The following commentary comes from an independent investor as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
) -- Shares of
( HRBN) have recently risen to a level of almost $21, based on positive sentiment toward potential China MBOs and due to recent comments made by the CEO.
The CEO released seemingly non-public information to a small number of analysts who published the information to a selected audience, which eventually found its way to public online bulletin boards. A subsequent
but quite notably did not confirm that the statements were factual.
In particular, the CEO mentioned that a bid for HRBN would occur on April 18. It has been one week and there has been no bid, no news and no comment from HRBN or its CEO.
I hate to sound like a conspiracy theorist, but I did note that the volume on short dated (just a few days remaining), out of the money call options jumped massively just before the leak of this information.
This adds to a long list of red flags at HRBN. As a result of my concerns over the information dissemination and due to the share price rise, I have chosen to take a moderate short position in HRBN.
The red flags I see and the concerns I have are as follows:
In contrast to TCM and CSR, HRBN's audit history is with the infamous Frazer Frost (of RINO and PUDA fame, among several others).
In comparison to other China RTO's HRBN is notably overvalued at $21. CSR provides a good contrast. Like much of the small-cap space, before its bid, CSR was trading at a price of $4 and a PE of about 4x trailing earnings.
HRBN on the other hand is trading at an artificially inflated price of nearly $21 on a PE of 9x. The only reason for this elevated price is the hope of an MBO, and absent those hopes HRBN would certainly be trading in the single digits, down 50-70%.
For those not familiar with the numerous red flags at HRBN, several detailed write ups can be found
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
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
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.
The $50 million loan represents the only long-term debt on HRBN's balance sheet. This is in sharp contrast to CSR which already had a loan facility in place from CDB -- and which did not require a share pledge. CDB is clearly comfortable lending against the assets of CSR and conducted due diligence.
It remains to be seen if the HRBN transaction will go through. It is notable that basically all sell side analysts are taking it as a given that it will in fact go through based on their own conversations with the CEO. Essentially, we are simply taking his word for it.
China Media Express
( CCME), analyst Ping Luo (formerly employed by Global Hunter) did substantially more than that. She "verified" bank statements, key contracts and tax documents -- all provided to her by management. The company was audited by Deloitte and had Starr Investments as a long term anchor investor.
What was most surprising about CCME was how tenacious management was in defending the stock even until days before the traumatic end. CFO Jackie Lam "categorically denied" all of the arguments made by short sellers and even as late as March 10 made comments to the effect that Deloitte had "found no significant issues" with the audit. On March 11, the stock was halted due to Deloitte's resignation. Deloitte's reasons for resigning were more than just "significant," they were massive and can be found
Similar to CCME, short interest has been high and rising steadily over the past few months. Despite the apparent inevitability of the MBO, which would raise the stock price from $21 to $24, short interest is currently over 6 million shares -- over 30% of HRBN's free float -- representing a $120 million bet that the transaction falls through. Put volumes have also been rising sharply.
I am not claiming that HRBN is an epic fraud like CCME. Rather I am highlighting a growing list of red flags in the company, the proposed MBO and the behavior of management.
Given the current valuations of Chinese RTO stocks, if there were no MBO in the works, HRBN would clearly be trading in the single digits right now, down 50-70% from the current elevated price . This is based purely on a fundamentals valuation and does not assume any sort of fraud or mismanagement. The remaining upside in the stock -- assuming the MBO is completed is only around 15%. Many are assuming that this 15% premium is risk free, but I believe that this risk is actually being significantly underestimated because it hangs entirely on one single thread.
Disclosure: the author is short HRBN
The author can be reached at email@example.com
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.
Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.