Harbin Electric: A Closer Look

Key concerns with HRBN include that its SAIC and SAT filings do not match its SEC filings and that its historical reported net margins of 20-30% are not consistent with industry averages of less than 10% and numerous conflicting data points with a substantial recent acquisition. Not even competitor China Electric Motor(CELM) could match these numbers.

CELM is currently halted due to accounting irregularities. It is notable that HRBN's net margin suddenly and precipitously declined to around 11% in the most recent quarter, despite fairly constant revenues. The new and lower profit margin raises questions about the company's past extreme profitability and certainly would alter the equation in terms of motivation for outside investors to finance the MBO.

As for the financing, it poses great challenges to common sense. HRBN last borrowed from Abax at a relatively high rate of 10% despite borrowing only $15 million. Clearly, if HRBN had to pay 10-15% to finance the entire MBO (over half a billion dollars), the transaction wouldn't work from the standpoint of simple economics and the highly levered company would not be attractive as a re-listing candidate in Hong Kong. So who will be financing this deal?

As a result of the high rate from Abax, HRBN chose to refinance through China Development Bank. Many investors have taken great comfort from this because it implies due diligence by CDB and raises the prospect that CDB will finance the entire MBO just like they are with CSR. This optimism is extremely misplaced and shows that many people are ignoring some key publicly disclosed details. As disclosed in the 10K, the CDB loan of only $50 million required the CEO to pledge 7 million shares -- a current value of over $140 million.

CDB also has the right to demand additional shares. With that much liquid, marketable collateral, due diligence becomes essentially unnecessary. CDB has protected itself by demanding collateral that values HRBN at a safety price of only $7. Even then CDB has the right to simply demand more shares or sell. So rather than taking comfort from the CDB loan, I find it to be a source of concern that CDB is unwilling to lend against the actual assets of HRBN and instead insists on having an easy liquidation option. I deliberately included the link, and I strongly encourage readers to read the above section of the 10K and make their own decision.