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Thursday, May 26, 2011

COGO

Cogo Group (COGO) Short Thesis [Draft 1]































COGO Group (Nasdaq:COGO)





Market Capitalization



218.36M



Date Written



05-25-2011



Long Term Debt



72.06M



Current Price



6.07



Total Cash



101.7M



 Estimated Value Per Share



0



Short % of Float


(as of Apr 29, 2011)



1.60%




The American listed Chinese RTO space has been a lucrative area for short sellers. Companies like China Agritech, China Media Express, and Tongxin International have all been delisted due to fraud allegations and there are many more Chinese RTOs that have been alleged frauds but they have not been halted yet or delisted.  Most of these Chinese listed companies already have a very high short interest, one of the companies that currently  doesn’t, but I believe does deserves one, is Cogo Group (Nasdaq: COGO) I believe the company has dubiously sold insider shares, bought companies in related party transactions [so what? To syphon off cash?]  and the accounting is suspect of manipulation.

  1. History of hiding Insider selling


When the company first went public, there were three original shareholders.

  • 13,163,199 shares: Comtech Global Investment, controlled by the CEO JingWei (Jeffrey) Kang

  • 5,467,790 shares: Ren Investment International, controlled by CEO JingWei (Jeffrey) Kang

  • 1,620,086 shares: Purple Mountain LTD, controlled by Yue (Justin) Tang


Shares of Ren Investment International would all be sold, but not before Ren Investments oddly changes the director of the company from JingWei Kang to Kang Yi, the CEO’s brother. Comtech Global Invest now owns 9,711,524 shares according to the last 10K. Purple Mountain LTD are no longer listed as a major shareholder and presumed to be sold out.

  1. Insider transactions (Viewtran)


As per the 2004 10K on page 46, the CEO, Jeffrey Kang, owned a 6.1% interest in Viewtran. Viewtran was eventually purchased in 2007 for 58,529,00 RMB. Which is a hefty sum for a company that “has no assessable profits up to 2006” according to the 2007 10K and 47,649,00 RMB was attributable to goodwill and 7,151,000 RMB was attributable to intangibles.  Nowhere in the 2007 report do they disclose the CEO had an interest in Viewtran before they bought it.

  1. Enlarged share count

























2004200520062007200820092010current
25,532,89831,840,88231,840,88238,498,76935,633,88636,117,86735,848,76435,973,892

Shares outstanding have increased 40.9% since going public.

  1. Unsophisticated website


The website, http://www.cogo.com.cn/, looks unsophisticated for a company doing 400 million in revenue. The site shows unsophisticated technology and a poor investor relations page. This is a poor reason to short, but it does not look right.

  1. Buying companies with a massive amount of goodwill relative to assets


After the large capital raise in 2006, the company used that money to make acquisitions and pay down debt. Here are some of the acquisitions.

In 2006, COGO purchased Viewtran Technologies (company with ties to the CEO) for 58,529,000 RMB. Of this purchase price, 47,469,000 RMB was in goodwill and 9,707,000 was in intangibles (of the intangibles, 6,610,00 was in customer relationships).

In 2006, COGO purchased the remaining 40% Shaghai E&T for 16,000,000 in cash. Of the purchase price was in 4,264,000 goodwill and 5,467,000 was intangibles assets (all from customer relationships)

In 2007, COGO purchased the remainder of the 45% interest in Comtech Broadband for 113,193,000 RMB  (2/3 in cash, 1/3 in stock) 47,561,000 RMB of this was in Goodwill and 74,578,000 RMB (66,202,000 was in Customer relationships) for the Intangibles.

In 2007 COGO purchased Keen Awards for 66,032,000 RMB, of which 73,007,000 was in intangibles and 63,009,000 RMB was in customer relationships.

In 2008, COGO purchased a 70% interest in Longrise for 60,921,000 RMB. Of that, 21,422,000 was in Goodwill and 34,567,000 was in intangibles.

In 2009 COGO purchased Mega Smart Group for 122,415,00 RMB (paid in installments) Of the purchase price 80,226,000 RMB is attributable to goodwill, and 50, 526,000 RMB to intangibles with 24,580,000 attributable to  customer relationships, and 8,876,000 attributable  to supplier relationships.

In 2011 COGO purchased MDC Technologies for 144,372,000 RMB. Of this purchase price, 49,669,000 RMB was in goodwill, and 113,417,000 RMB was in intangibles assets. Including 21,786,000 for customer relationships and 90,443,000 RMB for non-compete agreements.

None of these acquisitions give a break down the past profitability of these companies, as a stand-alone company. Only Viewtran technologies had a blurb about the past profitability, which was Viewtran “has no assessable profits up to 2006” I am suspicious the company is purchasing these companies at irrational prices in order to surreptitiously move capital from COGO to acquiring companies for sweetheart deals.  I have already pointed out a non-disclosed purchase with Viewtran, I think it is likely the company had interest in these companies without disclosing it to the shareholders. [well, not really since you know about it…]

  1. Obvious typo in the 10K


This might be a small matter, but there was an obvious typo on page 61 of the 2007 10K where the CEO’s name is miss spelled from Jeffrey Kang to Jeffrey KING. This might be nothing but I think it shows the lackadaisical manner the company releases information to the shareholders.

  1. Changing of the Auditors Deliotte to KPMG, no explanation why


In 2007, COGO dismissed the auditing firm Deliotte and hired KPMG. There was no explanation for this change.  [are you sure?  I think SEC requires some sort of reason.]

  1. Funky accounting (net income vs. cash from operations)


For most companies, operating cash flows are higher than net income. Sometimes net income can be higher than operating cash flows for a while, but not in perpetuity.  With COGO, there is a significant disconnect between their operating cash flows and their net income.  (All numbers are in ‘000 RMB)







































20102009200820072006200520042003total
Net income113,05583,16997,162152,443123,27586,84262,20228,483746,631
Cash from Operations(22,258)(33,510)97,46246,415202,838(35,074)(60,339)(25,406)173,128

There is a dramatic difference between the company’s net income and operating cash flows. This was seen with other Chinese RTO frauds like China AgriTech and RINO.  The company was able to make all their acquisitions due to excessive use of cash from financing.

[this is interesting.  Perhaps you can go a step further and see what’s eating up the cash.  A/R?  Inventory? And what does COGO say why these are increasing.]









































































20102009200820072006200520042003total
Cash from Financing352,283105,913(180,649)217,31872,69545,21272,69545,212730,679

Cash flow from financing mostly came from issuance of shares up until 2009 when the cash flow came from bank debt.

  1. COGO does not own the equity in the main subsidiary ShenZhen Comtech, instead has a contractual agreement with the vice president of Comtech and the CEO’s mother


Cogo group does not the equity of one of their main operating subsidy ShenZhen Comtech. Instead, COGO has a “contractual agreement” with Honghui Li the Vice President who owns 99% of ShenZhen Comtech and Huimo Chen, who owns 1% of the interest of ShenZhen Comtech and is the mother of the CEO Jeffrey Kang.   According to the 2005 10K, it is possible for the COGO group to own the equity interest in Comtech but it “requires special approval from the PRC Ministry of Commerce, which is time consuming to obtain.” I believe it highly unlikely US shareholders would be able to use obtain their economic interest in ShenZhen Comtech if there was ever a problem with COGO.

  1. What the business does exactly is unclear. Press releases & management is gobbledygook.


According to the filings, COGO is in the business of providing customized modules and subsystem design solutions. I have no idea what this means. Yet, looking at the financials it seems the company is really in the business of reselling electronic not in providing their some sort of value added engineering expertise.  According to their recent 10K, 2,554,991,00 RMB comes from product sales and  only 53,307,000 comes from service revenue.  Yet, if you read their press releases it makes it sound like they are doing high end technology announcing contracts for wind turbines, tablets, smart grids, high speed rails, COGO 3.O online strategy.

  1. Questionable stock repurchases due to “negotiated transactions”


Although for most companies, stock repurchases are a sign of company giving back investor capital. I am suspicious that COGO’s stock repurchases were not made on the open market but instead through “negotiated transactions.”  Since the company has a large insider ownership and a couple acquisitions have been made with stock, I am very skeptical these were made on the open market.

  1. Dividend released before the company went public like CCME


The company has not released a dividend to shareholders since going public in 2004. Although before initiating the transaction to go public, COGO released 41.4M RMB in dividends to shareholders.  China MediaExpress also released a dividend to its shareholders before going public.  COGO has no plans to release a dividend I the future and says it will have difficulties due to regulation on Chinese currency. I believe this is a dubious argument, in which COGO hides behind for not paying a dividend.

  1. Extremely hard to contact management


Contacting management is extremely hard. There is no IR contact on their website, either e-mail or number. The number listed on their SEC filings is to their ShenZhen Comtech office where the workers speak very little English. The company does have a quarterly conference call, but no way to get a hold of management other than the quarterly calls.

  1. Heartland advisor is a shareholder, they have also been duped on a Chinese RTO (the car one)


One of the major holders on record in Heartland advisors, a value based mutual fund.  Although most of the time it is good seeing fellow smart investors as part of the holders, heartland was previously duped by another Chinese RTO called Tongxin (TXIC.) I believe Heartland’s ownership is not a sign of confidence.

In conclusion I believe there is a large amount of evidence showing suspicious activities inside COGO group. Although I do believe COGO is a real operation, I do not believe in the company’s accounting or trust the company is making acquisitions in good faith for the shareholder’s interest. Since this company has no intent on paying shareholder a dividend I believe COGO intrinsic value is zero. I think it is unlikely COGO will ever go to zero, but I think it’s likely it will trade far less in the future. I am planning to exist my position around $1.50 a share.

Catalyst

  1. Company is unable to list in hong kong or never ends up listing.

  2. SEC doing investigations in Chinese Shorts

  3. Resignation of KPMG because they don’t want Chinese RTO risk.


Risks

  1. Company successfully lists in Hong Kong

  2. A private equity firm like Bain Capital makes an offer on the company.


Disclosure: I am currently short shares of COGO. Please do your own due diligence. This is not investment advice and I am not a financial advisor.  I may choose to cover my short at anytime.

Note: This is currently my first draft of the idea, I am planning to update my thesis as time goes. I welcome feedback from this idea and in fact, I would appreciate it greatly.

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