Richard Heckmann is one of a growing number of investors who believe they've been cheated by a special class of Chinese company, one that gains access to U.S. capital markets via a reverse takeover, or RTO.
Heckmann got on a plane to Hong Kong. When revenues continued to slide, Heckmann's team started calling customers, he says. He sent receivables to collection agencies. He says the agencies reported back that a lot of China Water's customers appeared to be fictions. Phone numbers had been disconnected. Offices appeared to be non-existent. When his new company wrote those receivables off, its stock tanked, losing two-thirds of its value before bottoming at $3.40. It now trades around $4.80. Heckmann says that the paper trail on the revenues led his team to an office within an office Xu had maintained in Shenzen, a mainland city adjoining Hong Kong. He says that, using a staff of around 20 there, Xu had inflated revenue by "round-tripping" product shipments with cronies. Heckmann charges that China Water routinely sent products to warehouses maintained by Xu's business associates, agreeing to buy the products back eventually. In reality, the sales were phony, Heckmann says. Xu has denied this in papers filed with the Delaware Chancery Court. Heckmann now relates all of that to comments he had heard earlier from accountants at Ernst & Young. The accountants had been hired to consult on tax issues related to the deal. He says they told him that the company's payments of value-added tax had been much less than expected -- the tax is 17% of the purchase price of products, to be collected and passed along to the state by the seller. According to Heckmann, China Water's executives had explained the tax discrepancy with a line of reasoning heard from other Chinese executives under similar circumstances. Executives with China-based companies commonly explain that payment of the full value added tax, on time, is unrealistic. To pay on time would kill their profits. The implication is that, in China, dodging taxes is as acculturated as gambling. No one, whether business or individual, is fully on the up-and-up when it comes to taxes, the executives say. This explanation has been a factor in several stock blow-ups mentioned to TheStreet by investment professionals familiar with the RTO business.