The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
) --During April and May, shares of
( CHBT) jumped from as low as $7.20 to more than $12 even as most other China small-caps were seeing significant selling pressure. However, the shares have recently dropped by more than 50%, hitting a new 52-week low of $5.87 on Friday.
In the past, my CHBT concerns were largely based on research conducted by other parties. To get more clarification, I spent the past week in Shanghai, focusing exclusively on CHBT's factory, operations, customers and employees. Management has been difficult to reach, with emails instead being answered by their IR firm.
This was frustrating because with other companies, I am easily able to get in touch with management even during quiet periods, as long as no recent financial information is discussed. I was, however, able to get in touch with some mid-level sales representatives by using Alibaba.com, and was able to visit both the Qingpu and Pudong facilities.
The Qingpu facility was completed last year following a $70 million capital raise from U.S. investors. Its main purpose is to focus on CHBT's bulk additives business, as opposed to health supplements. The facility is beyond impressive -- it's downright beautiful. It consists of two very large office buildings with one small building in the middle housing the production line.
The building on the left is currently used by CHBT employees, while the building on the right is currently not in use. Inside, there are high ceilings, modern design and an open floor plan with all glass partitions instead of walls. The first floor is mainly conference rooms, the second floor houses R&D and the third floor is for administrative employees.
Due to the open floor plan and glass walls, I was able to get a good count of employees at just less than 40. According to the sales staff, the correct number is "less than 200." I counted about 20 in admin, five to six in R&D and another five to six on the part of the production line that I could see. The production line requires very few employees and when we visited that building, the only part I could see was the fermentation tanks, not the line itself. That part is kept very secret and people aren't allowed to see it or take photos.
When evaluating companies in China, I typically stop by a day early to observe operations from outside and I come back on subsequent days without telling the company. The goal is to ensure that operations seem the same on days even when no visitors are present. I spent many hours each day observing with a bird's eye view of the plant. Operations definitely seemed consistent. During my week of observation I saw no commercial vehicles enter or leave. The number of passenger vehicles in the parking lot was fairly consistent at eight to 10 cars and scooters.
My next visit was to the Pudong facility, which in 2010 reported $80 million in revenues. The Pudong facility simply consists of a fifth floor office in a relatively small brick building. The single floor combines the functions of admin, R&D as well as the production line. Once again, I was not allowed to view the production line, so instead we simply discussed the company's products.
It was hard to get any count of staff, but during my time inside and outside the facility, I only saw a handful of people come or go. Staff estimated that CHBT had total employees of less than 100, but that sometimes temporary workers are added if needed. I was hopeful in arranging a visit to a CHBT store, but I was told that there aren't any stores to visit.
The only store in existence is a "customer service center" where people can ask questions about products. This is the same answer I received when I called CHBT's listed phone number, so it seems like the information is consistent and available to anyone who asks. We did not discuss fourth-quarter or full-year financial results for 2011, but the sales staff did mention that there was a considerable impact last year from the closure of stores. I observe that this seems at odds with the recent quarterly SEC financials which seem to suggest very steady growth.
I then met with journalist Lu JinYuan, who wrote several articles critical of CHBT in the Chinese press. Mr. Lu has toured both facilities and has interviewed numerous current and former employees from the Chairman all the way down to the lowest level employees. On CHBT, he is probably the single most informed individual outside of the company itself. I learned quite a bit from speaking with him.
I next went to see
China Economic Review
, which put out a report in March calling CHBT a "junk stock." In my opinion, many of the research reports that are coming out on China stocks are simply produced by one or two individuals using a recently created firm, so I was eager to evaluate CER's operations. CER was quite impressive. There are 50 to 60 people in a modern office in the Shanghai business district. In addition to the
China Economic Review
, the company produces five other magazines. The proprietor, Graham Earnshaw, was formerly
editor for all of Asia, and
Bureau Chief for China. CER has strict policies prohibiting its staff from taking positions in the stocks they write about.
The most important question I needed to answer was regarding customers. I spent quite a few hours making calls to numerous offices of Bright Dairy and Beijing DBN, CHBT's two major customers. While they had clearly heard of the company, I was unable to confirm if they in fact do any business with CHBT.
Ultimately, I was able to track down a cell phone number for CFO Travis Cai and have a brief conversation. Due to the quiet period there was very little he could comment on, even for major investors who have been recently asking. As for the employee count, he was surprised at my findings and said that CHBT has more than 400 employees. He said customers have been bombarded by calls from investors trying to get information. The calls are becoming problematic. As a result, he did not feel that it was appropriate to give me contact details.
In any event, I would be curious to know if other investors have had better luck in confirming customer relationships and how it has affected their view on the stock price.
I have been short shares of CHBT since early May, and after my weeklong evaluation of CHBT, I have decided to stay short. The concerns I have regarding fiscal year 2010 are that it doesn't seem possible for the small Pudong facility to have generated more than $80 million in revenues, while the activity at the Qingpu facility doesn't seem consistent with CHBT generating more than $80 million in just the first nine months of fiscal year 2011.
Obviously, by now any opinions by me or any other investors (large or small) do not matter. The only opinion that matters is that of auditor BDO which is responsible for signing off on the 2011 audit in a matter of days.
Disclosure: The author is extremely short shares of CHBT. The author can be reached at comments@pearsoninvestment
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.