Along with dog-and-pony shows and stock analyses that proved to be anything but independent, another hallmark of the Winner reverse takeovers was information fed to investors about how the firms were performing.
Kandi Technologies Corp., which manufactures go-karts and small electric cars, went public in an RTO that Kelley and his partners conducted in 2007. Chris Carey of sharesleuth.com pointed out that although the company claimed to have sold 1,005 electric vehicles in the second quarter of 2010, a subsequent annual report indicated that only 658 had been sold for the entire year. This past summer, Kandi declared that it had signed a letter of intent to make up to 20,000 electric cars for the Chinese city of Hangzhou. The news drove up Kandi’s stock. Chinese media reports suggested that the first 100 vehicles would be delivered in August, but the company’s third-quarter report, released in November, indicated that none of the fleet had yet been sold.
Then there is the case of Telestone. In 2011, the Forensic Factor, a stock research firm with a short position in Telestone, wrote that despite the company’s claiming spectacular revenue and earnings growth, it had failed to generate a penny of cumulative cash flow; that its accounts-receivable policy did not appear to conform to standard accounting rules; that two teams of auditors had resigned in a seven-month period; and that the firm was claiming to develop a new industry standard in wireless technology while spending less than $1 million a year on research. The Forensic Factor concluded that Telestone was either producing falsified financial results or failing to conform to GAAP accounting standards.
Soon afterward, an investigation firm called JadeStone, which carries out due diligence on Chinese companies, conducted its own inquiries into Telestone, including an on-site visit to its factory in Shijiazhuang, China. Among JadeStone’s findings was that Telestone’s real production capacity was 75% below company statements and there were differences of as much as 98% between Telestone’s financials as reported to the SEC and those appearing in local Chinese tax filings. A Telestone manager on site told JadeStone’s investigators that production was $15 million a year. “This figure is consistent with all of our findings and is 83% less than the company’s reported annual production of $90 million,” said JadeStone, which also took a short position on the stock. By this past fall, Telestone’s stock was down to $1.41 compared to a high of about $10 in the fall of 2011. The company disputes the reports by Forensic Factor and JadeStone.
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Kelley has conducted reverse mergers for at least 11 Chinese companies. Four of these were done with Winner, before his business relationship with Chiang terminated in 2007 after Chiang went to jail for several months after ignoring six Ontario court orders related to the nearly $10 million he owed his former supplier.
“Everyone realizes that four out of every five companies that go public by backing into a shell go bankrupt within five years,” Kelley said in an investor presentation reported by a Wall Street financial newsletter in 2009. In his case, Kelley said, none of his companies had gone belly up because of his rigorous due diligence. But of the 11 companies he had helped get listed, eight had fallen to penny-stock status by the end of 2012. Of the eight, several were delisted from the exchanges where they traded and one other merged with another company.
Undoubtedly, this dismal result has something to do with investors souring on Chinese reverse mergers in the wake of Sino-Forest and other scandals. But just as undoubtedly, it has something to do with the quality of the companies. Kelley declined to be interviewed for this story. One journalist who has heard Kelley speak is Wall Street veteran Bob Flaherty, who now says of RTO promoters: “The thing I saw wrong was not these companies going public; it was the fact you had this inside group coming in and getting the stock at extremely low amounts. ... It was not the Chinese really making money on this”—although others clearly were.