Chinese RTOs
Wonder Auto’s Wonderless Acquisition
The research firm OLP Global came out with an excellent research report on Wonder Auto Technology, Inc. (WATG) last week.
The report examines a $15 million acquisition that the company made in July 2010, and raises serious questions about whether the acquisition was legitimate.
Acquisition Overview
In its second quarter 10Q, the company announced it acquired Vital Glee Development Limited (“Vital Glee”) for $15 million on June 24, 2010. Vital Glee was an “investment holding company and through its subsidiary engaging in automotive shock absorber manufacturing business”.
“On June 24, 2010, [WATG’s subsidiary] agreed to acquire 100% equity interest in Vital Glee Development Limited (“Vital Glee”), for a total consideration of $15 million of which $8.7 million was settled in June 2010. The remaining consideration will be divided into 2 equal installments and will be settled by December 31, 2010 and June 30, 2011 respectively. The Company obtained control over Vital Glee on July 1, 2010 by appointing the sole director to Vital Glee. Vital Glee is an investment holding company and through its subsidiary engaging in automotive shock absorber manufacturing business.”
Little additional disclosure was given, in the 10Q or any subsequent SEC filings.
OLP investigated the acquisition further. From speaking with management, OLP determined that Vital Glee’s operating entity was Jinzhou Lide Shock Absorber Co., Ltd. This is further confirmed by a Roth Capital report on September 30, 2010.
After some investigation, OLP found serious issues with the acquisition, which I will summarize below:
1. Jinzhou Lide was formed in April 2010
According to the AIC records for Jinzhou Lide, which are included in the OLP research report, Jinzhou Lide was established on April 26, 2010. You can also see this on the Jinzhou AIC website here (use Google Chrome’s translation functionality if you cannot read chinese).
I’m doubtful that a business that has been operational for 2 months can be worth $15 million.
Management told OLP that Jinzhou Lide was formed from a reorganization of an older company, which engaged in the same auto shock absorber business in Jinzhou. Management, however, declined to provide the name of Jinzhou Lide’s predecessor company, and I discuss below my skepticism around management’s claim.
2. Jinzhou Lide was established at the same address as another facility owned by WATG
According to AIC records (see page 4 of OLP report or the website I show above), Jinzhou Lide was established and located at:
Bohai Street, Jinzhou Economy & Technology Development Zone, Jinzhou, Laoning
This is the same address of Jinzhou Wanyou Mechanical Parts Co., Ltd., a subsidiary of the company. OLP learned this by calling the company, but you can look on this site, this site to verify that Jinzhou Wanyou is located at Bohai Street, Jinzhou Economy & Technology Development Zone, Jinzhou, Laoning. Or simply search for the chinese characters of the address and the chinese characters of Jinzhou Wanyou Mechanical Parts Co., Ltd., which are found on pages 3 and 10 of the OLP report, respectively, in Google Chrome.
Not surprisingly, we also see this address show up in this 8k from April 4, 2007, where Jinzhou Wonder Auto Suspension System Co., Ltd. sells a stake in Jinzhou Wanyou Mechanical Parts Co., Ltd. to WATG. Click here for the relevant page showing the address. Jinzhou Wonder Auto Suspension System Co., Ltd. is shown as a related party throughout several historical SEC filings, such as its 2007 10K.
We now see that WATG paid $15 million for a subsidiary that was two months old and established at the same address as one of WATG’s current facilities.
3. Jinzhou Lide had a registered capital of only $1.2 million, and yet was sold for $15 million two months after being established
Jinzhou Lide’s registered capital is only $1.2 million, which implies that its shareholders only put in $1.2 million in April 2010 to establish the business. Yet it was sold to WATG for $15 million in July 2010. I’m doubtful that Jinzhou Lide’s value rose 1,200% in its two months of operations.
4. Management has not disclosed the identity of Vital Glee’s seller
In the vast majority of M&A transactions, investors are aware of the identities of both the buyer and seller. In this case, WATG management has not disclosed the identity of the seller, and investors cannot determine the identity of the seller through any other means. Vital Glee is registered in the British Virgin Islands (BVI), and the BVI registered agent will only release the director and shareholder information if Vital Glee management consents. Upon OLP’s request, the BVI registered agent sought permission on multiple occasions from Vital Glee management, but has yet to receive approval to release Vital Glee’s shareholder information.
OLP also asked WATG management to identify the name of the seller. According to OLP, the WATG CFO stated that he does not know the identity of the seller.
The question therefore remains: who owned Vital Glee and who received the claim to $15 million upon its sale?
WATG should publicly disclose the identity of Vital Glee’s sellers, and enable investors to independently access the relevant information from the BVI registered agent.
5. Jinzhou-based sources in the auto parts industry were unable to identify Jinzhou Lide’s predecessor, and weren’t aware of M&A involving any $15 million shock absorber businesses in Jinzhou
OLP identified 14 companies in the auto shock absorber business located in Jinzhou that have effective AIC registrations. They are listed here. OLP spoke to “numerous” members of this list in an effort to identify Jinzhou Lide’s predecessor and none of them were able to identify a company that could have been Jinzhou Lide’s predecessor.
Additionally, none of the sources were aware of a $15 million acquisition in the auto shock absorber sector in Jinzhou.
Conclusion
We have seen corporate governance issues and questionable financial and management practices at other Chinese RTOs structured and financed similarly to Wonder Auto. Like others, Wonder Auto has not chosen a top-4 auditor, instead choosing to go with PKF Hong Kong, a firm that boasts only 4 partners. Like others, Wonder Auto has eye-popping financial figures, claiming 40% to 50% revenue growth annually since 2005 and 20%+ operating income growth during that same time period, which imply extraordinarily high returns on capital on its capital expenditures and acquisitions. During the global downturn of 2008 and 2009, which impacted China just like the rest of the world, WATG doubled both revenue and gross profit, and increased EPS by 40%. The company has raised substantial amounts of dilutive equity at low valuations, such as $69 million in November 2009 at a valuation of less than 15x PE.
The facts behind the Jinzhou Lide acquisition are damning. WATG appears to have paid $15 million for a 2-month-old company established at the same site as one of WATG’s other subsidiaries. WATG has yet to disclose the seller of Jinzhou Lide, and its general disclosure of the acquisition is noticeably sparse. Numerous local competitors are unaware of a shock absorber business in Jinzhou that could have been the predecessor to Jinzhou Lide. They also have not heard of a $15 million acquisition in the sector. The shock absorber business community in Jinzhou is small enough that such a predecessor and acquisition would not go unnoticed.
If management wants to prevent further allegations of fraud, it should release an 8K elaborating on the details of the Jinzhou Lide acquisition. It should provide predecessor financial statements of Jinzhou Lide; the identity and backgrounds of its sellers; an explanation of why its initially registered address is the same as one of its subsidiary’s; a list of customers; and additional information that would allow independent analysts to verify Jinzhou Lide’s legitimacy.