Kandi Technology Group (KNDI), a purported leading manufacturer of Electric Vehicle (EV) parts in China, reported another weak quarter several weeks ago that saw the company continue to rack up losses while selling only a pitiful number of several hundred vehicles. I was content to ignore this underwhelming news and let the company continue naturally on its downward trajectory into delisting oblivion, but at the risk of being labeled a short basher, I feel obliged to comment on it in more detail, especially after an unexplained double-digit gain to start the week has brought the price right back to where it was before the poor earnings results.
I’m sure I’m playing right into the hands of proponents of the company that claim I’m just a nefarious short seller that is trying to “talk down” the stock. I’m flattered by the notion that I could possibly move markets, but I am not nor do I work for a “Big Short” that conspiracy theorists blame for the company’s poor stock performance. However, as someone who has followed the company’s checkered history on its way down from the $20s to under $4, I feel compelled to again warn unsuspecting investors from getting roped into yet another pump and dump.
Despite horrendous operational results, the company continues to be pumped to naïve retail investors. After being banned from both Seeking Alpha and StockTwits for excessive promotion of the company, noted stock promoter Arthur Porcari is back at it on Harvest.com with a defense of the company that I feel compelled to rebut due to its wishful thinking and outright misleading facts.
Porcari and other boosters of the stock continue to point at the company’s supposed history as the “#1 pure EV company in China,” which even if ever true was built on a business model of selling mostly to their own car share program that resulted in collecting subsidies on cars that are now gathering dust under an overpass in Wuhan. It is worth noting that the “Service Company” that is “operating” these vehicles is jointly owned by Kandi (9.5%) and their CEO (13%), so they were quite literally selling to themselves.
As noted in this recent article, this is illustrative of an epidemic of subsidy fraud in China, which I believe Kandi was perhaps the patient zero of, rather than an innocent victim because “everyone was doing it.” Either way, this is a major blow to their business model because it significantly increases the chance that many of these cars will not receive subsidies because the subsidy subterfuge ushered in a new rule that EVs must accumulate 30K km before being eligible, and the only thing these ones are accumulating is weeds.
Kandi’s “Car Share” Program
Yet in his article Mr. Porcari claims that Kandi has “received a partial payment of $58 million” in April of 2017 for these and other 2015 sales. Yet if you read the press release more closely, you’ll see that Kandi only received $35 million in April, with CEO Hu Xiaoming promising that “a further central government subsidy payment of RMB 400 million (approximately US$58.1 million) is expected to arrive,” but of course it still hasn’t. I think it might be more likely that the company could be on the hook to return some of the $53 million prepayment they received back in 2015 before this evidence of blatant subsidy fraud came to light.
This crackdown put a damper on the company’s grandiose production plans, with sales dropping from 24K vehicles in 2015 to only 10K in 2016, of which nearly half were still to the Car Share program, likely further delaying (perhaps permanently) receiving any subsidies on them.
Yet despite the resultant cash flow crunch from decreased subsidies and production, Kandi’s promoters boast of the JV company’s three “State of the Art, pure EV manufacturing facilities” with a combined 300,000 annual production capacity, despite the fact that they only sold a grand total of 365 units last quarter. Not 365K, just 365 cars total in the entire first half of the year after delivering zero in the first quarter.
Not content to run at what for a real company would be an unheard of capacity utilization of well under 1%, Kandi is also building another new $100M plus factory on the island of Hainan. Bulls are convinced this will finally start producing a desirable product for direct sales, going so far as to spin this announcement as evidence that Kandi is going to produce the Tesla (TSLA) Model 3 in China.
Of course, these rumors turned out to be completely unfounded, since this factory was originally announced in 2013, long before Tesla had even announced the Model 3. It is doubtful that Tesla’s vaunted Model 3 would be built on an old assembly line, considering they’ve barely got their own lines up and running at the Fremont factory. As noted in previous annual reports, way back in 2013, Kandi shelled out $54M upfront to a previously unheard of company called Nanjing Shangtong Auto Technologies to supply the assembly lines before the factory had even begun construction.
“As of December 31, 2013, the Company recorded a significant prepayment made by the Company to a supplier Nanjing Shangtong (as defined in Note 16) as an advance of RMB 353 million ($54,368,753) and deposited by Kandi Wanning (renamed to Kandi Hainan in January 2016) to Nanjing Shangtong.”
After a delay and move from Wanning to Haikou, the Hainan factory is still unfinished, as evidenced by the fact that the total Construction in Progress (CIP) in the most recent 10-Q is still less than the total that was advanced, and actually less than it has been in past filings, which had to be restated. This suggests that progress at the factory has regressed, or at the very least, the assembly line equipment bought and paid for over three years ago still has not even been installed in the factory, something that is supported by the most recent picture of the empty factory.
Kandi’s Hainan Factory Picture from meipian.cn
Interestingly, although it has since been removed from the quarterly filings, in the most recent annual report it was noted that Kandi has also paid what is now described as “total solution contractor” Nanjing Shangtong more than $56 million in research and development expenses.
“As of December 31, 2015, the Company made a total prepayment of RMB 353 million (approximately $50,821,714) to our supplier Nanjing Shangtong as an advance to purchase a production line and develop a new EV model for Hainan project. Nanjing Shangtong is a total solution contractor for Kandi Hainan project to provide all the equipment and EV product design and research services. In June 2016, Kandi Hainan made the prepayment of RMB 70 million (approximately $10,077,960) to Nanjing Shangtong for the design and development of a new EV model. In July 2016 and August 2016, two prepayments of RMB 30 million (approximately $4,319,126) and RMB 90 million (approximately $12,957,377) respectively, were made to Nanjing Shangtong for the same purpose. In November 2016 and December 2016, another two prepayments of RMB 51 million (approximately $7,342,514) and RMB 150 million (approximately $21,595,629) respectively, were made to Nanjing Shangtong for the same purpose.”
Also note that the “prepayment of RMB 353 million” was listed as “approximately” 3.5 million dollars less than in other filings, which reflects a basic misunderstanding of accounting. If the prepayment was actually paid, it should be stated in terms of the actual exchange rate as it stood then, not be continually adjusted. This is a continuation of a history of questionable accounting with Kandi’s auditors, with their former auditor being banned by the PCAOB and their current one being unable to be inspected by it.
This is particularly true with regard to the opaque JV financials. When their JV Partner Geely Auto (OTCPK:GELYF) sold their stake in the JV, possibly to sweep the subsidy scandal under the rug of the parent company Geely Holdings, the disposal agreement showed an $80 million difference in 2015 sales (RMB1818 million, or about $280 million) compared to what Kandi reported that year ($360 million).
And this quarter, the JV recorded revenue of $18.5 million. As previously mentioned, with unit sales of only 365, this means each EV sold for the preposterous price of $51K. Clearly, this is not believable for a lower tier EV maker, even one that is now suddenly putting up Tesla-esque levels of R&D, at least relative to nonexistent sales.
After years of somehow fielding a complete lineup of several EVs on an average of about $3 million in annual R&D spending, Kandi recorded $26 million last year and has already put up another $26 million so far this year, all funneled through our old friend Nanjing Shangtong Auto Technologies, which has somehow morphed from a obscure factory builder and assembly line installer to a top tier think tank.
This cost is ostensibly to develop a new EV, the K23, a “mid-tier pure electric vehicle designed to manufacture in Hainan facility for our targeted market with innovative built in technology and state-of-the-art body and interior designs.” I’ll leave it to readers to determine if this looks to be as described and worthy of upwards of $50M in R&D spending.
Kandi K23 Patent Declaration from bitauto.com
As desirable as it supposedly is, it will only be built in quantity if the factory is ever built, that is, since according to the latest conference call:
“Right now, the construction improvement of Hainan facility is underway. The company started to assemble the prototype modeling in the end of July and plans to send it to national testing center for inspection in the coming months. Once the prototype passes the inspection, the company will launch the trial production the year after.”
So, not even trial production until 2018, even though this was expected by the end of 2016 or “mid of 2017” at the latest in previous conference calls, a timeline which makes even Tesla’s annual delay of their “exponential” production ramp look good. But at least they’re allegedly doing it with advanced robots, whereas Kandi’s “assembly line” seems to be a couple of workers standing around in a still mostly empty factory.
Kandi K23 Prototype Assembly shared by @Relius on StockTwits
After giving up on the tenuous Tesla connection, Kandi bulls are pinning their hopes on this new model to re-energize Kandi’s flagging sales. However, the JV’s partner Geely Holdings continues to distance themselves from Kandi, even though Kandi makes every effort to spin it as advantageous to the company.
“In an effort to improve the JV Company’s development, Zhejiang Geely Holding Group, the parent company of Geely, became the JV Company’s -shareholder on October 26, 2016, through its purchase of the 50% equity of the JV Company held by Shanghai Guorun at a premium price (a price exceeding the cash amount of the aggregate of the original investment and the shared profits over the years).”
Notice that it is noted that Geely paid a “premium price” of $100 million (as noted in the sales agreement above) for their half of the JV, yet this didn’t stop Kandi from declaring the company is worth much more in their quarterly results PR.
“Despite second-quarter losses, Kandi Vehicles’ estimated value has exceeded RMB four billion, the management team will actively seek strategic investors based upon the estimated value to increase its competitive advantages.”
Acknowledging continued losses with a JV that was sold for a “premium price,” then stating a value 6 times higher in the same breath is a stretch. This was presented with no other justification of where that value came from, other than several cryptic notes of visits by Chinese billionaires that promoters love to name drop. Whether anything more comes of these supposed “strategic investors” remains to be seen.
If the behavior of Geely’s Li Shufu is any indication, then it is unlikely to benefit current shareholders. Their already convoluted relationship, which Li has rarely acknowledged directly, continues to become even more muddled.
“On May 19, 2017, due to business development, Geely Holding entrusted Hu Xiaoming, Chairman of the Board of the JV Company, to hold 19% equity of the JV Company from its 50% holding of the JV Company on behalf of Geely Holding as a nominal holder. On the same day, Geely Holding transferred its remaining 31% equity in the JV Company to Geely Group (Ningbo) Ltd., a company wholly owned by Li Shufu, Chairman of the Board of Geely Holding. On May 25, 2017, Mr. Hu pledged its 19% equity in the JV Company held on behalf of Geely Holding to Geely Holding.”
What these further machinations mean remains unclear, but the next line from the quarterly report does not bode well for Kandi shareholders that think they’ll reap the benefits of a turnaround that is just around the corner.
“On June 30, 2017, due to the JV Company’s operational needs, Kandi Vehicle pledged its 50% equity in the JV Company to Geely Holding as counter-guarantee because Geely Holding provides 100% guarantee on the JV Company’s borrowings.”
This related party collusion should be especially worrisome, because in addition to being due $140 million from the JV, Kandi is actually one of its major lenders!
“The amounts due from the JV Company include six short-term loans in the total amount of $43,514,175 that Kandi Vehicles lent to the JV Company.”
If the JV is unable to pay Kandi back for all these outstanding payables and loans, there’s no incentive for Geely Holdings to honor their guarantee because they would end up with the entire JV company anyway. Because of the circular reasoning of the debt guarantee, Kandi has no recourse because they’ve pledged their stake in the JV to the very company they’ve ultimately lent to.
I continue to maintain that this was the plan of CEOs Hu and Li all along, to build the company’s infrastructure at US shareholders’ expense, and then eventually end up owning it all. I’ll leave you with Kandi’s Byzantine Org Chart to let Kandi shareholders try to figure out what, if anything, they’ll actually own if they still want to buy the stock.
Kandi Organizational Chart from the latest 10-Q
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in KNDI over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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