GEO Investing

Summary:

  • We believe Lentuo International (LAS) does not adequately address the full spectrum of two undisclosed loans executed in 2013 totaling RMB 250 million  (RMB100M, RMB 150M).
  • LAS does not even address one of the loans at all (RMB100 million).
  • Assertion that Chairman’s “equity interest in the Company is not pledged as collateral to secure the RMB150M loan” ignores fact that Chairman personally guarantees the loan with his assets.
  • Assertion that the revenue of Company is not pledged as collateral to secure the RMB 150 loan ignores fact that revenue from all LAS’s 4S stores are collateral to loan.
  • In light of potential risk factors, it is evident that NYSE/LAS’s auditor need to scrutinize the loan structures and their potential impact to financial statements and disclosures made to shareholders.

On May 28, 2014 we published our due diligence findings on LAS. We provided evidence that a related party company in Lentuo International’s (LAS) corporate structure, Lentuo Electromechanical (“LE”), borrowed money through two trust agreements (Chinese investors) totaling RMB250 million (RMB150M + RMB100M). These loans were not disclosed in LAS’s SEC filings. We provided evidence showing that the Chairman’s assets and the revenues from ALL of LAS’s 4S car dealerships were put up as collateral to the trusts loans. We also stated that Lentuo Electromechanical is likely using loan proceeds to build/operate 4S dealerships that will compete with LAS. Lentuo Electromechanical owns 100% of the VIE that comprises the majority of LAS’s operating units.

After we published our LAS report the company responded on May 29, 2014 by stating:

“All of these statements are false and potentially misleading. As the Company’s annual report clearly disclosed, while LE is controlled by Mr. Guo, LE is not part of the Company. Any loan incurred by LE that does not impose any obligations or liabilities on the Company or its assets is not required to be disclosed. Mr. Guo has confirmed that LE incurred one loan with one trust fund in the amount of RMB150 million in January 2014, and this loan does not impose any obligations or liabilities on the Company and its assets. Neither Mr. Guo’s equity interest in the Company nor the revenue of the Company is pledged as collateral to secure this loan. Based on the above, the Company is not required to disclose this loan or include it in the consolidated financial statements for the year ended December 31, 2013. The Company believes that it has made full and accurate disclosure in its annual report on Form 20-F for the fiscal year ended December 31, 2013 in accordance with the rules and regulations under the U.S. securities law.”

We have read many rebuttals of U.S. listed Chinese companies accused of misrepresentations over the last few years that we believed dodged the relevant issues. In keeping with that theme, the comments made in LAS’s rebuttal contain obvious misstatements that we frankly can’t believe. Furthermore, investors may want to take note of what the company did not address. While the company did admit to the existence of the RMB150 loan, it did not comment on our RMB 100 million loan findings. Why?

Once again, we will explore the facts surrounding the loans that are clearly spelled out in the trust.

Our Full rebuttal:

  • We understand that LE is not part of LAS but it is in fact controlled by Mr. Guo.
  • LAS confirmed the RMB 150 trust loan but did not mention the other RMB 100 loan. It’s not clear whether LAS is denying the existence of that loan.
  • LE raised the RMB 150 million partly to finance its new Audi Dealership in Beijing (as disclosed in the trust documents), which should have been disclosed in LAS’s 20F since LAS has disclosed that it is building an Audi dealership in Beijing.
  • We believe consolidation of Lentuo Electromechanical into LAS’s financial statements is required. Of particular relevance is that LAS’s 2013 20F states :

“Furthermore, as our reorganization was conducted between entities under the common control of Mr. Hetong Guo, the historical financial results, assets and liabilities of the affiliated entities and Lentuo Electromechanical have been reflected in our consolidated financial statements as if the current organizational structure had always existed.”

It is highly likely that the trust loans incurred by LE should be accounted for or at least disclosed in LAS’s financial statements.

  • The RMB 150 million trust loan document clearly states the sources of collateral:

    “…

    a. Source of funds pledged to repay the loan:

    Revenue generated from all 4S stores (including 4S stores under construction) of Beijing Lentuo Electromechanical Group Co., Ltd.

    b. Guarantor:

    Beneficial owner of Beijing Lentuo Electromechanical Group Co., Ltd., Guo Hetong and his wife provide unlimited joint and several liabilities.

    …”

  • The trust file states the revenues generated from all 4S stores (including 4S stores under construction) are pledged as the source of funds to repay the loan. If pledging the revenues of the 4S stores is not collateral as stated by LAS in its rebuttal, then what is?
  • Play on words; The company is clever in its assertion that Mr. Guo’s equity interest in the Company is not pledged as collateral to secure the RMB150M loan. However, Mr. Guo is collateral to the loan putting all his assets at risk. As stated in the trust loan file, Mr. Guo and his wife provide unlimited joint and several liability guarantees for the trust loan. In the event of default, Chinese investors in the RMB 150 million trust loan could sue Mr. Guo and claim Mr. Guo’s LAS shares and other assets in court. LAS has not disclosed this risk factor in its SEC filings.

The other RMB 100 million trust loan carries similar provisions as the RMB 150 million trust loan and is being used to build 4S dealerships. We therefore do not understand why LAS denies the existence of collateral and the company’s potential exposure to Mr. Guo’s obligations if he is unable to repay the loans.

  • Does LE have other 4S stores outside of the ones owned by LAS that can be pledged as collateral?

We believe that NYSE and LAS’s auditor should review the facts and circumstances related to the trust loans extended to LE and guaranteed by Mr. Guo to determine whether LAS and its shareholders are exposed to potential liabilities if Mr. Guo fails to meet his obligations. In our opinion, LAS’s financial statements should be restated to reflect the loans.

Disclosure:  Short LAS

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