Evidence Casts Suspicion On Shougang Fushan
In Part I of our post, available here, we presented the first part of our piece on Shougang Fushan Resources Limited (HK 0639) (“Fushan” or the “company”), which is available in full at our website. In Part II, we present further compelling evidence that leads us to conclude that Fushan, a 2008 effective reverse merger trading on the Hong Kong stock exchange, has misrepresented its business and financial position to investors.
The objective of a pump and dump scheme is to talk up the share price through misleading financial performance so that insiders may dispose of their shares after other investors canada goose outlet take the bait.
The chart below shows that canadian goose jacket Mr. Xing and Chairman Wong dumped 90% of their interest in the company within 18 months of the 3 Mines transaction. We estimate that Mr. Xing grossed HK$ 4 billion and Chairman Wong grossed HK$ 4.5 billion.
Upon the consummation of the reverse cheap Canada Goose merger, Mr. Xing received a 15% stake in the company (670 million shares) and Chairman Wong’s ownership stake stood at 31% (1.4 billion shares). When the markets saw Fushan’s outstanding performance and the price of the company’s stock soared, Chairman Wong and Mr. Xing sold out.
canadian goose jacket A common denominator of Chinese reverse mergers that have collapsed under allegations of fraud is that their performance appears too good to be true. The play book is simple. Fraudsters hide costs through off books transactions with related parties in order to inflate margins and pump up their stock price. Once the stock canada goose store price soars on the wind of amazing profitability, insiders sell. Longtop Financial (LFT) was Canada Goose online the paradigmatic example of this scheme. canadian goose jacket
We believe that Fushan’s insiders have perpetrated a similar deception. Compared to other coal canada goose coats mining companies Fushan’s financial performance is simply incredible. The company’s EBITDA and EBIT margins easily trounce Canada Goose Jackets its HKEX and A share coal competitors, which, for buy canada goose jacket the most part, are much larger, vertically integrated, and more experienced organizations.
Fushan’s financial performance is so far superior to its competitors that it leaves only two choices: either it has revolutionized the coal mining business or the company is fabricating its financial statements.
It is highly unlikely that Fushan is the most efficient and best managed coal mine in the world, as its global and Chinese competitors should benefit from economies of scale. Fushan produces coal from three old and provincial mines. Yet it manages to generate better EBITDA margins than companies with much larger mines. Either Fushan is the most efficient and best managed coal company in the world or it is a fraud.
Canada Goose Online For those that would argue that Fushan’s margins can be explained by its focus on high quality, and therefore, high priced coal, we present the following chart comparing Fushan to other Chinese and leading international coking coal companies, which focus almost exclusively on high priced coal. Again, Fushan’s margins seem a work of fiction. Canada Goose Online
cheap canada goose uk The peer group we assembled in the above chart is made up of pure coking coal companies operating in Shanxi (Shanxi Lu’an, Shanxi Xishan), a neighboring province in China (Kailuan Energy), Southern China (Hidili) and in other parts of the world, such as North America, Australia, and India. cheap canada goose uk
canada goose uk shop Fushan cannot argue that cheaper labor can account for the discrepancy because in our comparison we included local competitors hiring from the same labor force. In addition, several of the above companies are industry leaders for metallurgic coal, with vastly greater purchasing power, technology, and management skills. Yet their margins still average 3500 basis points below those of Fushan. This fails the smell test. canada goose uk shop
canada goose black friday sale One of the hallmark features of Bernie Madoff ‘s Ponzi scheme was that he consistently produced exceptional monthly returns despite wild swings in the market. The consistency of Fushan’s margins bears a striking resemblance to Madoff ‘s returns: notice in the above chart how margins for Fushan’s peers fluctuate during the doom and gloom of the great recession (2008 2010). Yet Fushan’s margins appear immune to the cyclicality in coal prices during the same time period. canada goose black friday sale
To the contrary, in 2009, Fushan’s adjusted EBITDA margin (excluding stock option expense and charitable contributions) increased 724 basis points despite 1) its average selling price for raw coal declining by 18%, 2) its sales declining 6% on an annualized basis, 3) its production cost per ton increasing by 13%, and 4) the reported loss of the company’s most profitable customer who Canada Goose Parka accounted for 31% of gooseoutletvip.com sales in the prior year. Virtually all of its competitors suffered during this period. How was Fushan immune? Fushan, like Madoff, has a track record remarkable for both its excellence and its strange consistency.
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If we dig deeper into Fushan’s remarkable margins, we find that Fushan’s performance is driven by curiously high average selling prices (“ASPs”) for a commodity and an unreasonably low cost structure.
Canada Goose Coats On Sale Coal is found in continuous seams that stretch out over vast geographical areas, like an underground river. Below canada goose black friday sale is a picture of a coal seam (the thick black lines) which stretches across the countryside. Canada Goose Coats On Sale
It is particularly important to understand how coal seams affect the market price of coal. Canada Goose sale Each seam produces coal with different characteristics. But, and this is crucial, coal characteristics generally do not significantly vary within a seam at a similar access point. Thus, exchanges, companies and traders typically set a spot price for coal by the seam and nearest city of origin.
canada goose coats Fushan primarily mines seams 4 and 9 within five miles of Liulin. Coal from canada goose coats on sale seams 4 and 9 from the greater Liulin area are traded at prices set by the Liulin coal market. canada goose coats
canada goose How is Fushan more profitable than other coal companies? Part of the reason is that it sells Liulin 4 canada goose clearance sale and 9 coal at premium to the market prices for coal mined from the exact same seam. According to BNP’s recent research report, from 2009 2011, Fushan sold its Liulin 4 coal at a 19% premium to the Liulin 4 benchmark price, while the company’s 9 clean coal sells at a 10% premium to the Liulin 9 benchmark. canada goose
Coal is a commodity (or so we thought). How can Fushan’s coal sell at a significant premium to the same coal mined from the same seams? The whole point of setting a spot price for coal from each seam is that buyers and sellers can quickly and easily exchange the commodity without having to determine the unique characteristics of each lot. The notion that Fushan could sell its 4 coal for almost a 20% premium to the spot price of 4 coal is absurd.
canada goose factory sale This begs the deeper question: Who would pay a premium to the spot price for a commodity? canada goose factory sale
buy canada goose jacket The answer: a related party who, as a major shareholder, directly benefits from Fushan’s financial performance. buy canada goose jacket
In 2008,Mr. Xing’s conglomerate bought raw coking coal from Fushan at 72% above the price paid by other customers. The following table summarizes the transaction.
uk canada goose outlet In 2008, Mr. Xing’s related party premium for one 3 month period single handedly boosted Fushan’s 2008 sales and pre tax net income by 10% and 21%, respectively. Mr. Xing’s decision to buy raw coal from Fushan at a hefty premium came immediately after the reverse merger and just prior to the time when Mr. Xing and Chairman Wong dumped virtually all their shares. While this transaction was disclosed to investors, we think it Canada Goose Outlet should be noted that coal washing is a razor thin margin business, making it unlikely that Mr. Xing could afford to overpay for raw coal and still make a profit, and that it seems incredibly unlikely that Mr. Xing would ever buy raw coking coal from a third party, much less for a 72% premium, given that he owns 12 coal mines in the same area, 8 of which are within 15 miles of Fushan’s operations. uk canada goose outlet
Canada Goose Parka It is also worth noting that since 2008, Fushan’s board has maintained huge mandates for related party coal transactions with Mr. Xing, director Shi (who also owns competing coal mines in the area), and 27% shareholder Shougang parent (whose employees comprise nearly half of the board). Board approved transaction caps allow these parties to purchase coal for more than twice the price that Fushan commands with other customers. We believe that these arrangements provide a significant opportunity to related parties to manipulate the share price of Fushan by artificially boosting ASPs. Canada Goose Parka
In our opinion, the notion that Fushan sells a commodity at a large premium to a related canada goose clearance party is dubious. We suspect that such transactions take place at market prices but that Fushan marks up the price on the invoice in order to boost its margins. Make no mistake that insiders reap a massive benefit from such actions: outstanding margins boost Fushan’s stock price, allowing insiders to enrich themselves on the sale of the company’s shares.
buy canada goose jacket cheap In addition to reporting unrealistically high ASPs, Fushan achieves world beating margins because its costs, as a percentage of revenue, are so much lower than its domestic and international competitors’ margins. buy canada goose jacket cheap
Canada Goose online The graph below compares Fushan’s cost of goods sold as a percentage of sales against its pure coking peers. This chart is truly remarkable because it shows Fushan allegedly mines a commodity at gross margins that would be the envy of a software monopoly. Canada Goose online
The above graph suggests that Fushan has revolutionized the coal industry. It has discovered a way to mine coal so much more cheaply than its competitors that it seems like magic. Notice that cheap labor costs or geographic anomalies do not explain the difference: Fushan’s costs are ridiculously lower than domestic peers, including coal companies mining in the same province (Shanxi Lu’an, Shanxi Xishan).