Two days ago, China Metal Resources Utilization (“CMRU”) issued an announcement that responded to our earlier report, which was entitled “China Metal Resources Utilization: 100% Downside to This Zombie Company”.
We appreciate the company’s response, but find that it failed to refute the findings of our research or our key conclusions that the company is (a) facing severe financial distress; (b) that trading in the company’s shares exhibits signs of manipulation; and (c) that its acquisition spree appears to exhibit signs of financial mismanagement and undisclosed related party transactions.
In fact, we believe that as readers carefully compare CMRU’s response to our research, it becomes clear that instead of refuting our findings, the company instead largely confirmed, or in some cases simply side-stepped, our concerns.
There were multiple key items in our report that the company failed to address entirely. In particular:
CMRU’s response: None
CMRU’s response: None
CMRU’s response: None
CMRU’s response: None
CMRU’s response: None
In our report, we had identified that the company had acquired multiple businesses that were newly-formed, with little in the way of actual assets. The entities had minimal reported profits or had reported losses, and in two out of three cases had signed leases for its factories and equipment just months ahead of the acquisition announcements. The company paid vast sums for these enterprises that had seemingly owned very little, which we found highly suspicious.
In CMRU’s response, the company claimed that the acquisition targets were all newly formed because they had undergone “pre-acquisition restructuring whereby the proposed business to be acquired was injected to a newly formed entity.” The company claimed this was to avoid any hidden liabilities.
We find this explanation to be alarming and it further heightens our concerns.
Two of the newly formed entities signed leases for factories and equipment after their creation. What existing operations were being restructured if the entities didn’t own factory or equipment assets in the first place? The third acquisition had net assets of only RMB1.44 million. Again—exactly what assets were being restructured?
Furthermore, the original transaction announcements (1,2,3) in no way mentioned restructurings from a previously existing entity. For the first time, the company’s response to our report seems to acknowledge that the acquired entities were just shell entities acting in the middle of a broader transaction.
This raises new, critical questions that we encourage the company to address:
The company then sought to downplay the sums paid for these entities by stating that a “material portion” of the purchase consideration was non-cash and performance-based.
While it is true that a portion of the acquisition agreements called for earn-out compensation, nonetheless, over HK$626 million in cash was paid for three, newly formed entities. Once again, we do not believe these transactions made financial sense, and based on the company’s latest admissions, investors do not seem to have the full picture.
Our report also raised questions about related party transactions, both disclosed and undisclosed. In one instance, we asked: “Why did 4 entities owned by or tied to the Chairman/CEO’s daughters share a phone number with an “arms length” acquisition target?”
The company responded by acknowledging the relationship, and explaining that it was part of its pre-acquisition structuring:
“…the Group, as purchaser, took the lead in establishing Mianyang Zhaofeng and oversaw the other pre- acquisition structuring steps. As Mianyang Zhaofeng would become the Company’s subsidiary, it had also included various contact details of the members of the Group as company information of Mianyang Zhaofeng.”
We find this, once again, to be a rather alarming admission. Earlier, the company acknowledged, apparently for the first time, that the newly formed entities were shell entities.
Now, it appears the company is acknowledging that it had a role setting up at least one such shell entity, which it later acquired in a purported “arms length” transaction.
We encourage the company to answer: Did the company establish the other entities it acquired in its “arms length” “independent” transactions as well?
Beyond the obvious issues with apparent non-payment of bonds, we also identified that the company had rising accounts receivables and payables past 180 days, despite claiming that typical terms are 3 months or 30 days, respectively.
The figures cited in our report were drawn directly from the company’s financials, which painted a bleak picture of its ability to collect receivables or to pay its suppliers.
Rather than providing any explanation for why the company was experiencing prolonged collection and payment issues, CMRU simply claimed that (a) the old receivables were recovered and therefore no provision is required and (b) the company has settled most of its payables.
We find this explanation to be wholly inadequate. The company should provide a clear explanation for why its receivables and payables are aged well past its self-proclaimed typical terms.
Disclosure: We are short shares of CMRU (1636.HK)
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China Metal Resources Utilization Limited (“CMRU” or “the Company“) (Stock Code: 1636.HK), announced its 2020 interim results for the six months ended 30 June 2020 (the “Period”).