A Short History of Short Attacks, Part One

It all started with John Bird a.k.a. Waldo Mushman, one of the most vocal figures in the growing circle of short sellers targeting Chinese stocks. In early August of 2009 Bird proclaimed the TCM (Traditional Chinese Medicines) company China Sky One Medical (CSKI) a fraud: "Based on the massively inflated and inconsistent numbers, I have come to believe that China Sky One Medical is actively committing fraud." Over the next 12 months, Bird reiterated his call numerous times, on any platform or message board he found his way to.

The company responded with press releases and denied all allegations. In one of those attempts (July 23, 2010) "the management of China Sky One Medical reminded investors that Waldo Mushman was misleading investors by counterfeiting SAIC documents and posting them on its website and other blogs." It did not help them. The stock lost 81.63% of its value since John Bird's initial call, so we can safely assume that he made a good chunk of money with his short position.

Bird got help from other short sellers. On February 21, 2010, Manuel Asensio accused CSKI on Seeking Alpha of not disclosing material information: "The Chinese government order to stop selling eight of CSKI's products seems to be material to CSKI's operating condition, yet CSKI has provided no disclosure of the order to U.S. investors." In a similar vein, The Financial Investigator blogged on August 4, 2010, that "China Sky One did not disclose the receipt of its own subpoena in its filings nor did it reference that its auditors had received one." At that time the Securities and Exchange Commission had issued subpoenas to China Sky One Medical and its auditors, MSPC. And roughly one month later, The Street Sweeper published on its website that "MSPC is a past target of securities regulators that has since come under fire for allegedly approving flawed financial reports issued by CSKI itself."

China Sky One is still trading on Nasdaq at the time of writing. Yet the stock price is in a constant decline. From $22.75 at the end of 2009, the stock closed at $6.97 one year later, and now you can buy it for just $2.83. At Friday's close, CSKI is down 59.40% for the year.

The next target on our list of short attacks is L&L Energy (LLEN), a U.S.-based coal mining company with the majority of its operations in China. On January 11, 2010, The Street Sweeper portrayed LLEN as a "relatively new Chinese coal miner accused of misleading investors in the past, [that] has managed to become a stock-market winner by posting some of the most incredible numbers recorded in the entire industry."

The stock kept rising into summer until Herb Greenberg used his platform on CNBC to repeatedly attack the company and its Chief Executive Officer: "CEO and founder Dickson Lee was fined $65,000 by FINRA and banned from the securities industry for a year." Greenberg's attacks on live television sent the stock lower. From $11.05 at the time of the first broadcast (December 21, 2010), LLEN dropped 44.53% to close at $6.13 last Friday. The stock is down 43.25% for the year, but it has recovered some from its all-time lows, printed in early April at $4.29.

On January 26, 2010, a short-selling outfit named "Worthless Pennies" called out pharmaceutical company China Biologic Products (CBPO). "The urgent warning we have for investors today is that the background check and evidence we collected clearly prove direct ties between CBPO management/directors and convicted criminals who exercise control of the company, a criminal background of the CEO of its operating subsidiary and a history of laundering money stolen from investors, none of which the company disclosed in its filings." That call was initially very successful and sent CBPO 25.94% lower on the day of its release.

China Biologic reacted three weeks later by announcing a thorough internal investigation and stating that "the Company believes that this is an attempt to discredit the Company's management and disrupt the Company's business and operations." In December 2010 the company informed investors that "the Special Committee of its Board of Directors has completed its investigation of several allegations that appeared on certain financial websites in January 2010." CBPO's strategy was highly successful as the stock has more than doubled since the Special Committee was formed on February 17, 2010. It moved from $7.62 to $16.10 for a gain of 111.28%, and CBPO is one of the very few Chinese reverse mergers the market has not punished yet - the stock has gained 33.27% since the beginning of 2010, while most of its RTO peers have been thrown into the stock dumpster. The "Worthless Pennies" outfit seems to have closed its doors, and its website does no longer exist.

Citron Research's first target in the China small caps universe was newly uplisted SinoCoking Coal and Coke Chemical Industries (SCOK) on March 11, 2010. Citron called it "an ugly duckling Chinese coal deal with an utterly improbably rise and ridiculously unsustainable run-up." The stock was subsequently destroyed, dropping from $34.09 at the time of Citron's report to $5.93 last Friday, a loss of 82.61%.

Another attack on SCOK was launched by Sharesleuth on September 13, 2010. The author, Chris Carey, wrote "that no fewer than eight people who participated in [SinoCoking's share] placement have been the subject of Securities and Exchange Commission actions or criminal prosecutions." The stock is down 50.46% year-to-date and fails the Trading China Safety/Risk Model with an "Extreme Risk" score.

Lihua International (LIWA), a company that sells wire produced from refined scrap copper, was repeatedly a short seller target. On May 9, 2010, Seeking Alpha published a Steven R. Chapski article stating that "in order for the SEC financial statements to be correct, LIWA paid the Chinese government $4 million for income taxes in 2009, yet reported $0 in profit tax to the same Chinese government on their SAIC financial reports." The company responded two weeks later by providing its most recent SAIC documents on its website and "proving" that these results were consistent with those reported in the company's SEC filings.

Chapski didn't back off, though. In December he posted another article, insisting that in his belief "the SEC financial statements continue to be wrong." None of those reports had any permanent effect on LIWA's stock price. The stock closed 2010 with a 7.5% gain, and has only recently come under pressure, consistent with its Chinese reverse merger peers. For the year of 2011, LIWA is now down 33.9%, and the stock's short ratio has spiked to 25.65% of the float.

To be continued...

Nasdaq Proposes New Rules for Reverse Mergers

In a filing with the Securites and Exchange Commission last week, the NASDAQ Stock Market proposed additional requirements for Reverse Merger companies that want to apply for a Nasdaq listing. According to the filing, the purpose of this rule change is to enhance investor protection, as this group of companies has "raised regulatory concerns."

A previously unlisted private company that becomes a public company by merging with a public shell must file a Form 8-K with the SEC, within four days of completing this reverse merger. This filing must contain audited financial statements and most of the information that is usually provided in a Form 10. I am using SinoCoking (SCOK) as an example for this procedure: The operating business of this coal company merged into a shell company named "Ableauctions.com, Inc." (AAC) on February 5, 2010. The Form 8-K was filed three days later, and the new entity was quoted on the Over-the-Counter Bulletin Board under the new ticker "SCOK" on February 8, 2010. SinoCoking amended this 8-K filing on March 5, 2010 to include the required audited financial statements.

Nasdaq proposes now "to prohibit a company going public via a reverse merger from applying to list until six months after the combined entity submits audited financial statements to the SEC." In SinoCoking's case that would have meant that the company was not allowed to apply for a Nasdaq listing earlier than September 5, 2010. But Nasdaq was very eager to approve SCOK for an initial listing. The stock started trading on the NASDAQ Stock Market on February 18, 2010, or more than two weeks before the company even filed its first audited financials with the SEC.

The second proposed rule change calls for a company to maintain a bid price of $4 per share or higher on at least 30 of the 60 trading days immediately preceding the filing of the initial listing application, while trading in the over-the-counter market, on another national securities exchange, or on a listed foreign market. SinoCoking was trading on the OTC market for just eight sessions before it was allowed to move up to the big board.

An additional requirement for a reverse merger uplisting to NASDAQ should be the "timely filing" of at least two required periodic financial reports with the SEC for domestic issuers (10-Q or 10-K), or in the case of a Foreign Private Issuer, one or more reports including financial statements for a period not less than six months (6-K or 20-F). SinoCoking filed its second such report (10-K) on September 29, 2009, which - had the proposed new rules been already in place then - would have marked the day the company were allowed to apply for a Nasdaq listing. That is, if we interpret the requirement for "timely filing" only loosely. SCOK has submitted a Form NT-10, "Notification of inability to timely file Form 10-K or 10-Q", for three of the four reporting periods since it became a public company. With a strict interpretation of this rule, the company would still not be allowed to apply for a Nasdaq listing today, more than 14 months after the reverse merger completed.

Nasdaq elaborates in its SEC filing what prompted the proposed rule changes:

• extraordinary level of public attention to reverse merger companies
• financial press and short sellers raised allegations of widespread fraudulent behavior
• certain individuals who aggressively promote these transactions have significant regulatory histories
• RTO promoters have engaged in transactions that are disproportionately beneficial to them at the expense of public shareholders
• PCAOB identified issues with the audits of these companies
• the SEC recently took an enforcement action based on a firm's audit of a reverse merger company
• promoters manipulate prices higher to satisfy Nasdaq's initial listing bid price requirement
• companies have gifted stock to artificially satisfy the 300 round lot public holder requirement

Nasdaq believes the additional listing requirements would help "to discourage inappropriate behavior on the part of companies, promoters and others." Heightened review procedures for reverse merger applicants had already been adopted over the past year, but new rules would result in "significant investor protection benefits." We have seen only two reverse merger uplistings since September 2010, NFEC and KEYP (currently halted), and the only Chinese small cap stock that has been approved to move from the OTC market to Nasdaq this year is Asia Pacific Wire & Cable (AWRCF), but this is not a reverse merger company.

Nasdaq sees the following investor protection benefits:

• FINRA will have more time to view trading patterns and uncover potentially manipulative trading
• a more bona fide shareholder base
• assure that the $4 bid price was not satisfied through a quick manipulative scheme
• improve the reliability of the reported financial results
• auditors and the company's audit committee will have reviewed several quarters, at least, of the public company's operating results
• new internal controls, adopted at the time of the merger, will have been in place for a while

SEC, Congress and Chinese-company Accounting

The big story this week comes from The Wall Street Journal's Dennis Berman, who first wrote about an upcoming SEC probe into Chinese reverse merger and auditing practices.

"The Securities and Exchange Commission has begun a crackdown on the practices of the "reverse takeover" market for Chinese listings, according to people with knowledge of the probe. Specifically, the SEC's enforcement and corporation-finance divisions have begun a wide-scale investigation into how networks of U.S. accountants, lawyers, and bankers have helped bring scores of Chinese companies onto the U.S. stock markets, these people say. The SEC has also begun homing in on individual Chinese companies for accounting violations and lax auditing practices, these people say, beyond a number of previously announced investigations."

A couple hours later, TheStreet.com's Scott Eden followed up with a more detailed look into this issue. Eden said that in early September the U.S. House Financial Services Committee wrote letters to both the SEC Chairwoman Mary Schapiro and the PCAOB (Public Company Accounting Oversight Board), asking how those authorities planned to tackle the problem of sub-par auditing of Chinese companies. The letter demanded that "all market participants can trust the accuracy of the audit work for U.S. publicly-traded companies," including Chinese companies listed in the U.S. and especially also reverse mergers.

This is certainly a valid demand, and the SEC has already launched investigations into three Chinese RTO companies earlier this year: China Sky One Medical (CSKI), Fuqi International (FUQI) and Rino International (RINO). Especially the drama around RINO was a game-changer, and as I wrote here on this blog about one month ago, the fall-out from RINO was expected to be significant. It is very likely that there are more than those three companies with severe accounting "problems," and while the RINO disaster might have sped up an SEC investigation into the whole sector, we all knew that something like this would eventually have to happen. Scott Eden wrote in his article that the SEC "has shown interest in at least six additional companies," but concluded that the probe will not just be focused on individual companies, instead looking into a "systemic problem" that might exist in the Chinese RTO space.

If you are a long investor in China stocks, don't make the mistake to view this new development as a bad thing for the sector. It is entirely positive. The RINO's of the world have to be found, and as long as that doesn't happen the whole sector has to live with negative, often unsubstantiated allegations. It will also put pressure on Chinese management teams who, in many cases, still fail to understand their responsibilities as a public company, fail to take appropriate action to improve corporate governance and strengthen investor confidence. The majority of U.S.-listed Chinese stocks, also reverse mergers, is not deserving of the fraud allegations, but many of them apparently need this kind of pressure to differentiate themselves from RINO and co. - I expect many positive developments in this space next year.

Back to accounting, we have seen many Chinese companies upgrading their auditors this month:

- December 16: China Integrated Energy (CBEH) appoints KPMG
- December 15: Skystar Bio-Pharmaceutical (SKBI) Appoints Crowe Horwath
- December 13: China Automotive Systems (CAAS) appoints PricewaterhouseCoopers
- December 6: Wonder Auto (WATG) appoints PricewaterhouseCoopers

But this can just be a start. There are many Chinese companies still using auditors that don't seem appropriate for their size and level of maturity. All of them will have to upgrade their auditors in 2011, and if they don't then healthy skepticism should be in place. Any company with several hundred of millions in annual revenue can easily afford a top tier accounting firm, and if they don't choose to go that way, we should ask the question: "why not?" Is it that they are afraid of too much scrutiny? Is is that they don't get accepted as clients by one of the Big Four?

The new Trading China Custom Screen Tool makes it easy to identify companies with sub-par auditors. Filtering for Chinese stocks with a senior exchange listing and no Top10-ranked accounting firm, then sorting the results by market capitalization, gives you a good idea of companies that will have to take action. We might even find some of the six additional names, Scott Eden says the SEC has shown interest in, on that list.

Most striking is the large number of Frazer Frost-audited companies on that list. Frazer Frost, the auditor of RINO International, was a business combination of Moore Stephens Wurth Frazer Torbet, LLP (MSWFT) and Frost, PLLC, that broke apart after the RINO scandal. Since December 1st, both MSWFT and Frost resume operations as separate entities again. MSWFT has a history of problems and has been fined this week by the SEC to pay $129,500 in relation to allegations of professional misconduct stemming from the material overstatement of the financial results by a Chinese company back in 2004 and 2005. MSWFT also agreed not to accept any new clients from China, Hong Kong, or Taiwan until an independent evaluation of the firm has satisfied the SEC, and Frazer regains compliance with SEC standards.

In light of these developments all of Frazer Frost's current Chinese clients should feel forced to upgrade auditors as soon as possible, definitely in time for the 2010 annual report, usually due by the end of March. Those companies that don't take appropriate steps should be treated with extreme caution. The list of current Frazer clients is long, including Harbin Electric (HRBN), China Biologic Products (CBPO), China Valves Technology (CVVT), China Fire & Security (CFSG), and SinoCoking Coal (SCOK).

California-based Kabani & Company Inc. is another small firm with a large number of Chinese clients. Most of Kabani's clients are small, OTC-quoted companies, but there are two striking exceptions: L&L Energy (LLEN) and China Green Agriculture (CGA). Kabani has been singled out as a sub-par choice in several articles this year, most notably by Barron's influential "Beware This Chinese Export" piece in August.

With a market capitalization of more than $300 million, and a U.S.-based (Seattle) management team, LLEN must know that Kabani is no longer an appropriate choice for the company, and that the reputation of the auditor is being questioned by U.S. media. Yet the company reappointed Kabani for their 2011 fiscal year in September, continuing to be the (by a wide margin) largest Chinese client of the firm. In an obvious attempt to strengthen management credibility LLEN decided to hire or appoint several retired White House officials. In August, Norman Mineta (former U.S. Secretary of Transportation) was hired for an annual salary of $250,000. This week LLEN hired Edmund Moy, former Director of the U.S. Mint and special advisor to President George W. Bush, for an undisclosed salary.

Kabani's second largest Chinese client is China Green Agriculture (CGA), a company that has already come under pressure by short sellers this year. In late November, China Green retained Ernst & Young to assist the company with strengthening internal controls, and said they were continuing "discussions on the hiring of a new independent auditor." CGA seems to on the right track, however we'll have to wait if words are followed by actions anytime soon.

There are several other small U.S. accounting firms with a bunch of Chinese clients. Child, Van Wagoner & Bradshaw is a Utah-based firm with six partners and an office in Hong Kong. The 2009 PCAOB inspection of Child found several significant deficiencies. Among their clients are Longwei Petroleum (LPH, $265 million market cap) and Yuhe International (YUII, $175 million). Both these companies are growing fast, expanding their business rapidly, and I would expect them to be mature enough already to upgrade their auditors to at least a Top 10 firm.

And the last accounting firm I want to mention here is Sherb & Co., another small U.S. firm with many reverse merger clients. Almost periodically there are issues with Sherb clients, most recently China Education Alliance (CEU) came under severe pressure with fraud allegations that found their way to mainstream financial media and led to the stock being halted twice this month. The largest of Sherb's Chinese clients, China Integrated Energy (CBEH), took immediate action and upgraded to a Big4 auditor. This is what you want to see as a long investor, let's hope many others will follow suit.

China Coal Stocks Round-up

China Energy Corporation (CHGY) is currently trading at $1.98, up 141.46% for the year and down 51.95% from its April 9 high at $4.12. The Trading China Tracker Score is 12 (Strong Buy).

CHGY filed their quarterly report last week with revenues and earnings pretty much flat from the first quarter. That was not very impressive as their first quarter is usually the slowest of the year and China Energy's coal business is closed for about two weeks over the Chinese New Year holiday. Coal revenues were higher by almost 1000% over the year due to the fact that their coal mine was partially closed in 2009. However, China Energy is well on track to reach their net income guidance of $17 million to $18 million for 2010, which translates into earnings per share of about $0.40 and a current P/E ratio of 5. The company has no analyst coverage at this point.

As of May 31, China Energy had a working capital deficit of about $18.7 million, but the company does expect to generate sufficient cash flow for their working capital needs. I would expect the company to get approval for listing their stock on Nyse Amex later this year, however it might be advised to bring down their high share count via reverse split and try to get listed on Nasdaq. There is no indication from the company that they were planning a reverse split, though.

On valuation I believe we should not expect multiples higher than 7 or 8 at this stage. My 12-month price target would be $3.00 based on 7.5x 2010e EPS of $0.40.

L&L Energy (LLEN) is currently trading at $9.61, up 48.99% for the year and down 35.55% from its April 7 high at $14.91. The Trading China Tracker Score is 8 (Buy).

L&L Energy pre-announced FY 2010 numbers last week with a 10-K filing expected for Monday or Tuesday. The company announced net income of $30 million on revenues of $109 million for the year and stressed that they have beaten their own guidance. A look in the Trading China archives shows FY 2010 guidance, released on October 9, 2009, for $28.1 million net income on $108.1 million revenues - so the actual numbers were higher but only by a very small margin.

Investors should focus on FY 2011 (May 2010 to April 2011) numbers now, and LLEN projects revenue of $218 million and net income of $46 million or $1.61 per share. This represents revenue and earnings growth of 95% and 56%, respectively, and does not include the impact of potential acquisitions. Using the $1.61 from the guidance, LLEN is currently valued with a P/E ratio of 6 which leaves plenty of space for share price appreciation.

I view LLEN as the most mature of the six China coal plays covered in this article, and I believe the stock will be able to support higher multiples than its peers for the time being. Shareholder communication is good and it has the highest market capitalization of those six. As a U.S. company it is less vulnerable to "China gloom and doom" campaigns, LLEN is one of the few remaining China-based stocks in the Russell 2000, and it has a history of trading in the group of China stocks that is picked up first by momentum traders.

L&L Energy has no analyst coverage and no price targets have been issued other than the $19.50 from their IR firm Red Chip. I believe those $19.50 are achievable, although I would see a P/E multiple of 12 as the high end what is reasonable for a coal mining stock. My price target on LLEN is $16.50 based on roughly 10x FY2011e EPS of $1.61 per company guidance.

Puda Coal (PUDA) is currently trading at $7.35, unchanged for the year and down 38.22% from its April 7 high at $11.90. The Trading China Tracker Score is 16 (Strong Buy).

Back in May, Puda Coal reported very strong numbers for the first quarter and confirmed that gross margins should remain strong throughout the rest of the year. The company is in the process of consolidating several coal mines and back in May management said it expects to receive the business licenses for the Pinglu and Jianhe projects by the end of June. The lack of such an announcement might indicate a delay or just PUDA's failure to disclose this information. In case of a delay it might turn out as a major negative for PUDA as local government decisions are widely unpredictable. So there is some caution advised with the EPS numbers that are floating around.

Brean Murray is covering PUDA and currently rates the stock a BUY with a $18 price target. The analyst's estimates call for 2010 EPS of $1.17 rising to $2.31 in 2011. Puda management said that a recent announcement by the China National Development and Reform Commission (NDRC) to curb price hikes in thermal coal would not have a major impact on the company's results. However, with the NDRC action and the uncertain path for consolidating those coal mines, I would like to reduce Brean Murray's estimates by 15% just to be on the safe side here.

My price target for the stock is $15.50 based on roughly 8x 2011e EPS of $1.95. I believe PUDA should be valued with slightly lower multiples than LLEN for higher execution risk, less consideration of shareholder interests in the past (past financings) and also a higher risk of further dilution in the months ahead. However, PUDA should have the highest upside from current levels in the China coal stocks group.

Sino Clean Energy (SCEI) is currently trading at $5.52, up 8.23% for the year and down 40% from its March 31 high at $9.20. The Trading China Tracker Score is 17 (Strong Buy).

SCEI (formerly SCLX on the OTC/BB) also reported very strong first quarter numbers with revenue and net income up 215% and 246% year over year. The company also guided full year 2010 numbers to be 128% higher than 2009. That is truly impressive growth with the additional benefit of excellent gross margins of 41.2%, up 10% from the year ago period.

What's holding the stock back is the $35 million S-1 filing from June, which was posted just a few days after the Nasdaq listing became effective. The company should be able to raise funds at $5 per share, so the secondary offering would have a size of 7 million shares which would mean about 40% dilution of Sino Clean's current shareholders.

For my estimates I will just assume the SPO goes through at $5. Back in May SCEI said it expects at least $105 million in revenues and adjusted net income of at least $25 million for FY2010. My EPS estimate for the year, including those 7 million new shares, stands at $1.15 which leads to a current P/E ratio of 4.8. For my price target of $8.75 I use the CHGY multiple of 7.5 as both companies are similar in size and market position. However, I would prefer SCEI over CHGY as soon as the secondary offering is out of the way.

SinoCoking Coal (SCOK) is currently trading at $13.28, down 9.05% for the year and down 75.28% from its March 5 high at $53.70 (no typo). The Trading China Tracker Score is -9 (Strong Sell).

This is by far the most speculative of the six coal stocks mentioned here. SinoCoking is currently constructing a new coking facility which should triple the company's current capacity and expand gross margins. The company also got government permission to acquire and consolidate other coal mines and has already identified 22(!) potential targets. All those projects will require enormous funds and it is very unclear when and if SCOK will be able to successfully raise such funds, and at what terms.

Another risk factor here is that the future pricing of coking coal is significantly less certain than that of thermal coal as the Chinese steel industry is currently under severe pressure and a good part of SinoCoking's projected growth will depend on the recovery of their major customer's businesses. And if that's not enough... SCOK stock is the most expensive off all six coal stocks with a current 2010e P/E of 10.5.

Rodman & Renshaw initiated coverage on SCOK yesterday with a NEUTRAL rating, calling the stock fully valued at the current time. I believe that is a very optimistic view as all those risks have to be taken into account. I wouldn't touch the stock as an investment at any price higher than $5, based on the fact that significant shareholder dilution has to be expected in the next 12 months and meaningful earnings contribution of the new coking plant is at least one year away.

Songzai International (SGZH) is currently trading at $5.00, down 38.35% for the year and down 55.56% from its March 8 high at $11.25. The Trading China Tracker Score is 0 (Sell).

Songzai - which plans to change its name to "U.S. China Mining Group" this month - is the laggard in the otherwise thriving China coal sector this year. Huge problems at their coal mine led to a year-over-year decrease in revenues of 40% and net income has collapsed by almost 80%. The company said that the current second quarter will be another "quarter of continued pressure" but it expects operations in the affected Xing An mine to return to normal in the third quarter of 2010.

SGZH has acquired a second coal mine this spring with resources of approximately 143 million metric tons. The company said that beginning operation in the third quarter of 2010 will deliver meaningful revenues from the new mine this year and upwards of $50 million in revenues during its first full year of operation in 2011.

There have been many bad surprises for SGZH shareholders in the past year which leads me to take a very cautious stance with all company announcements regarding future revenues and earnings. However, it looks like SGZH might be able to turn around its business in the second half of this year and 2011 projections should look much better. At this time it is not possible for me to come up with reliable FY2011 estimates or a price target, although I would not sell the stock at current levels.

With Second Quarter earnings in August we should hopefully get confirmation that the business will be back on track soon, and if the company wants their share price to recover they better release some numbers for the combined two mines that investors can work with. SGZH might become a strong buy after the next report with the Xing An mine back to normalized production, and the contribution of the new Liujiaqu mine setting the stage for triple digit growth in 2011.

SinoCoking Coal (SCOK)

SCOK Valuation based on presentation filed last night (February 12):

FY 2010 (June 30, 2010) Net Income Guidance: $19.311 million
Diluted Share Count (Feb 5, 2010): 15,352,240
Implied 2010 EPS: $1.26
Current P/E (PPS $6.80): 5.4

- net income pretty much flat for the past 2 years
- margins declining

Maybe it's just me but all the photos of the facilities in that presentation make it look like an industrial ruin. SCOK operates their own coal mine, a coal washing facility, a coal trading business and a coking facility. Without the planned new coking facility there is very limited room for future growth.

SCOK plans construction of a new coking facility that would increase current capacity by factor 4.

"Plans to complete construction and start production by the first calendar quarter of 2011, assuming sufficient capital for construction (approximately $65 million in incremental capital) available by March 2010"

- adjusted cash about $8 million (incl. recent private placement)
- SinoCoking has received approval for a project loan in the amount of RMB 300 million ($USD 44 million)

Looks like the company is on track to start construction of the new coking facility this spring, another round of equity financing seems likely in 2010, though.

Projections of the company are based on a very optimistic scenario for steel demand in the next five years. Here are some articles on the subject of coking coal prices and steel over-capacity:

China Steelmakers Compete For Import Of Coking Coal (Mining Exploration News)
BHP Seeks Quarterly Revision of Coking Coal Prices (Reuters)

China Has More Idle Steel Capacity Than Japanese And Korean Production Combined (Business Insider)
China Baosteel’s Profit Falls in 2009 (Talksteel.com)

So.. bottom line is that betting on 10% annual growth for steel demand and accordingly rising prices for coking coal seems more risky than serving the power generation industry with thermal coal. The pricing situation could change dramatically until Q1/2011 and not just for a tighter lending environment. China's largest steelmaker Baoshan Iron & Steel already stepped back from a planned price increase for February.

And to compare SCOK with its peers:

Ticker    PPS   FY10e EPS   FY10e P/E
-------------------------------------
SCOK    $6.80       $1.26        5.40
LLEN    $6.85       $1.20        5.71
SGZH    $8.05       $1.80        4.47
PUDA    $4.90       $1.45        3.38

LLEN uplists to NasdaqGM on Feb 18
PUDA estimates might be too optimistic (under revision)

With limited growth prospects for the next 12 months and a substantially more risky business plan, I believe SCOK will likely underperform its peers this year. My favourite in the group is LLEN.