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A Note to All Chinese CEOs: Knock it Off or Die! (PUDA, LLEN, CGA, CHNG, VICL)

  • Puda coal, in the toilet
  • Here’s the problem, Mr.
    CEO
  • You’ll get taken to the cleaners, and
    maybe get executed

I’m a big believer in the Chinese growth story. As
famed commodity investor Jim Rogers says, “the 19th century was the century of the UK, the
20th century was the century of the US, the 21st century is going to be
the century of
China."

Until recently, one of my favorite ways to play
the inevitability of the China growth story was to buy a company called
Puda Coal (NYSE: PUDA).

If you’ve been reading my letter for very long,
you know what’s going on with coal in China. Coal burning power plants
produce over 2/3 of the electricity in China, and a significant portion
of that coal has to be imported to China from places like
Australia.

That means that demand for domestic coal
production has a margin of safety. For Chinese firms, domestic Chinese
coal is cheaper, easier to access, and absent of political or regional
conflicts or difficulties.

I particularly had interest in Puda, because the
company produces metallurgical or coking coal. This type of coal is vital
to the production of steel, and so, it’s vital to the production of
high-rises and skyscrapers that seem to be popping up in China today like
dandelions after a late-Spring rainstorm.

But it appears that at least one executive at Puda
may have ripped off American shareholders.
In a report from the notorious Chinese bear-raider Alfred
Little,
it’s alleged that Ming Zhao, the
Co-Founder and Executive Chairman of Puda may have “sold half the
company and pledged the other half to Chinese… investors.”

I don’t know if these allegations are true. And
that’s part of the problem. If we were talking about an American company,
you and I could look up source documentation on the SEC website, or we
could refer to audits from trusted accounting firms. There might be a
paper trail worth a darn to inspect. By the way, congratulations to
Alfred Little for discovering that there’s money to be made shorting
Chinese companies when their houses aren’t in order.

Regardless of whether Mr. Little is correct or
not, there needs to be accountability for these firms, and if the SEC
can’t do it, then the markets will.

That’s because we’re talking about a Chinese small
cap with one set of books that gets shown to the SEC and maybe another
set of books that’s shopped around with Chinese authorities, and perhaps
a 3rd set of books used internally.

It would be one thing if Puda was the exception –
but it seems as though malfeasance from Chinese companies, small-caps
especially, is becoming the rule.

With very few exceptions, such as Enron and
Worldcom, significant malfeasance at the corporate-financial level is a
moot point in the United States.

American chairmen at nearly any public company are
so well paid and so focused on profitability, that stealing money or
front-running shares just isn’t worth the risk.

But unfortunately, you can’t say the same thing
about many Chinese company chairmen.

For instance, our friend Mr. Ming Zhao only made
$26,000 last year, according to SEC filings. That includes compensation
in the form of salary, stock and exercised options.

For reference – and just to pick a random company
out of the air – San Diego based bio-tech firm Vical Inc. (NYSE:
VICL)
is about the same size as Puda, and the CEO Vijay B.
Samant made $720,000 in 2009. That’s more than the entire board of
directors made at Puda last year.

We know that $26,000 is not a lot of money in the
United States, and while those dollars might stretch a little bit further
in China, it’s still a pittance for an executive officer for any publicly
traded company.

That’s a small part of the problem, of course. The
real problem is a lack of transparency – or rather the illusion of
transparency that Chinese executives have figured out how to manipulate
to their advantage.

It’s not the first time we’ve encountered this
type of obfuscation from Chinese firms. Several of my colleagues here at
Wyatt Research tell me they’ve run into the same problem, again and
again, with firms such as China Green Agriculture (NYSE:
CGA)
, China Natural Gas (Nasdaq: CHNG) and even
with another Chinese coal company L&L Energy (Nasdaq:
LLEN).

I’m not saying that all of these companies are
crooked. I’m saying it’s really difficult to get an accurate read on
these companies just by looking at their “official” filings.

And if there’s one thing investors hate more than
anything, it’s uncertainty. That’s reason enough to stay away from Puda
today, or to sell your position.

If you’re a Chinese CEO and you’re reading this –
you better make sure your books are not cooked. People like Alfred Little
will take you to the cleaners – and for good reason – if you’re anything
but straight with your shareholders. That won’t just make it difficult
for your firm to access American capital markets, it will make it
difficult for any Chinese company to do so.

Oh, and your government might execute you when you
get caught. Remember what happened to two men in China  were
found guilty of selling tainted milk
just two years
ago…

If you have any questions about Puda or any other
Chinese company (hopefully commodity related) please drop me a line
at
editorial@resourceprospector.com.

Good investing,

Kevin McElroy
Editor
Resource Prospector

Full Disclosure: No Positions 

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