Time‐Lapse Video Shows China Integrated Energy Defrauded Investors March 28, 2011 China Integrated Energy, Inc. (NASDAQ: CBEH) is a complete hoax, according to a detailed investigation by the International Financial Research & Analysis Group (“IFRA”) commissioned by one of its hedge fund clients. The report, key excerpts of which I am publishing today, shows conclusively that: 1. Four months nearly continuous on site observation and video surveillance of CBEH’s biodiesel operations in Xi’an (Tongchuan) confirm no meaningful production activity, completely demolishing management’s repeated claims the plant is running at 100% of capacity and generated $22,876,791 gross profit in 2010. On March 10, 2011, investigators caught and filmed CBEH management “redhanded” staging phony production activity at the factory with the criminal intent to defraud a group of 20 investors touring at the expense of CBEH’s investment bank, Rodman & Renshaw (NASDAQ: RODM). 2. Three months of on‐site and video surveillance of CBEH’s recently acquired Chongqing Tianrun biodiesel plant confirm no meaningful production activity, either; completely contrary to management’s claims the plant is running at 100% of capacity since January. 3. The largest PRC auditor performed an independent audit of CBEH’s 2009 financial statements showing no revenue from biodiesel sales while gross profit from its wholesale and retail diesel division was 46% lower than reported in its 2009 10‐K filing. 4. The 100,000‐ton Tongchuan biodiesel production line never even bothered to obtain a production license, which is absolutely required before it can sell any biodiesel. Nor does the Tongchuan 100,000‐ton plant have any meaningful access to feedstock (waste or vegetable oils) or advanced technology as management claims. 5. Despite no meaningful production of biodiesel in its history and with little more than scrap value attributable to its idle plants, CBEH management falsely claims in its SEC filings that it invested $46.1 million acquiring and building out these totally unproductive assets over the last 5 years. Additionally, CBEH has announced it will spend another $46 million acquiring and building out its new Hainan plant in 2011. 6. In addition to greatly exaggerating the earnings of its wholesale and retail divisions, CBEH management falsely claims in its SEC filings it spent $53.2 million acquiring and leasing these assets over the last three years. It projects to spend another $8.2 million on Chongqing FengDou Keyu acquisition in 2011.
7. CBEH’s ongoing and continuous hoax allowed it to raise $85 million from investors to date, including $39.5 million most recently with the help of its investment banker Rodman & Renshaw (NASDAQ: RODM). The ongoing fraudulent acquisitions and capital expenditures combined with a legally unenforceable VIE structure in China will result in a total loss for U.S. investors. First, some background information. Some of my readers may recall that last September I published IFRA’s detailed report (here) on China Green Agriculture (NYSE: CGA). Then in November IFRA investigators contributed key customer reference evidence to the Muddy Waters LLC report on Rino International (Pink Sheets: RINO) leading to its chairman’s admission of fraud and subsequent collapse and delisting of its stock. IFRA also uncovered key tax evidence on RINO that I published (here). Needless to say, the team at IFRA (link to their site here) does excellent work rooting out fraud for their clients who are institutional investors or hedge funds both long and short. IFRA’s massive report on CBEH was prepared for one of its hedge fund clients, no doubt at considerable cost, after the fund became suspicious of CBEH’s incredible earnings performance compared to its competitors. I am fortunate that IFRA and the hedge fund gave me permission to publish key excerpts from the report in an effort to expose the truth and of course make some money since both the fund and myself are short CBEH. I had hoped to publish this report sooner but the effort is ongoing. The considerable video evidence (over a terabyte) took me a long time to personally review. The key findings of the report follow. 1. Four months nearly continuous on site observation and video surveillance of CBEH’s biodiesel operations in Xi’an (Tongchuan) confirm no meaningful production activity, completely demolishing management’s repeated claims the plant is running at 100% of capacity and generated $22,876,791 gross profit in 2010. The following is an explanatory overview image of the Tongchuan plant, shown from the perspective of the investigators’ surveillance camera, which focused on the single‐ entry/exit point identified below:
According to management, the Tongchuan plant’s 100,000‐ton production line produced 88,500 tons of biodiesel in 2010 (source Q3 10‐Q and Q4 conference call also here). By subtracting the 11 legal holidays and assuming the plant is open for business the remaining 354 days of the year, I calculate an average daily production volume of 250 tons per day. Assuming the raw material feedstock is approximately the same weight as the finished biodiesel, the Tongchuan plant likewise should consume at least 250 tons of feedstock per day. CBEH’s biodiesel and liquid feedstock are transported on 20‐30 ton tanker trucks according to management. Assuming 30‐ton tanker trucks are used to transport 500 tons of biodiesel and liquid feedstock per day, one would expect to witness, on average, about 500/30 =17 tanker trucks entering and then exiting the plant each day. The Tongchuan plant has a single‐entry/exit point for tankers. Filming 17 tanker trucks entering and exiting this gate would result in 34 instances of a tanker truck passing through the gate, each day, on average. Incredibly, during four months of almost continuous surveillance, the investigators witnessed only six (6!!) tanker trucks, ALL but one appearing on the spectacular day: the March 10, 2011 Rodman & Renshaw investor tour of the Tongchuan facility. But before I share the investor tour video, you need to review the videos of the completely idle Tongchuan plant as recorded by the surveillance team each and every day. I reformatted and uploaded 10 days of time‐lapse surveillance of the Tongchuan plant to Vimeo where anyone can view them (Click here for the Vimeo CBEH Channel). The videos are from February 10th to 19th. I selected these dates since on the fourth quarter earnings conference call held on March 10th, management replied to several questions from an investor (transcript available here or here see page 12), explaining that following normal annual maintenance the Tongchuan plant “is already back to full production on February 9, right after the Chinese New Year.” (Note: Institutional investors and research analysts can contact me for the complete catalogue of surveillance records available from IFRA.)
IFRA investigators first observed the Tongchuan plant in June of 2010 and then again in October before commencing surveillance on November 26, 2010. Four months later, they have yet to detect ANY meaningful evidence of production. The only apparent activity is workers and engineers installing equipment and testing the new 50,000‐ton production line. Combined with the plant’s lack of a production license, feedstock access, technology or any record of biodiesel sales in CBEH’s Chinese audited financials (see points 4 and 5 below), CBEH’s claims that it produced 88,500 tons of biodiesel generating gross profit of $22,876,791 in 2010 are a complete fraud. The facts prove CBEH has never produced and sold any meaningful quantity of biodiesel at all. On March 10, 2011, investigators caught and filmed CBEH management “red handed” staging phony production activity at the factory with the criminal intent to defraud a group of 20 investors touring at the expense of CBEH’s investment bank, Rodman & Renshaw (NASDAQ: RODM). In January 2011, CBEH received $39.47 million gross proceeds (see press releases here and here) from registered direct offerings arranged by Rodman & Renshaw, who earned a placement fee of 7% on the deals. On March 7th, CBEH made an investor presentation at Rodman’s annual China investment conference in Shanghai (list of presenting companies is here). Following the conference, Rodman & Renshaw arranged for a group of approximately 20 investors to visit CBEH’s Tongchuan biodiesel facility outside of Xi’an on March 10th at 9:45am. Aware of this visit, IFRA investigators anticipated that CBEH management might intentionally deceive the investors touring Tongchuan by staging phony production and distribution of biodiesel. Such deception caught on film could prove CBEH management’s criminal intent to defraud investors. Right up until March 9th, investigators continued making daily recordings of the idle Tongchuan facility. On March 9th investigators filmed CBEH employees busily cleaning and preparing the factory for the next day’s investor tour. Early on the morning of March 10th, four large biodiesel tanker trucks arrived and parked at the factory. It seemed CBEH management had indeed planned a “show” for investors that day. Prior to this date, the surveillance team had only witnessed one previous tanker truck enter the factory (on March 2nd). Rather than filling up with biodiesel as would be expected in a real business operation, the four tankers sat idle for 1 hour 20 minutes awaiting the arrival of the investors. At 9:45am the Rodman & Renshaw investors arrived precisely on schedule and were greeted by CFO Albert Pu and VP‐IR Susan Zhou. The plant immediately came alive with four 30‐ton tanker trucks pretending to fill up with biodiesel while loud humming sounds came from the production line. A fifth tanker truck arrived during the tour. As far as anyone in attendance could tell, the Tongchuan plant appeared to be busily operating at 100% of capacity, just as management had repeatedly publicly stated. After the one‐hour tour, CFO Albert Pu handed out gift bags and the investors departed. Management then departed. The last tanker truck departed. Most of the employees departed. The factory quickly went back to the same idle emptiness of the prior four
months. The March 10th Rodman & Renshaw investor tour was just an elaborate and criminally conceived hoax as anyone can see on IFRA’s March 913 surveillance videos I combined and uploaded to Vimeo (click here for the Vimeo CBEH Channel). 2. Three months of on‐site and video surveillance of CBEH’s recently acquired Chongqing Tianrun biodiesel plant confirm no meaningful production activity, either; completely contrary to management’s claims the plant is running at 100% of capacity since January. The following is a picture of the Chongqing Tianrun plant from CBEH’s website (link here). The 50,000‐ton Tianrun plant is half the capacity of the 100,000‐ton Tongchuan plant. I therefore assume it should have about half the traffic, equal to at least 8 large 30‐ton tanker trucks entering and exiting through the plants single tanker truck entrance pictured above. Filming 8 tanker trucks entering and exiting this gate would result in 16 instances of a tanker truck passing through the gate, each day, on average. However, during three months of continuous surveillance, the investigators witnessed no tanker trucks. The only evidence of any possible production during the ongoing surveillance has been the presence of the occasional truck carrying barrels that could contain oil feedstock. The total amount is certainly less than 150 tons over the entire three months. Even factoring out the Chinese New Year holiday, given
management’s claim that the plant is running at 100% capacity would indicate production and sales of over 11,000 tons during the three months of surveillance. The surveillance evidence therefore irrefutably shows there has been no meaningful production. I reformatted and uploaded ten days of IFRA’s timelapse surveillance of the Tianrun plant to Vimeo where anyone can view it (Click here for the Vimeo CBEH Channel). I hope you enjoy watching cars drive by as the paint peels off this idle and aging facility. 3. The largest PRC auditor performed an independent audit of CBEH’s 2009 financial statements showing no revenue from biodiesel sales while gross profit from its wholesale and retail diesel division was 46% lower than reported in its 2009 10‐K filing. IFRA investigators obtained a copy of an independent audit of CBEH’s Xi’an Baorun Industrial subsidiary, the operating entity that owns the Tongchuan biodiesel facility as well as the wholesale and retail divisions. Each year, Xi’an Baorun hires a Chinese audit firm to audit its financials in order to apply for bank loans. Baorun’s Chinese auditor for 2009 was Zhong Rui Yue Hua, which is the largest PRC auditing firm in China with more than 3,000 employees and 2,000 clients, 40 of whom are large SOEs such as Legend Holding (parent of Lenovo) and Baosteel Group as well as 90 publicly traded companies within China such as and Sinopharma and State Grid. A list of representative clients is available (here). Zhong Rui Yue Hua ranks fifth, right after the “Big Four” by the Chinese Institute of Certified Public Accountants (here). A partial translation of the 2009 Chinese audited financial statements can be downloaded (here). A comparison of the translated Chinese audited financial statements and CBEH’s 10‐K financials is available (here). For reference, the complete 2009 plus 2007 and 2008 Chinese audited financials (performed by different auditors) are available (Part I here and Part II here). Not surprisingly, the Chinese audit shows the company was making much less money than CBEH reported in its SEC filings. Since the purpose of these audited financials was to qualify for bank loans, I believe CBEH management prepared the financials to show as much assets and income as possible under PRC accounting standards. Most importantly, while the audit report includes the Tongchuan biodiesel plant assets on the balance sheet (see translation of footnote on page 14 here), there are no biodiesel sales, as shown in the sales breakdown by product on page 16 and 17 (translated here) Combined with all the other evidence, it again appears that CBEH has never sold any meaningful quantity of biodiesel. CBEH’s other divisions (wholesale and retail gas distribution) report grossly exaggerated earnings as evidenced by the Chinese Audit report. The 2009 Chinese audit report shows blended gross margin for the wholesale and retail oil business (non‐biodiesel) was only 4.79%, less than half the gross margin CBEH reported in its 2009 10‐K. The wholesale and retail combined gross profit was also around half the combined gross profit CBEH reported in its 2009 10‐K. The 2008
comparable gross margin and gross profit figures were even worse, as shown in the table below: Wholesale and Retail 2008 2008 2009 2009 Divisions Gross Profit Gross Margin Gross Profit Gross MarginChinese audit report $8,175,820 3.80% $13,633,215 4.79% CBEH 10‐K $16,123,771 9.69% $25,640,557 10.97% CBEH in its SEC filings repeatedly claims it is exempt from corporate income tax from 2004 to 2011 due to it use of waste oil, water and residues in the production of its products allegedly being exempt from income tax. However, based on the footnotes of CBEH’s Xi’an Baorun Industrial’s Chinese 2009 audited financials, Baorun’s income tax rate is 25% (see translation on p15 here). For the year ending 12/31/2009, its Chinese audited financials show income tax payable of RMB 14,336,425. Furthermore, IFRA contacted local tax bureau officials who confirmed Baorun is not exempt from income tax. CBEH’s phony income tax exemption is another huge boost to the false net income they report in their SEC filings. 4. The 100,000‐ton Tongchuan biodiesel production line never even bothered to obtain a production license, which is absolutely required before it can sell any biodiesel. Nor does the Tongchuan 100,000‐ton plant have any meaningful access to feedstock (waste or vegetable oils) or advanced technology as management claims. No production license. CBEH does not have a National Development & Reform Commission (NDRC) production license for its 100,000‐ton Tongchuan biodiesel production line. In China, all biodiesel plants have to obtain a license from NDRC before they can operate. In its 2010 10‐K filing, CBEH mentions several times that it has a biodiesel “distribution” license but there is no mention of a production license. IFRA investigators contacted Shaanxi provincial NDRC official Mr. Guo who confirmed that NDRC never issued a production license to CBEH’s 100,000‐ton Tongchuan biodiesel production line. IFRA also obtained a SAIC record confirming the Shaanxi NDRC official’s statement. The record shows that CBEH tried to set up a Tongchuan biodiesel subsidiary in 2007 but was unable to obtain the NDRC biodiesel production license and was specifically forbidden to produce and sell any biodiesel products. As a result, the proposed Tongchuan subsidiary was dissolved in late 2009 (see SAIC record here). Luckily CBEH did receive an NDRC biodiesel production license for its new 50,000‐ton production line at Tongchuan (adjacent to the 100,000‐ton line) on August 25, 2010 (here). CBEH used the new license to finally establish a legitimate subsidiary in Tongchuan but it is still not allowed to produce biodiesel for its old 100,000ton production line. This is further evidence that CBEH’s biodiesel business is a complete hoax having no meaningful sales to date. No feedstock. CBEH claims in its 10‐K it uses non‐edible seed oil, waste cooking oil and vegetable oil residue as its key feedstock for production of biodiesel. 1) Let’s take waste
cooking oil as an example. CBEH claims it purchased waste cooking oil from four Xi’an EPA‐designated waste cooking oil processing companies (see page 10 of the 424B5 filing on 1/5/2011 here, with a government website list of the collection centers available here). After calling all four collection centers, IFRA found that the whole city of Xi’an generates less than 25 tons of waste cooking oil per day. All four centers combined could only collect less than 15 tons per day. The balance of 10 tons is processed by small‐unlicensed cooking oil recyclers and sold to unscrupulous restaurants. Please check out the call summaries and contact info of the four processing centers (here). In addition to the insufficient supply, three of the centers deny they have sold any waste cooking oil to Baorun Tongchuan in the last two years. The centers claimed they sell the majority of their oil to chemical companies to make soap. One center (Xi’an Zhongrun Environment Protection Technology, Inc.) claimed it sold at most 1 ton per month of oil to CBEH. CBEH listed 5 local associations on page 9 of its 1/5/2011 424B5 (here), with which it has raw material purchasing contracts to buy biodiesel feedstock. Out of 4 forestry bureau associations, only the one, in Yongshou County, acknowledged the existence of a purchasing contract with CBEH but admitted the county does not grow much Chinese Prickly Ash. The staff also said he wasn’t sure the actual tonnage CBEH actually purchased under its contract. Three other county‐level forestry bureau associations all denied the existence of having any relationship with CBEH. Most importantly, none of these three counties (Danfeng, Ningqiang, Liuba) said they actually plant any significant amount of Chinese Prickly Ash, cornel or Chinese Pistachios. Lastly, investigators could not confirm the existence of Tongchuan City Chinese Prickly Ash Association, even after checking various sources including the municipal government of Tongchuan, Forestry Bureau of Tongchuan and SAIC in Tongchuan. Nor does the Tongchuan association have a local phone number. Interestingly enough, a Tongchuan government report (here) shows the aggregate tonnage of Chinese Prickly Ash produced in Tongchuan in 2009 was only 563 tons. Thus the Tongchuan City Chinese Prickly Ash Association, even if it does exist, produces too little oil to provide a meaningful supply to CBEH. In summary, CBEH obviously lied about its suppliers and raw material purchasing relationships. These findings again support fact that the 100,000ton biodiesel plant has never produced and sold any meaningful quantity of biodiesel. No Technology. CBEH touted its “strong R&D relationship” with leading universities in China for its biodiesel production technologies. IFRA contacted the 3 institutions listed in its 10‐K as research partners: Xi’an Petroleum University (XPU), Beijing Qingda Kema Technology Co Ltd (a company under Tsinghua University that does biodiesel research) and Northwest Agriculture & Forestry University (NAFU) to obtain their opinion of CBEH’s biodiesel technology. Investigators contacted several colleges/departments under XPU and couldn’t find any department having a research program on biodiesel production. Professor Zhou, one of the two researchers in charge of Qingda Kema, could not recall an agreement with CBEH and made it clear they would have never agreed to transfer any technical know‐how to a 3rd party as specified in CBEH’s 10‐K. Shockingly, a NAFU professor from the biodiesel research program confirmed existence of a cooperative agreement, but told us CBEH never lived up to its terms. According to
NAFU, CBEH never took any serious look at their technology nor used it to produce a single ton of biodiesel. All CBEH cared about, according to the researcher, was having their name listed as a sponsor in the official evaluation of the research results. Although NAFU did develop a technology to produce biodiesel using Chinese Prickly Ash as feedstock (patent #: ZL 200610105197.0), CBEH never applied the technique. Furthermore, NAFU’s technology has never been used in any commercial scale production. In the researcher’s own words, “CBEH was never really interested in making biodiesel and merely wanted to use the name of NAFU and its technology to raise money.” 5. Despite no meaningful production of biodiesel in its history and with little more than scrap value attributable to its idle plants, CBEH management falsely claims in its SEC filings that it invested $46.1 million acquiring and building out these totally unproductive assets over the last 5 years. Additionally, CBEH has announced it will spend another $46 million acquiring and building out its new Hainan plant in 2011. Considering that all of the evidence indicates CBEH has never produced and sold any meaningful quantity of biodiesel, I do not attribute any value to CBEH’s biodiesel assets (other than scrap value). Yet, over the past five years CBEH continues to “invest” massive amounts of money raised from U.S. shareholders in the expansion of its biodiesel division. Just as CBEH’s reported profits from its biodiesel division are clearly a fraud, its “investments” in this division are also a fraud. IFRA’s thorough review of all the relevant SAIC filings of all the subsidiaries show undisclosed related party transactions with the Chairman’s son as well as other serious inconsistencies with CBEH’s SEC filings. This has been well documented elsewhere. I can only conclude that CBEH management simply used the phony biodiesel business to attract U.S. investment that it then looted from shareholders. 6. In addition to greatly exaggerating the earnings of its wholesale and retail divisions, CBEH management falsely claims in its SEC filings it spent $53.2 million acquiring and leasing these assets over the last three years. It projects to spend another $8.2 million on Chongqing FengDou Keyu acquisition in 2011.
Considering that the Chinese Audit Report shows CBEH’s wholesale and retail divisions generate about half the gross profit it claims in its SEC filings. Additionally, CBEH failed to report in its SEC filings that it pays 25% corporate income tax. CBEH continues to “invest” massive amounts of money raised from U.S. shareholders in the expansion of its wholesale and retail divisions. Just as CBEH’s reported profits of these divisions are clearly a fraud, its “investments” in these divisions are also a fraud. IFRA’s thorough review of all the relevant SAIC filings of all the wholesale and retail divisions also show additional undisclosed related party transactions with the Chairman’s son as well as other serious inconsistencies with CBEH’s SEC filings. This has been well documented elsewhere. One can only conclude that CBEH management paid far less than reported for the acquisitions and expansion of its wholesale and retail divisions, again proving management looted shareholders. 7. CBEH’s ongoing and continuous hoax allowed it to raise $85 million from investors to date, including $39.5 million most recently with the help of its investment banker Rodman & Renshaw (NASDAQ: RODM). The ongoing fraudulent acquisitions and capital expenditures combined with a legally unenforceable VIE structure in China will result in a total loss for U.S. investors. As I stated above I give zero valuation to CBEH’s biodiesel business since it is a complete scam and does not generate any meaningful earnings. Theoretically, based on the Chinese Audit Report, I estimate the 2010 gross profit from the wholesale and retail divisions could be equal to one half of what CBEH disclosed in its 10K, or $20.15 million ($40.31m/2). After deducting general and administrative expenses and interest expenses CBEH’s pre‐tax income could be around $11.41 million. Since Xi’an Baorun is subject to 25% corporate income tax CBEH’s true net income for 2010 could be at most be $8.56 million. Applying a distressed market valuation of 3x values the wholesale and retail divisions at $25.7 million. According to CBEH’s shareholder letter dated 3/23/11 (here or here) the unrestricted cash balance at 12/31/10 was $30.3 million, after management deducted working capital and prepayments from customers. I add to this the total net proceeds of $36.73 million CBEH raised from Rodman & Renshaw investors to get $67.03 million. I then subtract $ 46 million CBEH is spending on the Hainan Lin Gao acquisition and $8.2 million it is spending to acquire Chongqing FengDou resulting in only $12.83 million cash balance today. Combining the $25.7 million value of the existing enterprise plus $12.83 million cash I value the whole
company at $38.53 million. CBEH’s fully diluted share count is 45.65 million following the recent offerings. I therefore theoretically value CBEH at $0.84 per share. However, since the videos clearly show management criminally defrauded U.S. investors, the stock is worthless in my view. Chairman Gao Xincheng, if convicted of fraud, will be forced to resign from the management of CBEH and its subsidiaries. But Gao will certainly refuse to step down from CBEH’s Xi’an Baorun operating company. At that point the U.S. investors will find it impossible under Chinese law to enforce the VIE contract between Xi’an Baorun (legal owner of all the assets) and the U.S. listed company’s 100% owned Chinese subsidiary (Redsky). Furthermore as soon as Chairman Gao feels the threat of legal action he is likely to misappropriate the remaining shareholder funds. As a result CBEH shareholders will almost certainly recover nothing. Note: I am short CBEH *** About the Author Mr. Little has over 35 years investing experience having begun his career as an accountant at Deloitte. He spent 10 years in China, from 1994 to 2004, representing various foreign investors including Coke, P&G, and Budweiser as they established beachheads in the worlds fastest growing economy. Today he lives in New York and Shanghai and spends his time researching Chinese and other high growth companies. Having built a very successful track record investing the last decade, he now shares all his investing ideas in his financial blog "Little Als Big Emerging Market Picks". Mr. Little is also a leading contributor in the China sector on Seeking Alpha. Official Site: http://labemp.wordpress.com/ Alfred’s previous reports and articles can also be found on Seeking Alpha at: http://seekingalpha.com/author/alfred‐little/articles Email: email@example.comLinkedin: http://www.linkedin.com/pub/alfred‐little/26/228/724 In China Alfred can also be reached at +86 15900855608