expense understatement and large related party payables
  • A CFO that was previously the Director of Research at a firm that turned out to be one of the largest ponzi schemes in U.S. History
  • A new auditor that will need to address the issues and questions raised by TFF in this report - a process that could be the impetus for a large accounting restatement

The full report can be read below, and a pdf is provided for readers' convenience (link).

AutoChina (AUTC) - The Most Preposterous Chinese Reverse Merger Yet

The
recent onslaught of media coverage focused on Chinese reverse mergers
has finally started to illuminate one of Wall Street's darkest, and most
dangerous, corners. The fallout from the accusations (and confessions)
of accounting irregularities and potential fraud has been single-digit
"earnings" multiples, increased regulatory scrutiny, painful investor
losses, and high levels of disdain towards most Chinese reverse mergers.

One company that has somehow managed to avoid scrutiny until now is AutoChina (NASDAQ: AUTC). However, after a deep dive into AutoChina, The Forensic Factor ("TFF") has concluded that AutoChina is potentially the most dangerous Chinese reverse merger that we have examined. As
the AutoChina story gets exposed, we would expect a significant share
decline of at least 50% and a material increase in the short interest
(incredibly, less than 1% of the shares are short - a true rarity among
the Chinese reverse mergers).
TFF believes investors would be
prudent to avoid AutoChina at all costs. At the same time, we implore
regulators to protect the investing public and launch an investigation
into AutoChina. This report, Part I of II that we will publish on
AutoChina, will highlight the following issues:

  • An
    extensive use of the same gain-on-sale accounting that led to the
    entire sub-prime industry blowing up. As we will discuss, AutoChina's
    accounting methods were dubbed "Crack Cocaine Accounting" by Bloomberg
    in a story on the sub-prime lenders
  • A
    mockery of U.S. GAAP accounting, resulting in massively overstated
    revenue and earnings that should not be relied upon by investors
  • A harrowing $450 million discrepancy between operating cash flow and net income over the past six quarters
  • A
    labyrinthine org structure and a reliance on related party debt that
    has become the primary funding source for the core business
  • The
    largest funding source for the company's auto loans appears to be a
    related party operator of grocery stores called Beiguo Commercial
    Building Limited
  • The
    most dilutive, and shareholder unfriendly, earnout that we have ever
    seen. The perverse earnout has potentially incentivized management to
    use logic-defying accounting to drive specious revenues and earnings
  • A misunderstood market capitalization based upon future earnout shares that do NOT appear to be included in sellside models
  • Massive expense understatement and large related party payables
  • A CFO that was previously the Director of Research at a firm that turned out to be one of the largest ponzi schemes in U.S. History
  • A
    new auditor that will need to address the issues and questions raised
    by TFF in this report - a process that could be the impetus for a large
    accounting restatement

Accounting Dramatically Overstates Income, Restatement Likely

Before
delving into an accounting schematic that we thought had died with the
subprime debacle, it is worth mentioning the unusual birth of AutoChina.
The operating company is located in China, but the holding company is
incorporated in the Cayman Islands [we will explore the unusual
corporate structure later illustrating a similar structure to Rino
International (pink sheets: RINO)]. AutoChina came public in April 2009
in a reverse merger with Spring Creek Acquisition Corp. At the time of
the merger, the company's primary operations were new and used car lots
in China. Just a few quarters after the reverse merger was consummated,
the core business was disposed of (12/09) so that the company could
focus on leasing commercial vehicles. This unusual change in corporate
strategy was quite a gamble at the time, given the leasing business had a
history of less than one year, "ACG's commercial vehicle sales,
servicing and leasing segment has only been operating since 2008, and
after the sale of our automotive dealership business is the only
business we operate" (
http://google.brand.edgar-online.com/DisplayFiling.aspx?TabIndex=2&FilingID=7139746&companyid=762060&ppu=%252fdefault.aspx%253fsym%253dAUTC).

The
leasing business is relatively easy to understand: they find a truck
buyer, order and buy the truck, provide the financing, and then lease
the truck at a marked-up value. The high level leasing concept is where
the straightforward ends and where the mysterious begins. Simple
arithmetic suggests the numbers that AutoChina provides in its financial
statements are nonsensical. The company's 2010 guidance is $600 million
to $650 million of revenue on 12,000 to 13,000 "leased" vehicles. This
equates to exactly $50,000 of revenue per vehicle. Reported revenue per
transaction of $50,000 per vehicle would seem to represent a sale rather
than a "lease." On page 28 of their investor presentation (
http://edg1.vcall.com/irwebsites/autochinaintl/Autochina_December2010.pdf),
AutoChina outlines the economics of a typical lease, which includes
$48,000 of total collections over the life of a lease (26 months) and
$38,000 for the cost of the truck. The difference is shown as the
$10,000 of gross profit potential (before SG&A and interest expense)
over 26 months.

Table 1

Total collections over life of the lease

$48,000

Cost of Goods Sold

$38,000

 Potential profit over life of the lease

$10,000

 Average lease

26 months

Source: Company presentation and company filings

 

However, TFF believes AUTC is actually recognizing almost all of the potential profits upfront. For example, in the third quarter 2010 AUTC recognized over $8,000 of gross profit for each new vehicle it leased (sec.gov/Archives/edgar/data/1417370/0001...).

 

Table 2

AUTC's Actual 3Q Results

 

3Q10 Revenue per vehicle leased

$50,382

3Q10 COGS per vehicle leased

$42,358

 3Q10 Profit per vehicle leased

$8,023

Source: Company filings

 

TFF
believes this is an extremely aggressive form of accounting. In fact,
this accounting treatment is nearly identical to the "non-cash gain on
sale" accounting popularized by the subprime mortgage industry before
they all went bankrupt. A prominent story by Bloomberg described this accounting method as the financial world's equivalent of "Crack Cocaine" (
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIOWGBzzWpNo).
This form of non-GAAP accounting generates substantial "paper" income
but significantly overstates and misrepresents economic income. While
AutoChina's sales-type lease accounting generates 60% to 80% upfront
profits, it is important to compare this to the actual cash flows of a
loan. According to the example below (Table 3), AUTC does not get to
breakeven cash flow until month 22 of a 26 month lease!!! Even if the
company did not have to finance its leases, it would still take 20
months to breakeven. Keep in mind this analysis does not even include
any overhead costs, costs for collections, or potential defaults that
would push the average breakeven out even farther.

 

Table 3

Cash Accounting

 

 

Outflow for vehicle

 

($38,000)

Down payment

 

$11,400

 Cash out of door

 

($26,600)

 

 

 

 

Lease collections

 

$34,600

Months

 

 

26

Payment per month

 

$1,331

 

 

 

 

Initial monthly cash financing cost - at 9%

($155)

 

 

 

 

Months to breakeven CF

 

22

Source: Company presentation and TFF analysis

 

This
unsavory and alarming dynamic of reporting positive "accounting"
profits despite enormously negative cash flow is obvious when comparing
AutoChina's cash flow from operations to its net income. The company has
blown through $384 million of operating cash flow over the past six
quarters. This is amazing considering reported net income was $69
million over the same period. The discrepancy between the CFO and the reported earnings is a staggering $450 million over that same timeframe (www.sec.gov/Archives/edgar/data/1417370/...).
AutoChina's inexplicable delta between operating cash flow and net
income is one of the more alarming statistics that TFF has ever
uncovered.

 

Table 4

 

2Q09

3Q09

4Q09

 

Cash from Operating Activities

-35,027

-86,600

-74,548

 

Net Income

5,493

6,992

23,822

 

Difference

-40,520

-93,592

-98,370

 

 

 

 

 

 

 

1Q10

2Q10

3Q10

Total

Cash from Operating Activities

-50,220

-142,269

4,832

-383,832

Net Income

6,246

17,177

9,463

69,193

Difference

-56,466

-159,446

-4,631

-453,025

Source: Company filings

 

To
be absolutely certain that AutoChina was an anomaly with regard to its
overly-aggressive accounting, we examined other leasing models. TFF
could not find one public U.S. company that utilized the same aggressive
accounting treatment for their main business. Every U.S. leasing
company that TFF evaluated (including GMT, MGRC and TAL), used straight
line accounting methods. If AUTC used straight line accounting that
recognized revenue over 26 months, the income statement would be
materially lower. Table 5 presents the amortization schedule other
leasing companies would use for a typical AUTC lease. As Table 5
illustrates, in the first three months of the lease, the company would
recognize just under $1,600 in interest revenue offset by interest
expense (~$400 at 6% interest rate). This would equate to $1,200 of net
interest margin. Even if the company recognized a $2,000 upfront mark-up
gain (which we believe should also be amortized), AUTC would still
be overstating the first three months of revenue on a new lease by a
whopping 92.5% while overstating gross profit by almost 60%
.

Table 5

Amortization Schedule

 

 

 

Period

Payment

Principal

Interest

Balance

 1 

$1,331

$784

$547

$25,816

 2 

$1,331

$800

$530

$25,015

 3 

$1,331

$817

$514

$24,199

 4 

$1,331

$834

$497

$23,365

 5 

$1,331

$851

$480

$22,514

 6 

$1,331

$868

$463

$21,646

 7 

$1,331

$886

$445

$20,760

 8 

$1,331

$904

$427

$19,856

 9 

$1,331

$923

$408

$18,933

 10 

$1,331

$942

$389

$17,991

 11 

$1,331

$961

$370

$17,030

 12 

$1,331

$981

$350

$16,049

13 

$1,331

$1,001

$330

$15,048

 14 

$1,331

$1,022

$309

$14,026

 15 

$1,331

$1,043

$288

$12,984

 16 

$1,331

$1,064

$267

$11,920

 17 

$1,331

$1,086

$245

$10,834

 18 

$1,331

$1,108

$223

$9,726

 19 

$1,331

$1,131

$200

$8,595

 20 

$1,331

$1,154

$177

$7,441

 21 

$1,331

$1,178

$153

$6,263

 22 

$1,331

$1,202

$129

$5,061

 23 

$1,331

$1,227

$104

$3,834

 24 

$1,331

$1,252

$79

$2,582

 25 

$1,331

$1,278

$53

$1,304

 26 

$1,331

$1,304

$27

$0

 

AutoChina's
"non-cash gain on sale" accounting would not be as ridiculous if they
also accrued for loan losses. As TFF dug through the disclosures and
assumptions behind AutoChina's loans, we were shocked to see zero
accruals for losses. By recognizing 60% to 80% of profits upfront,
almost all of the potential profit is recognized immediately. A
consequence of this policy is future credit losses will provide a huge
downside surprise (reversal of recognized gains, costs of repossession,
and loss on collateral). TFF believes this concern is quite relevant
given the recent jump in delinquent accounts relative to the minuscule
provision for loan losses. In fact, TFF believes AutoChina has only
reserved $1.1 million against $410 million in loans. According to SEC
filings, over 4.25% of AutoChina's loans were delinquent as of September
30, 2010. This deteriorating loan book paints a different picture than
the paltry reserve that represents less than 0.27% of the total lease
portfolio (see Table 6) (sec.gov/Archives/edgar/data/1417370/0001...).
Management has claimed that they have experienced less than 20 defaults
(versus 20,000 leases) and cumulative losses of roughly 15 basis points
(http://www.investorcalendar.com/IC/CEPage.asp?ID=161965).
TFF believes this defies all conventional logic. But then again, TFF is
using the same financial logic that would NEVER place delinquent loans
into accounts receivable on the balance sheet (during the company's most
recent earnings call management confessed to this uncommon treatment of
delinquent loans -
http://www.investorcalendar.com/IC/CEPage.asp?ID=161965). TFF was almost as shocked to hear this statement, as we were when we heard the unbelievably low loss frequency and severity.

 

Table 6

 

12/31/09

3/31/10

6/30/10

9/30/10

Trade accounts receivable

2,425

2,794

4,008

17,438

Net investment in sales-type leases current

123,413

154,775

208,649

246,597

Net investment in sales-type leases LT

93,164

116,633

148,220

145,654

 

219,002

274,202

360,877

409,689

% delinquent

1.11%

1.02%

1.11%

4.26%

Reserve for loan losses

(298)

(504)

(543)

(1,126)

Reserve as % lease portfolio

0.14%

0.18%

0.15%

0.27%

 

 

 

 

 

Coverage of reserve to delinquencies

12.3%

18.0%

13.5%

6.5%

Source: Company filings

Given
the myriad of related party transactions and checkered history of
management (see below), TFF is extremely skeptical about AutoChina's
claims of pristine credit quality. Compounding our concerns towards
credit is the company's initiative to provide financing for fuel, tires,
and insurance. The lack of collateral associated with these unsecured
loans should justify higher loan loss reserves. Despite an extensive
search, TFF has not been able to find another leasing company that
provides loans for diesel. TFF wonders why a customer base as healthy as
AutoChina's would need loans to buy diesel fuel and tires….. perhaps
it's a question, along with many others, that the new auditors will
flesh out.

Regional
accounting firm Crowe Horwath was the company's auditor for fiscal
2009. TFF finds this odd because Crowe Horwath didn't even form its
Chinese business until September 2009 (http://www.chcncpa.com/english.asp).
For the fiscal year just completed, Big 4 accounting firm
PricewaterhouseCoopers will be performing the year-end audit. While this
may appear promising, TFF would use Duoyuan Printing (NYSE: DYP)
as a cautionary tale for AUTC investors. In 2010, DYP switched from a
regional accounting firm to Deloitte. When Deloitte began the audit,
troubling accounting discrepancies were discovered. When these issues
came to light, DYP's shares dropped over 62% in just three days (
http://goingconcern.com/2010/09/duoyuan-printing-is-all-kinds-of-screwed-up-after-firing-deloitte/).
We have prepared a number of questions and concerns for PwC to address
as they begin their work in February for their first audit. Given the
issues above (and below), TFF would not be surprised if AutoChina
restates its financial results.

The Organizational Chart - Not that much to say

If
Sherlock Holmes was looking for a challenge, we would ask him to
decipher the baffling ownership structure that is a hallmark of
AutoChina. This convoluted chart illustrates the inherent complexity and
risk in the ownership structure of AutoChina (http://www.sec.gov/Archives/edgar/data/1417370/000114420410014943/chart.jpg). 

An article in China Economic Review provides a good description of AUTC's corporate structure: "In
April 2009, Spring Creek acquired ACG, a Cayman company owned by Honest
Best, and changed its name to AutoChina International. ACG was formerly
KYF, Inc, a holding company set up in 2007 by the CEO of AutoChina, Li
Yong Hui. ACG operates three subsidiaries: Kaiyuan Logistics, Kaiyuan
Auto Trade, and Hebei Xuhua Trading. All are owned by Hebei Kaiyuan Real
Estate Development, a company founded in 2005 by Li"(
www.chinaeconomicreview.com/stock_profile/sinosage/2010_05_12/AutoChina_running_on_empty.html).

TFF
can not overstate the risks that this type of structure presents for
investors. We invite investors to compare AutoChina's org chart with the
org chart of another well known Chinese reverse r /edgar/data/1394220/000114420410017658/chart1.jpg): 

****Sometimes two nearly identical pictures are more powerful than all of the forensic analysis in the world.

3 for 1: A Notorious Earnout, Perverse Incentives, and more accounting issues

The
org structure above is complimented by one of the LEAST shareholder
friendly earnout agreements that TFF has ever reviewed. This earnout
arrangement was initially developed under the reverse-takeover
agreement. According to AutoChina's 20-F, the earnout stipulates that
the public company will pay the CEO "between 5 and 20%" of the total
shares outstanding annually as an "earnout." Literally, shareholders
will be diluted by at least 5% every single year, regardless of
performance. The earnout is scaled based upon the level of growth
achieved in that year (obviously it is not based upon cash flow) (sec.gov/Archives/edgar/data/1417370/0001...).
In early 2010, AUTC issued CEO Li over 2.6 million shares, diluting
existing shareholders by the maximum amount of twenty percent. Shockingly,
this vulpine program is in place until 2013. With the maximum issuance,
AUTC could give Mr. Li an additional 19.5 million shares over the next
three years, which would dilute shareholders by roughly 50%
(only 20.3 million outstanding at 9/30/2010 - www.sec.gov/Archives/edgar/data/1417370/...). This might be one of the most lopsided compensation packages ever offered to an executive.

 

TFF
believes this massive future dilution is not currently reflected in
AUTC's stock price. In a perverse twist, should AutoChina actually hit
analyst expectations, then the sellside price targets would be off by
50% (double the shares out). On a fully diluted basis, AutoChina's
market cap could double to $1.1 billion over the next few years with the
stock price remaining flat. For the company to maintain its same
valuation, the stock price would need to decline by 50% (forget the fact
for a moment that TFF believes the current "E" is extremely
unreliable).

What
is perhaps most worrisome about the earnout is that the financial
metric of choice is "reported" EBITDA growth (not on a per share basis).
TFF does not understand why more shareholder friendly metrics like
return on equity, free cash flow, or even EBITDA per share were not used
instead. This benchmark for the earnout incentivizes Mr. Li to pursue
the most aggressive earnings and revenue recognition policies.

Finally,
this stock compensation expense appears to be hidden from investors and
is not reflected in the company's income statement.

After examining FASB guidelines, TFF believes these earnouts should be
expensed through the income statement and are not currently treated in
accordance with GAAP.

Although there is
some ambiguity, FASB has provided a framework for expensing earnouts.
According to EITF 95-8, "situations in which employee compensation other
than the contingent payments is at a reasonable level in
comparison to that of other key employees in the combined enterprise may
indicate that the contingent payments are additional purchase price
rather than compensation" (
72.3.243.42/pdf/abs95-8.pdf).
Further, if the "substance of some agreements for contingent
consideration is to provide compensation for services…the additional
consideration should be accounted for as expenses." According to the
proxy statement, Young Hui Li has received only $1.00 in salary and no
bonus or other compensation in the last fiscal year. This level of
compensation would clearly be defined as well below "other key
employees" (
www.sec.gov/Archives/edgar/data/1417370/000114420410030941/v186933_ex99-1.htm).
As a result, it is clear to TFF that the earnout should be considered
"compensation" expense under U.S. GAAP. The value of stock issued to Li
in 2010 was over $57 million. If this was expensed appropriately, AUTC
would show negative pretax earnings in 2010 (www.sec.gov/Archives/edgar/data/1417370/...).
The company could issue over 3.6 million shares in early 2011 to
fulfill the earnout, representing almost $100 million of potential
expense in 2011. Instead, this massive dilution and expense will never
even hit the income statement based upon AutoChina's renegade
accounting.

TFF
believes a salient question is why exactly are shareholders
compensating the CEO with this extremely generous earnout? If China
Economic Review is correct and "each truck financing subsidiary is
held by a separate legal entity owned by Kaiyuan Auto Trade – which is
owned by Li, not by AutoChina" (
www.chinaeconomicreview.com/stock_profile/sinosage/2010_05_12/AutoChina_running_on_empty.html),
then the earnout compensation would appear to exist so the CEO does not
walk away from AUTC? If that is the case, then the earnout is
unquestionably an expense. But a more concerning reality for AUTC
shareholders is that based on the org structure it appears equity owners
in AutoChina do NOT own the operating companies.

Should
PwC agree with TFF and force AutoChina to expense the earnouts,
shareholders would suffer dramatically based on two recent examples.
Shares of CNInsure (NASDAQ: CISG),
declined over 25% in a month when a report from OLP Global highlighted
the "company's sales incentive program is actually an equity incentive
plan that should be, but currently isn't, reflected in the company's
expenses"
www.fool.com/investing/general/2010/12/02/cninsure-shares-plunged-what-you-need-to-know.aspx. The mistreatment of earnout accounting and subsequent restatement drove Huron Consulting (NASDAQ: HURN) down over 70% (http://seekingalpha.com/article/153334-the-spectacular-blow-up-of-huron-consulting). TFF believes earnout accounting will be ANOTHER issue driving the need for a restatement at AUTC.

 

Related Party Debt

AutoChina's
atrocious cash flow characteristics (see Table 4 above) result in an
incessant need for new capital. This need for capital has created an
"un"virtuous cycle for management in order to keep the game going. Since
the company recognizes most of its profits upfront before they are ever
earned, the only way to grow is through additional originations.
However, to drive incremental originations, the company needs debt and
equity capital. Because raising capital from U.S. investors would
require opening the kimono, AutoChina has relied on prodigious levels of
related party debt.

Since
the company's inception, the largest provider of debt to AutoChina has
been an entity called Beiguo Commercial Building Limited. TFF was
shocked to discover that this legitimate sounding financial entity is
actually a PRC-based operator of grocery stores owned by the CEO of
AutoChina
(http://www.travelchinaguide.com/cityguides/hebei/shijiazhuang/shopping/) and (google.brand.edgar-online.com/EFX_dll/ED...).
But their grocery-store partner is just one of many strange bedfellows.
AUTC's complicated web of related party debt financing has fluctuated
wildly in recent periods, but represented a whopping $126 million at
September 30, 2010. Based on TFF's analysis, we believe the actual
number is closer to $865 million of transactions funded by related
entities through the first nine months of 2010. (page 27, http://www.sec.gov/Archives/edgar/data/1417370/000114420410063155/v203555_6k.htm).

This
reliance on related party transactions and debt can often be associated
with unscrupulous activity and/or exchanges which are clearly not arms
length in nature. The sheer volume and magnitude of related party
activity is very suspicious:

 

Table 7

 

 

 

 

Amount (millions)

 

 

Related Parties

9M 2010

Ownership

Comment in Filing

Hebei Kaiyuan

67,246

CEO and wife own / control

Bank loan guarantee provided to the company by the affiliates.

Hebei Ruihua Real Estate

11,955

CEO and wife own / control

Bank loan guarantee provided to the company by the affiliates.

Kaiyuan Shengrong

2,989

CEO and wife own / control

Loan provided to the Company during the period.

Beiguo

229,934

CEO owns 21%; Direct Lau owns 22%

Customer deposits received by the Company from affiliates for the purchase of automobiles

Beiguo

31,508

CEO owns 21%; Direct Lau owns 22%

Deposits for inventories made by the Company to affiliates for the purchase of trading materials.

Wantong Longxin

3,719

CEO's brother owns 40%

Deposits for inventories made by the Company to affiliates for the purchase of trading materials.

Renbai

35,261

CEO owns 20%; Direct Lau owns 20%

Customer deposits received by the Company from affiliates for the purchase of automobiles

Hebei Kaiyuan

6,260

CEO and wife own / control

Purchase of trading materials from the Company during the period.

Kaiyuan Doors

1,055

CEO and wife own / control

Sale of trading material to the Company during the period.

Kaiyuan Shengrong

19

CEO and wife own / control

Interest paid by the Company during the period.

Wantong Longxin

4,628

CEO's brother owns 40%

Sale of trading material to the Company during the period.

Beiguo

209,551

CEO owns 21%; Direct Lau owns 22%

Sale of trading material to the Company during the period.

Beiguo

218,686

CEO owns 21%; Direct Lau owns 22%

Purchase of automobiles from the Company during the period.

Beiguo

19,012

CEO owns 21%; Direct Lau owns 22%

Purchase of trading materials from the Company during the period.

Beiguo

3,906

CEO owns 21%; Direct Lau owns 22%

Interest paid by the Company during the period.

Renbai

9,638

CEO owns 20%; Direct Lau owns 20%

Sale of automobiles to the Company during the period.

Renbai

853

CEO owns 20%; Direct Lau owns 20%

Interest paid by the Company during the period.

Renbai

9,178

CEO owns 20%; Direct Lau owns 20%

Purchase of automobiles from the Company during the period.

TOTAL Related Party

865,398

 

 

Source: Company filings

 

 

 

Who was the CFO's old boss?

Guilt
by association is dangerous and often times unfair. At the same time,
if you are the CFO of a Chinese reverse merger, any questions from your
past must be properly vetted. TFF wonders how well AutoChina's CFO was
scrutinized given a checkered past that revolves around a massive fraud
that was perpetrated by his former employer.

 

According to SPAC Update, AutoChina hired Jason Wang as CFO in July 2009, stating that he was "formerly a senior member of Private Equity Management (PEM) Group"

(http://webcache.googleusercontent.com/search?q=cache:y-QgkKIp1fQJ:spacupdate.com/index.php%3Farticle%3D186+%22a+senior+member+of+Private+Equity+Management%22&cd=1&hl=en&ct=clnk&gl=us).
According to his bio, Mr. Wang was the Director of Research at
PEMGroup. PEMGroup turned out to be one of the largest ponzi schemes in
U.S. history, milking investors for a reported $800 million. New York
Magazine christened PEMGroup as the "Most Insane Alleged Fraud of 2009,"
quite an accomplishment given the competition that year (http://nymag.com/daily/intel/2009/04/and_the_title_for_most_insane.html).

PEMGroup was founded and run by the legendary fraudster and suspected murderer Danny Pang (http://online.wsj.com/article/SB123976601469019957.html).
According to an SEC lawsuit, PEMGroup demonstrated "a persistent
pattern of abuse" that began in 2007 and "continued through Mr. Pang's
stepping down in April 2009" (
http://images.ocregister.com/newsimages/2009/05/08/PangReceiver20090506.pdf).
While it is probably a mere coincidence, Jason Wang joined PEM Group in
2007 - the year the SEC alleges the abuses began in earnest. According
to the SEC, PEMGroup's "spending spree was funded by new monies coming
in, giving rise to the claim of a Ponzi scheme." To be clear,
regardless of any perceived similarities, TFF is NOT comparing
AutoChina's incessant need for new capital to fuel its growth to a ponzi
scheme.
The SEC complaint provides several anecdotes detailing the culture of PEMGroup, including:

 

·         A
time when management "recovered $4 million from a former employee who
had been embezzling" from the company's funds. Once recovered, rather
than paying this back to the Tranches, Mr. Pang reportedly divided it up
amongst senior management."

·         "In the troubled year of 2007, the staff was treated to a $1.5 million trip to China"

·         "In
December 2008 and with many of the loans in the investment portfolio in
default…Mr. Pang provided his entire staff with a cruise on a Disney
boat at an expense of $1.0 million."

 

TFF
has no reason to suspect Mr. Wang was anything but above board. And for
the record, Mr. Wang was not accused of any wrongdoing. But the SEC's
observation that "PEMG's senior management appears to have provided
little opposition and in many instances facilitated the spending
schemes" was disconcerting because Mr. Wang was labeled a "senior
member" of PEMG by SPAC Update (
http://images.ocregister.com/newsimages/2009/05/08/PangReceiver20090506.pdf).
Also, The Wall Street Journal and New York Magazine point out Pang was
quite open about the fraudulent activity at the firm. According to one
employee, "Pang came into his office and said: 'Nasar, I want you to
know we are in a Ponzi scheme" (
http://nymag.com/daily/intel/2009/04/and_the_title_for_most_insane.html).
While at PEMGroup, Mr. Wang may have been oblivious to the fraud, but
his responsibilities did include "analysis of prospective investments,
credit and cash flow analysis, and valuations. He was involved in both
equity and debt investments." (
www.autochinaintl.com/en/InvestorNews/AutoChina_International_Limited_Appoints_New_Chief_Financial_Officer/). According to the SEC's complaint, PEMGroup's employee base was very small, consisting of "approximately 30 individuals" (http://images.ocregister.com/newsimages/2009/05/08/PangReceiver20090506.pdf).
Given the small number of employees, the scale of the fraud, Danny
Pang's documented openness, and Mr. Wang's considerable
responsibilities, TFF believes it would be natural for investors to
revisit how the Board vetted Mr. Wang prior to being appointment CFO.
[TFF Note - In September 2009, just prior to his trial, PEMGroup founder
Danny Pang committed suicide. As a result of his death, the SEC dropped
its case against Pang and PEMGroup]

 

While
we have no reason to think Mr. Wang was involved in the Ponzi scheme,
TFF believes Mr. Wang's resume has had inconsistencies, a problem his
old boss Danny Pang had as well. Mr. Pang alleged he was an investment
banker at Morgan Stanley and got his MBA from the University of
California at Irvine. Both of these statements were lies (gawker.com/5231292/danny-pangs-last-gamble).
Turning to Mr. Wang, AutoChina's financial filings state that Mr. Wang
received "Bachelors degrees from both the Wharton School and the School
of Engineering and Applied Science at the University of Pennsylvania in
May 1994" (http://google.brand.edgar-online.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=6706146-1058-11246&SessionID=XcKRHWLzxztZAl7).
However, on AutoChina's webpage, Mr. Wang's date of graduation is
different by four years, "Mr. Wang received Bachelors degrees from both
the Wharton School and the School of Engineering and Applied Science at
the University of Pennsylvania in May 1998" (
http://www.autochinaintl.com/en/Investor/Officers/).
If would appear from the first set of dates in AutoChina's SEC filings
that Mr. Wang graduated from Wharton at the age of 18 - if so, kudos to
him. Either way, the inconsistencies are a small drop in an overflowing
bucket of questions relating to AutoChina.

So
how could so many problems at one company go unnoticed by the sellside
analysts that follow it? TFF does not believe that the analysts are in
cahoots with the company, but instead have no base of knowledge to cover
this type of business model. TFF could only find two analysts that
actively cover AutoChina, one from Chardan Capital and one from Rodman
& Renshaw (the same reverse merger juggernaut that Barron's has been
so critical towards). From what TFF can surmise, the Chardan analyst is
a technology analyst who covers a universe of tech companies such as
Skyworth, EZChip, and Tower Semi. In fairness to him, it is extremely
unlikely he has ever seen lease accounting before. The second analyst
from Rodman covers an eclectic basket of Chinese names, ranging from
battery manufacturers to recycling companies. TFF believes that
AutoChina is the only finance company that either of these analysts
follows. So despite being ill-equipped to analyze lease accounting, we
fully expect both analysts to support AutoChina all of the way down.
Why? Chardan Capital and Rodman were recently selected to underwrite a
new SPAC called Prime Acquisition. This new SPAC's CEO and Chairman is
none other than AutoChina's CEO, Yong Hui Li (
http://247wallst.com/2011/01/21/blast-from-the-past-china-spac-ipo-filing-pacq-autc/).

 

 

TFF
believes that when the dust settles, AutoChina will be a single digit
stock. As of January 24, 2011, the 72 companies in Roth Capital's
Chinese Investment Universe Publication traded at 7.7x earnings. If
AutoChina simply traded inline with the broad Chinese universe, it would
be $14 per share based upon consensus estimates. Taking into
consideration the possible 50% dilution, the stock would be closer to
$7.00 with an inline multiple to the peer group. However, given the
quantity of issues that TFF has discussed, it would seem logical that
investors would value AUTC at a discount to its peer group (assuming the
earnings do not vanish in a restatement). TFF would point out that
should bad debt increase, or funding dry up, there are ample scenarios
where AUTC equity could go to zero. We believe the serious issues TFF
has raised warrant investor skepticism. It is the opinion of TFF that
investors will suffer at least 50% downside from current levels.

As we like to say, "If it looks like a duck, walks like a duck and quacks like a duck, it probably is a duck."

Disclosure:
***
The author of this article is short AutoChina stock.  TFF goes to great
lengths to ensure that all information is factual and referenced. All
facts that we present herein are true to the best of our knowledge. All
opinions presented are our own and accurately reflect our opinion on the
relevant subject being discussed.  We recommend that investors perform their own extensive due diligence before buying or selling any security.

 


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Tue, 02/01/2011 - 12:34 | Link to Comment HelluvaEngineer
HelluvaEngineer's picture

Is there any chatter about the numbers coming out of BIDU these days?  They are up 8% today.

Tue, 02/01/2011 - 12:36 | Link to Comment Cognitive Dissonance
Cognitive Dissonance's picture

TFF believes investors would be prudent to avoid AutoChina at all costs. At the same time, we implore regulators to protect the investing public and launch an investigation into AutoChina."

Only if they send this report to the SEC attached to some tranny porn does it stand a chance in hell of being opened, never mind read.

Tue, 02/01/2011 - 13:26 | Link to Comment bonddude
bonddude's picture

Today's winner !

Tue, 02/01/2011 - 12:39 | Link to Comment Herd Redirectio...
Herd Redirection Committee's picture

Sell first, and ask questions later!  Having quickly looked through their report,  I know what I would do if I was a holder of AUTC!   To go short something that will shortly be delisted, though, that is the question!

Check out the latest from the Capital Research Institute

http://www.capitalresearchinstitute.org

Tue, 02/01/2011 - 12:59 | Link to Comment cougar_w
cougar_w's picture

Won't be de-listed evar. No money is that for the Exchange.

Tue, 02/01/2011 - 12:40 | Link to Comment HarryWanqer
HarryWanqer's picture

Who cares.  People will buy a train wreck right now.  Rally On.

Tue, 02/01/2011 - 13:12 | Link to Comment Cognitive Dissonance
Cognitive Dissonance's picture

Who will give me a $1,000? Going, going.......gone.

 

Tue, 02/01/2011 - 13:45 | Link to Comment SheepDog-One
SheepDog-One's picture

Harry will even buy a train wreck! Rally on, moron.

Tue, 02/01/2011 - 12:44 | Link to Comment Gubbmint Cheese
Gubbmint Cheese's picture

People deserve the markets, regulators and politicians they tolerate (and their outcomes).

I personally can't wait for this crap to burn down.. this is madness.

 

Tue, 02/01/2011 - 13:49 | Link to Comment SheepDog-One
SheepDog-One's picture

Bottom line thats correct, the people deserve this kind of daily insult if all they do is put up with it and even come under the Stockholm Syndrome spell of sympathy and even admiration for your captors as Harry and others exhibit around here.
I cant wait for this madness to burn down either, daily hope to see some wheel fly off this stupid Rube Goldberg contraption that by any measure should even roll much less fly.

Tue, 02/01/2011 - 12:49 | Link to Comment topcallingtroll
topcallingtroll's picture

Thanks tff.

Tue, 02/01/2011 - 12:58 | Link to Comment Oh regional Indian
Oh regional Indian's picture

This is permitted fraud. Make no mistake about it.

Wall street vipers!

The chinese can teach one a thing or two about fraud.

ORI

http://aadivaahan.wordpress.com/2010/06/16/time-faster-now/

Tue, 02/01/2011 - 12:58 | Link to Comment cougar_w
cougar_w's picture

Down 7%.

I coulda shorted that shit.

Tue, 02/01/2011 - 13:06 | Link to Comment Dingleberry Jones
Dingleberry Jones's picture

Any followup with China Green Agriculture (CGA)?  They seemed to have rebounded from the allegations from Muddy Waters that were shared here a few weeks ago.

 

Will be interesting to see what pans out with these companies.  They probably take some of their stock profits and pump it back into the stock slowly, POMO style.

Tue, 02/01/2011 - 13:13 | Link to Comment Zero Govt
Zero Govt's picture

TFF have done an excellent job finding "aggressive accounting" and an also excellent job whistleblowing. They have completed their work, buyer beware....

They are however misguided i believe calling on regulators or for an investigation. You can't really prove fraud before it occurs, it's extremely difficult. Nor should you shut down a company based on your view of the companies operations and how it is leveraged. Only the market and time can decide that truth as ultimate arbitor.

Would TTF have blown the whistle on Ryanair who offered fairs at £1.99 when traditional flag carriers were priced at £299?

It is a fallacy to think you know what will happen or you can prevent something occuring. Only the market proves that point, not supposition or worse oppression of new businesses before they get out the starting gate.

Who do TTF suggest look into it, the NY Fed whose own "aggressive accounting" is leveraged at 80/1 ? 

Tue, 02/01/2011 - 13:25 | Link to Comment Comrade de Chaos
Comrade de Chaos's picture

Riot. 

Tue, 02/01/2011 - 13:26 | Link to Comment Ploutos
Ploutos's picture

No shares available to short on IB

Tue, 02/01/2011 - 13:30 | Link to Comment Greater Fool
Greater Fool's picture

Thanks, ZH! I love that I can get this kind of detail here.

Do NOT follow this link or you will be banned from the site!