Are Advanced Battery Technologies’ Financial Statements Accurate?

Eiad Asbahi, CFA

In this article, I’m going to analyze Advanced Battery Technologies, Inc. (ABAT) and provide evidence that the company is inflating its financial statements.

This article summarizes key points that we have put together in a longer report available here (.pdf). An alternative copy for backup purposes is available here.

A video summary of the findings, along with discussions with certain customers, are available at the following links:

• ABAT Analysis Video 1 of 2
  
• ABAT Analysis Video 2 of 2
  
• ABAT Customer Interview 1
  
• ABAT Customer Interview 2 (Video 1 of 2)
  
• ABAT Customer Interview 2 (Video 2 of 2)

Our customer interviews feature recorded conversations with ABAT customers. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”.

Some of our arguments have been discussed in prior Seeking Alpha articles by other authors, including here, here, here, and here. For instance, in our report, we discuss how ABAT’s SAIC filings show that the company’s actual revenue and profit are a fraction of what is reported in SEC filings. We also show that ABAT’s $20 million acquisition of a Shenzhen battery company appears to be a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.

In this article, we’re going to highlight new information that ABAT is inflating its financial statements, including:

• A comparison of the profit margins of ABAT to 106 global battery makers as provided by Bloomberg and a list Chinese battery makers as provided by Research and Markets in its “Global and China Rechargeable Lithium Battery Industry Report: 2009-2010” industry report. ABAT shows the highest profit margins out of any global and Chinese battery maker, despite having no technological advantage, limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.
• Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators in our report. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
• Extensive discussions with customers and partners that confirm our beliefs that ABAT is fabricating its financial statements.

Impossible Economics

Selling a commodity product into a competitive market with no technological advantage is difficult. It’s especially difficult for a small business without economies of scale, limited customer relationships, and no distinguished brand name. But ABAT purports to be not just surviving, but thriving with industry-leading margins and an ROIC that warrants explanation.

A company with an EBITDA margin of 45% in 2010 must have some uniquely special competitive advantage. Yet ABAT itself recognizes that it has no special technology for its main products. The following is taken from its 2010 10-k (.pdf):

The technology utilized in producing polymer lithium-ion batteries is widely available throughout the world, and is utilized by many competitors, both great and small. ZQ Power-Tech’s patents give it some competitive advantage with respect to certain products. However, the key to competitive success will be ZQ Power Tech’s ability to deliver high quality products in a cost-efficient manner. This, in turn, will depend on the quality and efficiency of the assembly lines that we have been developing at our plant in Harbin.

In choosing a set of comparable companies for ABAT, we’ll use companies listed by Bloomberg in its “Batteries/Battery Systems” industry classification.

The results are startling. In terms of EBIT margin, ABAT ranked #1 out of 106 global companies, with an EBIT margin of 39%, compared to 23% for the next closest competitor Exide Industries Ltd of India, a $40 billion revenue business.

click to enlarge

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Is it possible that a company with only about 5 years of operating experience is generating higher margins than a company such as Energizer (ENR) with its 15% EBIT margins, based on the “quality and efficiency of the assembly lines”?

Perhaps it’s ABAT’s position in China and access to cheap labor that gives it such an amazing edge in the global arena. We can test this hypothesis by comparing ABAT to a handful of other Chinese battery manufacturers. The independent third party research organization Research in China publishes an annual report titled “Global and China Rechargeable Lithium Battery Industry Report”. In the 184 pages of the 2009-2010 edition, no mention is made of ABAT or its subsidiaries. The report does, however, make mention of China BAK Battery Inc. (BAK), BYD Company (BYDDY.PK), SCUD Group Ltd, and Tianjin Lishen, which generate respective revenue of $222m, $5,805m, $185m, and $295m.

Other Chinese battery manufacturers which are not active in the lithium polymer market can also be compared to ABAT. Examples include the Coslight Technology International Group Limited and Tianneng Power International Limited, with $352m and $330m of revenue respectively in 2009. Gross margins and operating profit margins for all six of these companies, as well as ABAT, have been summarized in the table below for the most recent available fiscal year:

Company	Gross Margins	Operating Profit Margins
China BAK Battery, Inc.	10.6%	-9.7%
BYD Company	17.7%	7.3%
SCUD Group Ltd	18.1%	5.8%
Tianjin Lishen*		5.4%
Coslight Technology	26.6%	9.1%
Tianneng Power	28.5%	14.3%
ABAT	47.3%	39.0%

*This is a subsidiary of CNOOC (CEO) and financial statements were not readily ascertainable, although it is evident that the Research In China report is using numbers specific to Tianjin Lishen.

ABAT’s operating margin is nearly triple that of its closest competitor and six times that of the median operating margin of our Chinese battery makers.

Obviously, strong operating performance alone would not normally be cause for concern. But when a company is doing as well as ABAT, investors need to understand why or how. ABAT clearly states in its annual report that it has limited (if any) technological advantage, and is competing in what is predominantly a commodity market. We have spoken to a customer who has visited ABAT’s Harbin battery manufacturing plant, and he has stated that there was nothing uniquely special about the Harbin facility. We also hired investigators to visit the Harbin facility and their findings are discussed later in this article.

The founder of ABAT, Zhiguo Fu, established it in 2002 despite having experience in construction and real estate, as opposed to battery manufacturing (see here (.pdf)). Furthermore, this company didn’t begin manufacturing until 2004 (see here (.pdf)).

ABAT has limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.

Yet it seems like no matter how we compare ABAT to its competitors, ABAT’s financial figures come out ahead despite the numerous causes for concern discussed elsewhere in our report.

Wuxi ZQ and Heilongjiang ZQPT Site Visit

As part of our investment research process, we sent an experienced factory inspector to both the Wuxi electric vehicle facility and the Harbin battery facility. What we found was not encouraging.

Summary points from the Wuxi visit included:

• Out of four assembly lines, only three were operational.
• Staff included 200+ workers, but only 20 are office workers, indicating likely weaknesses in R&D, engineering, QC, and sales.
• Factory management indicated 20,000 unit sales for 2010, with prices ranging from $450-$920 USD. This compares to 90,000 units reported to us by ABAT VP of Finance Dan Cheng on a conference call, a number which can also be backed into using data provided in ABAT’s 10-k.
• The facility does not have a motorcycle manufacturer’s permit issued by the Chinese government.
  • Management claims to use the VIN of a partner, which is illegal.
• Our investigators’ greatest concern was the lack of quality control (QC).
  • No line inspector or inspection of finished products.
  • No inspection list attached to each bike.
  • No testing center inside the factory.
  • The facility lacked basic equipment to test different parts for new product development.
  • Motor speed and efficiency testing machines were present, but no noise, temperature, or salt-fog testing machines.
  • No incoming parts inspection.

Photographs of the Wuxi facility are available in our report.

As lacking as the facilities were in the Wuxi facility, the Harbin site visit was even more disturbing in light of the world-class margins and the company’s reliance on this facility to support the bottom line.

Our investigators concluded the following:

It appears that the Harbin plant is in operation, does produce cells, and has sales. The semi-automated processes… are more advanced than some of the battery companies of China, and far less advanced than battery companies of international standing such as ATL, Lishen, Samsung, LG Chem. It appears that they do some things well, and have some potential great strength, but appear to have limited ability and concepts in the marketing and sales of their product. Selling cells to packagers is a common business model for Asian battery factories, but not one that realizes as much profit. And I note that the CTO acknowledged that the packagers and trading companies were making the entire margin and he was not. Again, normal for Asian cell makers – but not a way to gain success.

A proprietary BMS (Battery Management System) is essential for a successful battery company in the Light Electric Vehicle space. And the lack of such is a major handicap for Harbin. It appears to me that this company has a tiny business selling Li Ma or LFP (Lithium Iron Phosphate) cells to packagers for use in low priced battery packages sold to the domestic China market. This is the least profitable business they could have. The LI-Polymer cells are apparently not really in production (the normal issue with Li poly) due to high cost of materials and resulting high cost of the cells making them uninteresting to most applications. The LFP cells cannot be exported due to patent issues… So the only apparent product fo
r any significant sales would be Lithium Manganese cells, and for that to make money for Harbin they would, probably, need to develop their own BMS, become their own packager, and compete with Phylion, Zhenlong, AEE, MGL, LG Chem, Lishen, HYB, and others.

Conversations with ABAT Customers

Since Advanced Battery’s inception, management has made numerous claims regarding relationships with suppliers, distributors, research partners, and other related parties. As part of our due diligence process, we attempted to contact most of the relevant parties that ABAT has mentioned having a relationship with. In many cases, the parties we have contacted have been nonexistent, non-locatable, unwilling to speak, or had something strongly negative to say about ABAT.

In multiple cases, we found customers who either came away from their visits to the company’s factories unimpressed or confident that the company was inflating its financial figures. In this section, we provide a recording with one such customer, but have concealed and modified his voice.

This customer had signed a contract to receive scooters from ABAT’s Wuxi facility in 2009. After receiving a defective product, the customer demanded to visit the Wuxi facility that had supposedly been manufacturing the scooters. During our conversation, the customer indicated that he had visited numerous other Chinese manufacturing facilities to which Wuxi could be compared, and he described the Wuxi facility as a “joke” multiple times. The facility was described as “four empty walls”, the inadequacy of which made him suspect Wuxi was some sort of distributor operation rather than a manufacturing facility. Furthermore, the customer stated that he thought about contacting the SEC to report ABAT for fraudulent claims made in press releases. He said that “none of the stuff they put out was accurate”.

Other customers we’ve been in touch with have voiced similar opinions of ABAT. For example, in 2010, ABAT touted an agreement to re-enter the US market, expecting to deliver 200,000 electric scooter units to All-Power America for $1.1 million. Only half the delivery was taken before serious issues surfaced regarding quality control and licensing. The following comprises one excerpt from the long conversation we had regarding these issues and more with an All-Power executive:

All-Power:	Every step of the way we had some serious QC issues… The licensing is the official word that we gave out to everybody because that was a very tangible problem that the retailer used to return the products. But licensing was a major part of it, they should have checked for licensing compliance before they sent it.
Prescience:	So Wuxi, which is the company that you got the cycles from, they sent you sh**** product, am I reading you right? I’m not sure if I follow you?
All-Power:	Yeah, and that caused a major loss of confidence with our customer. Plus, we missed a lot of deadlines, and the customer said “you missed a lot of deadlines plus you have licensing issues, we’re going to send you all of them back”. So they put them on trucks and sent them back. Now we’re stuck with the inventory that I don’t know how the hell to move.

Wuxi ZQ mentions additional customers in its February 3, 2010 press release and in this excerpt (.pdf) from ABAT’s 2010 10K. We reviewed our diligence with many of these customers in our report.

Conversations with ABAT Partners

Alongside numerous ruined or strained customer relationships, we have also uncovered a number of failed partner relationships. In our report, we discuss our conversations with ZAP (ZAAP.OB) and Altair Nanotechnologies (ALTI), as well as our attempts to contact numerous other ABAT partners. Our conversations, as well as our inability to locate many of ABAT’s obscure or hard-to-locate partners, reinforced our belief that ABAT’s business is much smaller than its SEC financial statements indicate.

Conclusion

Our longer report elaborates on the evidence discussed in this article. Our evidence that ABAT is inflating its financial statements includes:

• SAIC filings show that ABAT is reporting significantly lower revenue and operating losses to the authorities in China. For 2009, SAIC filings showed less than $2 million of revenue, compared to $64 million in SEC filings.
• ABAT has unreasonably high margins in an established industry with strong competitors. The Company’s SEC-reported margins and return on capital are virtually impossible. Out of 106 global battery manufacturers as classified by Bloomberg, ABAT has the highest operating profit margin by a wide margin. When compared to six leading Chinese battery makers, ABAT’s operating margin is triple that of its closest competitor and six times that of the median operating margin of the comparable companies.
• Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
• In December 2010, ABAT announced that it was acquiring a Shenzhen battery maker for $20 million. We believe this acquisition is a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.
• Confirmation from former customers and partners that the company is likely a fraud. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”.
• Low quality auditors and high turnover. The company has had 4 auditors in the past 7 years, with no auditor being ranked in the top global 100 auditors at the time of hire.
• Unqualified CFOs and high turnover. A CFO or auditor has resigned at least once a year. The company’s past three CFOs have included: (i) a company insider who has been general manager of the company’s main operating subsidiary since 2004, and is therefore not remotely independent, (ii) a 29-year-old who was formerly VP Finance at China Natural Gas, another fraud, and (iii) a candidate whose primary experience comprised of being a financial adviser at Smith Barney.
• Continuous share dilution through secondary offerings, despite having more than adequate cash reserves. Through repeated share issuances, the company has grown its outstanding shares from 10.0 million following the 2004 reverse merger to 76.4 million today.

Disclosure: I am short ABAT.

Additional disclosure: Please read the full disclaimer at the end of our report.

Eiad Asbahi, CFA, is the founder and Managing Partner of Prescience Investment Group. Prescience is a research-driven, performance-oriented investment and advisory firm specializing in extensive, independent research on companies in order to develop unique insights and identify singular investment opportunities. Prescience manages a private investment partnership as well as separately managed accounts.  This article is reprinted with permission from the author.