VIMC Investors Hold a Worthless Bag
WWW.TRINITYRESEARCHGROUP.COM DECEMBER 8, 2014 VIMC INVESTORS HOLD A WORTHLESS BAG DECEMBER 8, 2014
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TABLE OF CONTENTS
Disclaimer ...... 2
Executive Summary ...... 4
List of Exhibits ...... 5
Introduction ...... 6
The Government Giveth… ...... 7
Government Corruption in the Chinese Technology Sector ...... 7 Shanxi, a Hotbed of Political Corruption ...... 8 One of VIMC’s Government Sugar Daddies Sacked ...... 8 Hidden Assets ...... 9
Insiders Taketh Away ...... 13
It’s (Related) Party Time! ...... 13 EmbezzleCo ...... 15 Step 1: Carve the Operating Value Out of the Business ...... 17 Step 2: Relist the Valuable Operations Where US Investors Can’t Find You ...... 20 Step 3: Pillage the Land ...... 22 Step 4: Bait and Switch US Investors ...... 27
Pump and Dump ...... 32
Conclusion ...... 37
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EXECUTIVE SUMMARY
SELL — Target Price: $0 Ticker: Nasdaq:VIMC FD ADS Outstanding (mn): 23.8 Last Close: $6.41 Free Float (mn): 15.025 52 Week Range: $1.70 - 11.79 Ave. Daily Volume (ADS): 669,000 Market Cap (mn): $160 Short Interest (mn): 1.778
Over the past four years, assets we estimate to be worth over $600 million (4x the market cap of VIMC) were embezzled from VIMC into privately held related parties controlled by VIMC’s co-founders and other insiders.
After looting VIMC of all its intrinsic value, insiders further enriched themselves by falsifying VIMC’s financials and issuing numerous press releases to pump and dump the worthless US-listed shares.
Consequently, VIMC’s US investors now unwittingly hold shares of a worthless company, with no legal recourse to claim what was embezzled from them since it is now privately owned in China by the co-founders.
Although US investors will never recover what is rightfully theirs, some justice may ultimately be served as the family of VIMC’s chairman is being investigated in a famous case of graft involving a government official named Shen.
We believe Shen, who is close to VIMC Chairman Deng, was one of several government sugar daddies VIMC used to illegally obtain valuable assets from the government to transfer to the co-founders.
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LIST OF EXHIBITS
1: VIMC’s Major Dealings with the Government (Page 10) 2: VIMC Organizational Chart of All Historically Owned and Controlled Entities (Page 11) 3: Current VIMC Organizational Chart (Page 12) 4: Related Parties Disclosed in 2010-2013 20-F Filings (Page 13) 5: Related Party Transactions Disclosed in 2010-2013 20-F Filings (Page 14) 6: Flow Chart of Asset Transfers Disclosed in 2010-2013 20-F Filings (Page 16) 7: VIMC’s Major Disposals, 2010-2013 (Page 17) 8: 2010-2012 Summary Financials for Vimicro Wuxi from SAIC Filings (Page 17) 9: Vimicro Wuxi’s 2010 Financials Filed with the SAIC (Page 18) 10: Vimicro Wuxi’s 2011 Financials Filed with the SAIC (Page 18) 11: Vimicro 2012 Wuxi’s Financials Filed with the SAIC (Page 19) 12: Vimicro Shenzen’s SAIC-Registered Business Scope Includes Real Estate Rental (Page 21) 13: Model Picture of Vimicro Shanghai’s Commercial Real Estate Project (Page 22) 14: Current Pictures of Vimicro Shanghai’s Real Estate Project (Page 23) 15: Shenzhen VMC Plaza Project Details (Page 25) 16: Construction of Shenzhen VMC Plaza, an EmbezzleCo Project (Page 26) 17: VIMC’s Quarterly AR and Net Cash after Establishment of Zhongtianxin (Page 28) 18: VIMC’s Revenue and Sequential Increase in AR from Related Parties, Q1 2013-Present (Page 28) 19: VIMC’s Net Cash Position, Q1 2013-Present (Page 28) 20: Zhongtianxin’s Liabilities and Equity (Page 29) 21: Zhongtianxin’s Related Party Transactions (Page 30) 22: 2011 Press Releases (Page 32) 23: 2012 Press Releases (Page 33) 24: 2013 Press Releases (Page 34) 25: 2014 Press Releases (Page 35) 26: USD Value of Insider Sales, 2008-Q3 2014 (Page 36)
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INTRODUCTION
It is no secret that corruption runs rampant within the Chinese government, where many senior officials have historically used their positions of power to enrich themselves and their cronies at the expense of the Chinese populace. One of the hallmarks of PRC President Xi Jingping’s first two years in office is a solemn campaign to crack down on the highest levels of this corruption. Even senior government officials have not been immune to this crackdown, as evidenced by the recent investigation of Zhou Yongkang1. Many companies affiliated with corrupt government officials have lost much of their value as anti-graft investigations reveal the use of such companies as vehicles for embezzlement, bribery and financial fraud.
In this report, we unveil how insiders of Chinese video semiconductor and surveillance camera manufacturer Vimicro International Corporation (“VIMC”), led by co-founders Deng Shonghan and Jin Zhaowei (the “Co-Founders”), systematically gutted over $600 million worth of government funding, government-granted real estate assets, and proceeds from commercial government contracts from the Nasdaq-listed VIMC for personal gain. We believe much of this value was derived by bribing government officials such as recently sacked Shen Weichen, former Party Secretary of China’s Association for Science and Technology. Deng, VIMC’s Chairman, is among the numerous businessmen implicated in the bribery and general corruption charges that resulted in Shen’s sudden ousting.
The premeditation and callousness with which VIMC’s Co-Founders built a company to serve as a vehicle for their exclusive enrichment makes VIMC the worst case of embezzlement (from both their company and the government) we have ever found.
We discuss our findings in the following sections:
1. The Government Giveth. We discuss how the Co-Founders used their government connections to obtain hundreds of millions of dollars in valuable assets for VIMC. 2. Insiders Taketh Away. We examine the privately held vehicles used to transfer VIMC’s assets to the Co-Founders. We reveal how the Co-Founders proceeded to loot VIMC of all its worth, transferring to themselves at nominal cost VIMC’s only profitable business, its valuable real estate assets, and much of the cash over a three-year period. Accounting red flags were raised many times throughout the embezzlement bonanza of the past few years, but the management team was able to cover them up by firing CFOs and auditors who posed a threat to their accounting trickery. 3. Pump and Dump. Not content with their enormous embezzled gains, the Co-Founders then used a clever scheme involving related parties to maintain the appearance of VIMC as a valuable going concern, pumping its shares with inaccurate press releases and overstated financial reports. Predictably, they have been dumping their shares aggressively as duped US investors buy the pump.
1 http://thediplomat.com/2014/07/in-zhou-yongkang-xi-bags-the-ultimate-tiger/
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THE GOVERNMENT GIVETH…
Government Corruption in the Chinese Technology Sector
Having declared the technology sector a key investment area for the growth of the Chinese economy, the government has invested hundreds of billions of dollars (trillions of RMB) over the past two decades to support domestic entrepreneurship, research and development in the sector. This government support, which is allocated through several regional and national government bodies managed by a select few, often takes the form of tax breaks and grants of funding, land for commercial use or commercial contracts with the government.
As is typical within the Chinese political system, when that much responsibility and capital is left at the hands of an unmonitored few, the results are predictably corrupt. As reported on October 31, 2013 by China Youth Daily2, investigations by China’s Ministry of Science and Technology into the allocation of RMB 2.42 trillion from 2006 to 2012 revealed “shocking corruption” that has triggered a revamping of the way the government monitors its research spending. It turns out the vast majority of research funding ultimately went not to the intended projects, but to corrupt cronies and accomplices of the government officials issuing the grants. The article reviews cases of bribery, embezzlement, accounting fraud to cover up missing funds, secret expense accounts to fund everything from everyday expenses such as meals to cars, and more.
Source: China Youth Daily
2 http://zqb.cyol.com/html/2013-10/31/nw.D110000zgqnb_20131031_1-06.htm
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Shanxi, a Hotbed of Political Corruption
Shanxi, a province located in China’s Northern region, is the country’s most infamous area for political corruption. Shanxi was one of the areas targeted by President Xi’s anti-corruption crackdown, especially this year. As noted on Wikipedia:
Since Xi Jinping's ascendancy to power at the 18th Party Congress, numerous highly ranked officials in Shanxi have been placed under investigation for corruption-related offenses, including four members of the province's highest ruling council, the provincial Communist Party Standing Committee… They were all removed from office around August 2014... Shanxi was therefore the 'hardest hit' province during the anti-corruption campaign of 2013-2014. Targeted corruption investigations on such a massive scale was unprecedented; it amounted to a wholesale 'cleansing' of Shanxi's political establishment.
And the news about Shanxi’s widespread corruption keeps flowing. Last week, China.org.cn reported about some of the very recent political cleansing in Shanxi3, and this week, Caixin Online4 reported the highest-profile case yet about corrupt tie-ups between government officials and companies that bribe them for all types of illicit political favors. This was not an isolated case, as Caixin reports: “a string of corrupt officials and former government employees have been uncovered recently.”
One of VIMC’s Government Sugar Daddies Sacked
Several Chinese media outlets reported earlier this year that Shen Weichen, a long-standing senior official in Shanxi who held various government posts such as Mayor of Taiyuan City, Secretary of Taiyuan’s Municipal Party Committee, Secretary of Shanxi’s Provincial Party Committee, and Party Secretary and then Vice Chairman of China’s Association for Science and Technology, is one of the numerous officials who fell from grace this year. Throughout his long tenure as influential politico, Shen was apparently happy to do political favors for his cronies so long as he received considerable kickbacks from those who greased his palms.
One news article5, dated 4/17/2014, concludes that more corrupt businessmen will be investigated and caught now that their government sponsor Shen has been sacked:
有境外媒体引述北京政界人士说，申维辰落马的原因，和较早前被抓的山西人大副 主任金道铭一样，是涉嫌在山西的贪污腐败。金道铭是在今年 2 月因涉嫌严重违纪 违法而被查。还有分析认为，接下来将会有更多山西官商被抓。
3 http://www.china.org.cn/china/Off_the_Wire/2014-11/26/content_34160236.htm 4 http://english.caixin.com/2014-12-02/100758187.html 5 http://news.163.com/14/0417/11/9Q1HLMGH0001124J.html
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Translation: Politicians say Shen Weichen was arrested due to corruption, the same reason as Jin Daoming, the Deputy Director of Shanxi people's Congress. Jin Daoming was arrested in February due to corruption. Some analysts believe that, then there will be more officials and businessmen in Shanxi province to be arrested.
The article’s prediction has come true, and one of the businessmen affected is none other than VIMC Chairman and CEO Deng, who has been implicated with Shen’s corrupt practices now that his wife Tan Jing (a famous singer from Shanxi who was also Shen’s mistress while he was in power) is under investigation67:
京城有传言：中纪委在调查另一宗案件时，一名有国家一级演员名衔的山西籍著名 女歌手因涉案被问话时，交代曾与申有过一段“私情”。
Translation: Early this year… a Shanxi singer (Tan Jing) got involved in the corruption case and was investigated by China’s Investigation Bureau….
刚刚落马的中国科协党组书记申维辰，是今年首名受查的正部级官员，亦是首名落 马的中纪委委员。网传申维辰情妇是山西籍著名女歌手，网友她猜测演过《乔家大 院》。同时，网友们还翻出谭晶的个人资料，称她老公叫邓中翰，中星微电子有限 公司董事长。
Translation: Tan Jing, is close to Shen Weichen. Internet users have pulled up Tan Jing's profile and said her husband named Deng is Vimicro’s Chairman.
It is also noteworthy that Deng used to work with Shen as a senior officer at the state-run Association for Science and Technology that Shen used to oversee.
Hidden Assets
VIMC’s corporate history makes clear that the company was built in large part through government relationships from which funding, land rights, commercial contracts, and joint ventures were obtained. A careful read of VIMC’s past eight 20-F annual reports shows that the company has been a beneficiary of government generosity since 2007, a watershed year for VIMC. Eight years after its founding in 1999, for seemingly no valid reason, VIMC became a favorite of the government. Starting that year, VIMC received grants of land at ultra-low prices in Shenzhen, Shanghai, and Nanjing (Jiangsu province); received follow-on funding (outright grants or loans) to develop that land; collaborated in two joint ventures (JVs) with the local governments of Tianjin and (no surprise) Shanxi province; and received R&D-related funding in Qingdao and Wuxi. The details are shown below in Exhibit 1.
6 http://www.ymysw.cn/List.asp?ID=7011 7 http://m.blogchina.com/blog/view/uname/zhenhepeng/bid/2235158
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Exhibit 1: VIMC’s Major Dealings with the Government8
Shenzhen City Shanghai City Jiangsu Province Tianjin City Shanxi Province Qingdao City Date 6/26/2007 11/15/2007 12/26/2007 and 12/29/2008 September 2013 2013 2010-2012 Event Acqusition of land Acquisition of land 2007: Acquisition of Formation of Vimicro Formation of Receipt of use rights use rights land use rights Tianjin, a JV with the Zhongtianxin, a JV government grant in 2010-2012: receipt of government, and with the government, cash. VIMC is one of RMB 42 million receipt of RMB 250 and receipt of RMB 98 five companies to ($6.69M) in cash million ($36.6M) in million ($14.5M) in receive total of RMB cash cash 280 million ($45.5M) Go v ern men t Shenzhen Municipal Zhangjian Administrative State-owned Asset Sh a n xi Gu o xin City of Qingdao entities Bureau of Land Semiconductor Committee of Nanjing Management Investment (Group) Resources and Industry Park Co. Ltd. Xuzhuang Software Corporation of Tianjin Corporation, a Housing Management (state-owned entity) Industry Base and Economic-Technical financial holding Nanjing Xuanwu Development Area group associated with District Management ("Tinajin SAMC") the Shanxi and Investment of government State-Owned Asset Holdings (Group) Co. Ltd. Terms 3,947 square meters 20,900 square meters 80,000 sqare meters VIMC and the VIMC and the None for $0.9 million for $5.7 million for $5.4 million government each own government each own 49.99% of the JV, co- 49% of the JV, co- founders' private founders' private company owns 0.02% company owns 2% Ratioale Corporate use only Corporate use only Corporate use only Design, manufacture Focuus on security Investment in city's (VIMC office building) (VIMC office building) (VIMC office building) and sale of digital surveillance businesses video surveillance investment, services products and products
Although we looked beyond the SEC filings to find some of these dealings, we think it is most likely the company had more such dealings that we were unable to find throughout our research process. We found the cash grants from the city of Wuxi (in Jiangsu province) and the cash grants from the city of Qingdao9 shown in Exhibit 1 not in SEC filings but from our own research of Chinese SAIC filings and local city governments’ public disclosures.
Interestingly, none of the government asset grants were disclosed in the types of highly promotional (and, as we show later, misleading) press releases that VIMC loves to issue whenever it signs a new contract with the government. This year alone, VIMC has announced 11 such stock-pumping press releases promising hundreds of millions of future orders from the government10. We note that several of these deals were done with the infamous Shanxi government in the city of Taiyuan, no less, where most of the cases of graft and government- baked corporate fraud have been discovered this year by the Chinese central government. These press releases would have you believe 2014 was quite a year for VIMC, in spite of the fact that both the CFO and the auditor were inexplicably replaced.
Instead of getting caught up in the pomp and circumstance of these announcements of government orders that never amount to much in audited financial performance, investors must take a closer look at the hidden value in the minimally disclosed government asset grants. We are happy to serve as your guide, since this hidden value is obfuscated by a complex organizational structure that makes it hard to track what is going on.
8 Source: 2010 20-F, 2010-2012 SAIC Filings, Qingdao City government website 9 http://govinfo.nlc.gov.cn/sdsqdfz/xxgk/qdsrmzf/201310/t20131010_4001224.shtml?classid=439 10 http://phx.corporate-ir.net/phoenix.zhtml?c=194779&p=irol-news&nyo=0
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