China Integrated Energy (PINK:CBEH)

Important CBEH Update:

Recall the following excerpt from our CBEH research note on March 25, 2011:

Note that we are not sure whether the WFOE (FIE), RedSky, is holding a substantial amount of income. Theoretically, the VIE can send the WFOE its net income. This transaction would be an expense to the VIE and taxable income to the WFOE. However, usually, in the VIE structure, the WFOE does not hold a substantial amount of income. We have not obtained the WOFE's filings at this time, but we have yet to come across a situation where a WOFE retains a significant amount of income in our analysis of VIE ChinaHybrids. Furthermore, in its rebuttal, CBEH made no mention of the WOFE retaining any income.  Regardless, if we locate a substantial amount of income in CBEH's WOFE, we may be inclined to change our opinion. Another possible scenario is that CBHE choose to report its true revenue standing to the SAIC/SAT agencies. In doing this,the company likely paid the appropriate VAT tax.  However, CBEH may have went on to overstate expenses to avoid income taxes (rendering SEC margins to be accurate). Remember that the penalty for VAT tax avoidance is much more severe than the penalty for income tax fraud. Still, the magnitude of a net income tax avoidance scenario would be rather large in the case of CBEH and we feel improbable (we are willing to accept tax fraud of around 30% underpayment). The bigger and more disturbing questions become:

• How do auditors like KPMG verify tax payments and allow companies to show tax payments on SEC documents that may have actually not been paid?
• If SEC documents are accurate, where does the phantom tax paid go? Back into the company or to line the pockets of management? 
• What would be the penalty for income tax fraud that is greater than a 30% underpayment?

We have now received the SAIC filings for RedSky.  Comments From Bob:

We obtained the SAIC and SAT of the WFOE of CBEH last night. The SAT and SAIC filings match each other, as should be the case for an FIE. Unfortunately, according to our findings, the WFOE does not have any substantial business. Thus, we will assume that our original analysis of the VIE of CBEH was originally correct, meaning that net income for CBEH is minimal and that the SEC documents grossly misrepresent profitability.

Earnings Recap from blog entry 

CBEH is another Chinese RTO company that has come under fire. The company recently reported 2010 vs. 2009 fourth quarter EPS of $0.38 vs. $0.30, exceeding analyst estimates of $0.34.

We were recently turned off by the CBEH story when the company raised money at insanely cheap valuations, despite having a "healthy" cash balance: 

CBEH raises funds

"XI'AN, China, Dec. 29, 2010 /PRNewswire-Asia-FirstCall/ -- China Integrated Energy, Inc. today announced that it has entered into definitive agreements with several institutional investors for a registered direct placement of approximately $15.3 million of common stock at a price of $7.00 per share. The Company will issue a total of 2,185,716 shares to the institutional investors.

In addition, the Company will issue to the investors warrants to purchase up to 1,092,858 shares of common stock, which, if fully exercised, would provide an additional $7.65 million in gross proceeds to the Company. The warrants have an exercise price of $7.00 per share and are exercisable for six months following the closing date.

The Company anticipates that the capital raised in this registered direct placement will be used for biodiesel capacity expansion and working capital for wholesale distribution of finished oil and heavy oil products.

GeoTeam® Note: What can we really say? Why offer stock?

• Cash balance of $79.7 million.
• Analyst estimates indicate that 2011 EPS will grow 28.5% to $1.85.
• Just appointed KPMG as auditor.

The company should let these positive developments play out before issuing stock at an absurd PEG ratio of 0.22. Dilution will only be 8%, assuming conversion of IN THE MONEY warrants. At least the this may end the overhang that this development was possibly having on CBEH's stock price."

In our recent blog note, we had originally commented that:

• The company had just finished working off past dilution. A new round of shares will once again hamper EPS growth in 2011. (We should note that EPS estimates have been raised to where now the street expects CBEH 2011 EPS to grow to $1.62 from $1.28. Previous 2011 estimates stood at $1.42)
• We believe CBEH has left the door open for another capital raise since its 10K states that it will have sufficient working capital to sustain its current business for the next 12 months, as opposed to commenting that it has capital to expand past current business goals.

On March 16, 2011 we issued an alert that we went short CBEH around $5.00, inspired by a convincing hit piece.

In order to gain clarity on the current CBEH situation, we ordered its SAIC documents. We just received the filings of CBEH's main operating subsidiary and have applied the logic from our circle of trust article, published a few days ago. (SAIC filings confirms the information provided by hit pieces).

Step 1 – Use SAIC documents to determine if companies (who pay VAT) are worth exploring

Confirm revenues. Is CBEH a shell? Pass

• CBEH is not a shell since revenues match SEC filings with in ~25%

• 2009 Revenues SAIC vs SEC: $216 million vs. $289 million
• 2008 Revenues SAIC vs SEC: $151 million vs. $216 million

Taking an additional look at companies where revenues are in an acceptable range of SEC filings – Further analysis to confirm that taxes paid and net income match. Fail

• CBEH is likely misrepresenting margins and/or tax paid since net income in essentially non-existent

• 2009 Net Income SAIC vs SEC: $129 thousand vs. $38 million 
• 2008 Net Income SAIC vs SEC: Loss of $302 thousand vs. $18 million

Confirm that cash balances, assets and liabilities match - TBA (At this point we only need these figures to establish a bottom on CBEH stock price)

Step Two - Perform on-the-ground due diligence.

• Not worth the trouble at this point

Step Three - Supplemental criteria to support SAIC/SAT filings 

• Not worth the trouble at this point unless we are given permission to view SAT filings, as we will not put trust in the KPMG audit.

On March 23, 2011, CBEH published a shareholder letter to rebut information in the hit piece. The company referenced boiler plate rhetoric to down play the relevance of SAIC filings.  We then posed the following question:

If SAIC filings are irrelevant, as management claims, then why are SAIC revenues within 25% of SEC revenues? Is it just coincidence that revenues match but net income is way off?

Conclusion: This reminds us of the FUQI events, where revenues on SAIC filings matched SEC filings, but net income did not.  FUQI is in the process of restating SEC filings and just received its delisting notice. Unlike FUQI, CBEH is a VIE, so there is no annual inspection between the SAIC and SAT. However, since revenues in CBEH's SAIC filings match SEC filings, we will surmise that there is a very high possibility that CBEH SAIC net income figures are a true representation of CBEH operations, with maybe some tax fraud. Valuing CBEH shares is tricky. Since the corporate structure is a VIE, non-PRC entities technically have a questionable legal claim to CBEH's cash. Furthermore, will investors apply logic for companies where it appears foul play has occurred, especially during massive panic times? SAY NO MORE!!!  In order for CBEH to validate its story, we are requesting that the company allow the GeoTeam to inspect SAT filings directly with the SAT agency ASAP. We are not impressed that the company just announced a share buy back, given that CBEH may have misrepresented its business operations. CBEH should have used its "mountain" of cash to buy back stock a long time ago, as opposed to tapping equity markets.  Better yet, they should immediately approve and pay a large one time special dividend.

Note that we are not sure whether the WFOE (FIE), RedSky, is holding a substantial amount of income. Theoretically, the VIE can send the WFOE its net income. This transaction would be an expense to the VIE and taxable income to the WFOE. However, usually, in the VIE structure, the WFOE does not hold a substantial amount of income. We have not obtained the WOFE's filings at this time, but we have yet to come across a situation where a WOFE retains a significant amount of income in our analysis of VIE ChinaHybrids. Furthermore, in its rebuttal, CBEH made no mention of the WOFE retaining any income.  Regardless, if we locate a substantial amount of income in CBEH's WOFE, we may be inclined to change our opinion. Another possible scenario is that CBHE choose to report its true revenue standing to the SAIC/SAT agencies. In doing this,the company likely paid the appropriate VAT tax.  However, CBEH may have went on to overstate expenses to avoid income taxes (rendering SEC margins to be accurate). Remember that the penalty for VAT tax avoidance is much more severe than the penalty for income tax fraud. Still, the magnitude of a net income tax avoidance scenario would be rather large in the case of CBEH and we feel improbable (we are willing to accept tax fraud of around 30% underpayment). The bigger and more disturbing questions become:

• How do auditors like KPMG verify tax payments and allow companies to show tax payments on SEC documents that may have actually not been paid?
• If SEC documents are accurate, where does the phantom tax paid go? Back into the company or to line the pockets of management? 
• What would be the penalty for income tax fraud that is greater than a 30% underpayment?
  

As the GeoTeam® speculated, in its research note on August 5th, China Bio Energy was able to exceed analyst estimates.  The company reported earnings per share of $0.25 compared to an estimate of $0.19.  CBEH also reaffirmed its previous guidance. 

We should note that we had made an error in our last research note when we stated:

Additional upside may arise as China Bio's guidance does not include the planned acquisition or lease of additional retail service stations.

In fact China Bio Energy guidance had included:

"the addition of 50,000 tons of incremental biodiesel production capacity expected to come online during Q3 2009 and include the planned acquisition or lease of additional retail gas stations."

The current reaffirmed guidance assumes the following:

Guidance includes the addition of 50,000 tons of incremental biodiesel production capacity expected to come online during Q4 of 2009 and include the planned acquisition or lease of additional retail gas stations.

The GeoTeam® has provided potential valuation scenarios for CBEH.

Source: PR Newswire (August 11, 2009)

China Bio Energy (NASDAQ:CBEH) shares are rising today, approaching a 52-week high. The GeoTeam® coded the stock as a GeoSpecial on June 1, 2009 ($4.25).   We are speculating that it is quite possible that the company may be able to exceed its previously stated guidance. 

Why?

The company announced its 2009 business outlook at a time when oil prices were much lower than current levels. China Bio Energy manufactures biodiesel, a commodity with pricing that should move in concert with oil.

Additional upside may arise as China Bio's guidance does not include the planned acquisition or lease of additional retail service stations.

China North East Petroleum Holdings (AMEX:NEP) is another company that some investors have speculated will also benefit from higher oil prices.