In terms of stock market performance, the Company's portfolio
companies fell 39.6% during the six month period ending 31 March
2011. This underperformance far exceeds that of any index and may
be attributed to the concentrated, illiquid nature of VOC's
portfolio. The fact that reverse merger companies have been
especially affected during this period is certainly a contributing
factor to the decline in value.
Realisations
During the period, we realised proceeds from the sale of the
Company's entire position in China Security & Surveillance
Technologies (CSR). CSR is a company that provides the design,
installation and service of complex security systems in China. We
invested $8.0 million (at a price of $4.00 per share) in the
company last May as a part of a larger financing. CSR has been
among the more liquid names in the Company's portfolio, typically
trading 1-2 million shares per day in the open market. While the
growth of their business has been impressive, CSR has been
criticised for the large amount of accounts receivable on its
balance sheet. As a consequence, CSR has traded at quite low
multiples for some time. During January 2011, the CEO announced his
intent to take the Company private in a management buyout, offering
$6.50 per share. CSR is one of several firms presently looking to
'go private', presumably in an attempt to relist on another more
amenable market at a later date. Whatever the reason, the share
price of CSR remained significantly below the proposed price. When
full-year results for CSR were released showing little change in
the accounts receivable situation, we decided to look for an
opportunity to exit. Shortly thereafter, we were able to sell VOC's
entire holding for $10.2 million, achieving a 41% IRR on the
investment. Recent company announcements suggest that the
management buyout appears to be proceeding at a price of $6.50,
though the shares remain at a 20-25% discount in the market.
We also sold all but a stub warrant position in Keyuan
Petrochemicals (KEYP). VOC invested $2.0 million in April 2010 as
part of a larger financing. We realised proceeds of $2.7 million in
the sale. Having traded at up to a 10x forward multiple, we felt
that in the current environment the company was about
fully-valued.
The most controversial component of VOC's portfolio during this
period was the Company's holding in China Integrated Energy (CBEH).
CBEH is a vertically integrated producer, wholesale distributor and
retail seller of biodiesel and petroleum-based fuels in China. CBEH
was the Company's third-largest holding accounting for 12.1% of the
Company's NAV at 30 September 2010 and, at 31 March 2011, was VOC's
4th-largest holding accounting for 4.4% of the Company's NAV. VOC
had invested a total of $14.7 million in CBEH, through a
combination of both direct investments and open market purchases.
Potential issues regarding CBEH first came to light in late summer
2010 when one of the research reports was especially critical of
Sherb & Co., the Company's then auditor. Considering this
matter significant, we encouraged management to upgrade their
auditor to one of the 'big four'. The company agreed and, in
December 2010, announced that it had retained KPMG to conduct its
2010 audit.
The US-listed China sector remained under pressure and the share
price of CBEH drifted back down to about $6.00 by early March 2011.
With the expectation of favourable earnings to be announced any
day, when combined with the relatively good trading volume, we felt
that selling the position would be premature. Then, on the eve of
CBEH's filing of its annual report on the Form 10-K, an anonymous
short-seller's research report levelled serious allegations against
the company, including, among other things, that the chairman had
enriched himself personally through self dealing transactions.
In addition to launching special diligence initiatives, we
engaged management directly and received reasonable explanations
responding to the most damning allegations. However, the company's
public response was weak and failed to effectively rebut the
charges. About 12 days later, a second report emerged that included
video footage suggesting a biodiesel refinery owned by CBEH
purportedly operating at full capacity was in fact idle.
CBEH responded more forcefully this time, announcing that the
independent board members had commissioned Deloitte and Pillsbury
(et al) to conduct a full independent review of the business.
Throughout this period, VCA was conducting behind-the-scenes
diligence on CBEH. These efforts failed to restore our confidence
in the company and as such we decided to realise as much of the
Company's investment as we could. By 31 March, VOC holding of CBEH
were down to 1,290,061 shares and sales proceeds totalled $5.1
million during the six months ending 31 March 2011. VOC further
realised $1.8 million in sales proceeds before the stock was halted
from trading by NASDAQ on 20 April 2011, leaving the Company with a
holding of 475,859 CBEH shares. Subsequently, additional filings by
CBEH noted the resignation of Deloitte and the other firms hired to
conduct the special investigation, the resignation of the
independent director serving as the audit committee chairman
(although the vacancy has since been filled), the withdrawal of the
2010 Form 10-K and resignation by KPMG, and the resignation of the
CFO.
Following these events, VOC has written the value of its
remaining position in CBEH to zero. All told, through our recent
sales and earlier efforts, we were able to realise 82.1% of the
Company's total investment in CBEH. Any further realisations of
CBEH, regardless of the value, are likely to be delayed for some
time.
Throughout the period, we were also able to make several small
sales of the Company's portfolio holdings and open market trades
that netted an additional $1.1 million in cash for the
portfolio.
Portfolio Positions
At the date of this report, the Company's portfolio consists of
four major positions, six minor positions and cash.
Shengkai Innovations (VALV) is engaged in the business of
designing and manufacturing ceramic industrial valves and valve
components. As at 31 March, VALV represented 43.6% of the Company's
portfolio. Commercial production at VALV's new manufacturing
facility has proceeded as scheduled and has reached full capacity
based on a one-shift operation in December 2010. Management has
reiterated its revenue guidance of between US$93.0 million to
US$95.0 million and raised its non-GAAP net income guidance to
between US$31.0 million and US$34.0 million (excluding non-cash
changes in the fair value of instruments and share-based
compensation costs) for the fiscal year ended 30 June 2011. In
November and December 2010, VALV closed two secondary public
offerings at US$5.50 per share for total net proceeds of
approximately US$17.5 million, net of all offering costs. VOC did
not participate in these offerings.
QKL Stores (QKLS) operates a chain of supermarkets and
hypermarkets in Northern China. As at 31 March, QKLS represented
29.0% of the Company's portfolio. QKLS fell short of its new stores
guidance during the quarters ended 31 December 2010 and 31 March
2011, opening five and six new stores, respectively, instead of the
expected seven new stores for each quarter. However, during the
first four months of 2011, QKLS had opened a total of 11 new
stores, which is close to its guidance of 12 new stores for 2011.
As of 27 April 2011, QKLS had 54 store locations with an aggregate
total of approximately 306,000 sq. metres of store space. This is
comprised of 35 supermarkets, 15 hypermarkets and four department
stores.
China Gerui Advanced Materials (CHOP) is a manufacturer of
specialty steel products. As at 31 March, CHOP represented 9.2% of
the Company's portfolio. Originally planned to be completed by
October 2010, construction of CHOP's two new cold-rolled,
wide-strip steel production lines (150,000 metric tons of total
annual capacity) and a new chromium plating line (200,000 metric
tons of cold-rolled steel processing capacity) experienced delays
related to severe flooding in North China over the summer season.
The new chromium plating line started normal operations in March
2011, while the two new cold-rolled production lines are expected
to commence production in the second quarter of fiscal year 2011.
In March 2011, CHOP received proceeds of US$77.6 million when
investors exercised 15.5 million warrants which were originally
issued in March 2009.
China Ceramics Corporation Limited (CCCL) is a manufacturer of
ceramic tiles for both residential and commercial buildings. As at
31 March, CCCL represented 3.8% of the Company's portfolio. During
the three months ended 31 December 2010, CCCL completed the first
phase of expansion at its Hengda facilities, increasing the
facility's annual capacity from 28 million to 32.3 million sq
metres of ceramic tiles. As of the beginning of 2011, the combined
annual production capacity of the Hengda and Hengdali facilities
was 42.2 million sq metres. CCCL expects to further expand its
capacity to 72.0 million sq metres by the end of 2011 and 86.0
million sq metres by the end of 2012. CCCL was also ranked in
Fujian's Top 300 Enterprises in 2010 by the Fujian Evaluation
Center and the Fujian Enterprise Evaluation Association.
VOC also has small share holdings (less than 2% of NAV each) in
Wuhan General Group (WUHN), Jingwei International (JNGW), Global
Education & Technology Group (GEDU) and Concord Medical
Services Holdings Limited (CCM) and holds small warrant positions
in Keyuan Petrochemicals (KEYP) and Tianyin Pharmaceuticals (TPI),
accounting for a combined total of 4.1% of the portfolio.
The Way Forward
While it is a heart-breaking conclusion to reach after so many
years of hard work and dedication, we support the Board's decision
to move to an orderly realisation of the Company's investments and
return of surplus cash to shareholders.
Adam Benowitz
Chief Investment Officer, Senior Managing Director
Vision Capital Advisors
Date: 23 May 2011
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