Asia Cork (PINK:AKRK)

Further Due Diligence into the AKRK Story:

Yesterday we reported that that AKRK may have remedied an outstanding liquidity issue concerning a past due payment of $700,000 and accrued interest owed to Ancora Greater China Fund as part of a funding arrangement in June 2008. Part of our conclusion was due to the close proximity of shares that the CEO and Chairman pledged to secure the arrangement (7,630,814) vs. the amount of stock they disposed of outlined in recent S-4 filings (7,930,000). As always it’s prudent to continue the due diligence process in order to confirm a conclusion or possibly consider alternate scenarios.

Thus, we also took a look at some recent S-3 documents which show that that three board members were allotted an aggregate of2.8 million shares. After several attempts we were able to reach management for a comment on our initial assumption and offer an explanation into the recent share activity.

The Company has informed us that the 7.9 million shares were not transferred to Ancora, but to a number of high level executives in the Company. This action broadens share ownership among the Company’s top executives and board members and will help facilitate a possible public offering by meeting the stock markets' listing requirement, and also to better link the interest of the management personnel to the company. So what does all this mean?

It seems that Asia cork may be planning on a public offering which actually coincides with some information disclosed in its 2009 September quarterly filing stating that it had “signed an exclusive financial advisor agreement with Global Arena Capital Corp., to act as the Lead or Managing or Co-Underwriter or Investment Banker in connection with a proposed public offering.” The initial agreement expires on May 31st, 2010, providing us with a window of when an offering could occur.

We had also eluded that Investors may find it intriguing that an 8K filed on 12/24/2009 revealed some board changes at the company. Specifically, the December 24, 2009 8K outlines the appointment of a new COO, CTO and three independent Board of Directors members as well as the establishment of charters related to the Audit and Governance Committees. These actions can often coincide with an up-listing move and/or a financing transaction. Being that AKRK is below $3 per share it would need to affect a reverse split to minimally qualify for the AMEX, a very common move these days by U.S. listed Chinese companies. While the outstanding Ancora debt still exists we have learned that the due date for the promissory note has been extended for another year which means that AKRK is no longer past due on this obligation. obligation We believe that an offering, depending on Ancora’s involvement, could ultimately address this issue and provide necessary capital for expansion goals.

On the whole we still view these developments as a positive since it aligns management’s incentives with the best interests of public shareholders, offers conjecture that the AKRK may be preparing for an up-listing and takes a short-term liquidity problem off the table. Of course, the topic of dilution is now back on the table, which will depend on the use of funds.

GeoSpecial, Asia Cork Inc. (AKRK) has been on the GeoTeam’s radar since August 20, 2009. We were encouraged that, in its 2009 first quarter 10Q, the company hinted that business was on the verge of rebounding from negative effects of the global recession. Asia Cork’s second and third quarter results reflected and reaffirmed this sentiment.  Add that the stock was selling below its book value per share and the story began to gain some luster.

Well, after further due diligence we eventually found the proverbial monkey in the wrench. In June, 2008, the Company consummated an offering of convertible promissory notes and common stock purchase warrants to an investor (identified as Ancora Greater China Fund in a June 2008 8K filing) for aggregate gross proceeds of $700,000. The one year note obligation was past due as of June 2009. The Company’s obligations under the promissory notes were secured by an aggregate of 7,630,814 shares of common stock pledged by the Company’s CEO and Chairman.

We were unsure as to the dilutive implications of potential activities required to rectify this issue.  As indicated in our earlier article, Opportunities in Cheap Chinese Stocks, these situations often present prospects for savvy investors who can identify imminent resolutions to liquidity roadblocks. Stocks mentioned in the article such as Orient Paper (ONP), Lotus Pharmaceuticals (LTUS) and China Agritech (CAGC) have handsomely rewarded investors who followed this train of thought. We had also mentioned AKRK as a stock to watch.

On December 31, 2009 we noticed some increased trading activity in Asia Cork’s shares. Unable to locate any news on the wires, we decided to sift through SEC documents and noticed recent S-4 filings outlining a series of transactions where the company’s CEO and Chairman disposed of 7,930,000 shares. Given the CEO and Chairman pledged 7,630,814 personal shares to cover the debt obligation owed to investor, we are speculating that these shares were transferred to the investor to settle the debt obligation, maybe putting the liquidity issue to rest. Even more notable is that the transactions were valued at $0.49, nearly 100% above the price of AKRK shares at the time of the S-4 filing. If our assumptions can substantiated, we see this as a very positive development, especially since the transaction appears to be non dilutive and indicates a prominent investor’s willingness to become a large equity holder (estimated at 20%) inAKRK. Investors may also find it intriguing that an 8K filed on 12/24/2009 revealed some board changes at the company.

In light of these findings, we have added to our AKRK position, postulating that this development will be enough of a catalyst to push shares past its book value per share of approximately $0.60. Investors still need be cognizant that the company has expressed an interest to expand operations, so we can’t rule out an equity raise at some point in the near future. Also, the company has not commented on the accuracy of the scenario we have outlined.  

On October 21, 2009, The GeoTeam® conducted an interview with Asia Cork (OTCBB:AKRK), one of our GeoSpecials, with the help of an interpreter.  The Company has been a leader since 2004 in the development, manufacturing and marketing of cork-based building materials. Some common cork applications include flooring and cabinetry as it provides acoustic and thermal insulation and is a resilient building material that is less affected by impact and friction when compared to products such as hardwood and vinyl. The interview with Asia Cork reinforced our belief that the Company is certainly targeting an unique market, although there are several issues that need attention before total growth potential can be unleashed. According to the Company, global "green" initiatives, especially in China, support the growth case for the cork-based building industry. We weren't able to locate industry statistics on the cork industry.

Why Cork Products Are Green

Cork products emanate from the bark of the cork oak tree. After performing some research, we learned that cork is a “rapidly renewable material”, meaning it can it can be grown and harvested for production within a 10-year cycle or shorter. On average, each cork oak tree is harvested 15 to 18 times in its lifetime with the largest trees yielding up to 1 ton (0.9 metric ton) of cork per harvest. This translates to a reliable cheap source of raw material and makes this business appealing from a margin point of view. Asia Cork currently outsources it raw material supply, but is exploring ways to reduce dependency on outside sources, a key to potentially unlock several advantages:

• Improve margins from owning the raw material.
• Improve margins due to less transportation costs.
• With a more centralized operation, the Company will be able to squeeze more capacity from its existing production lines.
• Supply sources for its competitors would be eliminated.

Cork is grown principally in the Mediterranean region and China.

A Prospect of Growth

The Company had been experiencing consistent growth in sales and earnings over the past three years, nearly reaching full production capacity during 2008.

As demand does return to pre-recession levels, the problem Asia Cork may face is the inability to materially increase sales past 2008 levels, an obstacle that leaves us to wonder how they will achieve this short-term goal. Growth will be contingent upon its ability to increase production capacity, internally or externally, without diluting shareholder value.

Asia Cork's business operations may become an exceptionally strong entering the second half of 2010, when the Company hopes to make acquisitions to bring its raw material supply in-house and increase manufacturing capacity. Furthermore, like many stocks we have followed in the past, to attract investor attention, Asia Cork must address some outstanding liquidity problems via the utilization of favorable financing terms.

Discussion With Management

Here is an overview on our interview with Asia Cork management:

Question: How can the Company grow its business if it reaches full capacity?

Answer: The Company has third party relationships to which it can outsource production of cork products.

Question: Do you have near-term plans to increase manufacturing capacity?

Answer:

• On March 26, 2007, we initiated a vertical move to acquire one of our major providers of raw material. This Company also manufactures end user products, including a portion of ours. A deposit of $1,465,738 was made that will be applied against the purchase of raw materials from the supplier if the acquisition does not occur before the end of year 2009.”
• We have an agreement to purchase a factory’s fixed assets. We have paid deposits $2,022,719 as of December 31, 2008 and $1,891,810 as of the year ended December 31, 2007. The deposit is fully refundable if the purchase does not close by September 30, 2009.
• We are always exploring acquisition targets.

Question: Over 70% of you products are sold in China. What are your plans for international expansion?

Answer: The Company is currently testing a new cork product for the US market and will explore international initiatives.

Question: Please address the following excerpt contained in your filings:

On June 4 and June 12, 2008, the Company consummated an offering of convertible promissory notes and common stock purchase warrants for aggregate gross proceeds of $700,000. The notes mature one (1) year from the date of issuance and bear interest at an annual rate of 18%, payable at maturity in USD. Upon the successful closing of an equity or convertible debt financing for a minimum of $2,000,000 ("Financing"), the promissory notes will be convertible into shares of common stock at a 50% discount to the price per share of Common Stock sold in the Financing. Since the Financing did not occur within 12 months of the date of the promissory notes, each investor has the option to be paid the principal and interest due under the promissory note or convert the note into shares of common stock at a conversion price of $0.228 per share. The promissory notes are secured by Common Stock pledged by Pengcheng Chen, our Chief Executive Officer and Fangshe Zhang, our Chairman. However, at the present time we do not have sufficient cash or cash equivalents to repay the promissory notes should the investors demand payment upon maturity.

Answer: Although the Company wasn't prepared to get into a deep discussion on this subject it certainly understands the importance of resolving the situation. "The Company is seeking an extension of the maturity dates of the promissory notes and alternate financing."

GeoTeam Assessment of Risks

We feel that it is worthwhile to follow the AKRK story. Of course, there are several risks we needed to consider during our first pass of due diligence on the AKRK story.

• The cork building market is an arena for which we don’t have much market data.
• The favorable industry growth parameters may attract better capitalized competitors.
• As far as we can tell, the agreements to complete the capacity-increasing acquisitions (referred to in our Q&A) are at or near expiration.
• The Company’s accounts receivable outstanding for over half year increased to $3,333,692 "
• Most importantly, we don’t have insight into when and how the Company will rectify its liquidity issues, nor how it intends to raise capital to implement its expansion plans. Are they technically in default? Dilution is a related risk. This is the biggest wrinkle.

Some Concerns Clarified

Today’s 10Q filing has provided clarity to some of the above concerns.

1. Concern that the agreement to acquire one of its major providers of raw materials was set to expire by end of year 2009.

   3rd quarter 10Q provides clarity: Agreement has been extended to June 30, 2010

2. Concern that the agreement to purchase a factory’s fixed assets expired in September of 2009
   
   3rd quarter 10Q provides clarity: Agreement has been extended to September 20, 2009
   
3. Concern regarding verbiage per the 2009 second quarter filing: "Due to adverse effect in the prior period, the Company’s accounts receivable outstanding for over half year increased to $3,333,692

   3rd quarter 10Q provides clarity: As of September 30, 2009, the accounts receivable outstanding was valued at $5,599,865 (equivalent to RMB 38,226,526), nearly none of which was outstanding more than six months.

We feel these developments bode well for the Company’s goal to vertically integrate and eventually resume EPS growth. We are also going out on the limb and speculating that if the Company was comfortable with extending its purchase agreements it may be closer to a financing arrangement.

With so many unknowns, investment in AKRK may not be suitable for risk-adverse investors. As the GeoTeam's appetite for risk is abnormally immense, we have taken a chance on the stock and its motivated management team.

Disclosure: Long AKRK

The GeoTeam® will issue an update on GeoSpecial, Asia Cork shortly.  We are awaiting the filing of the company's 10Q which will give us more direction on whether the stock will still qualify as a GeoSpecial. Specifically we need to ascertain if business has improved as was indicated in its second quarter report. We also need to achieve clarity on some liquidity issues.