Interestingly, if CHNG trades a comparable valuation to Clean Energy Fuels Corp. (NasdaqGS: CLNE), which trades at 9.6x Sales (ttm) and is losing almost a $1.00 per share, CHNG would trade at $45.00. 

2009 Revenue increased 19.7% over 2008 to $81.1 million.

Gross profit was up 22.7% to $40.2 million, while gross margin increased 120 basis points to 49.5%.

Income from operations increased 19.0% to $25.1 million from $21.1 in FY08.

2009 Net income was $18.8 million, or $1.12 per diluted share, up from $15.2 million in 2008, a 24.0% increase over 2008.

2009 Net Margins were 23.2%.

Part II of the Worthless P Blog on CHNG again shows the sophomoric analysis of its authors who refused to identify themselves.  The Chairman graciously answered their questions and allegations on the 4th quarter conference call and expressed that CHNG always values and respects any comments, questions, and concerns investors have. 

Again, these bloggers make several unfounded assumptions and demonstrate their ignorance of both the Company and how the natural gas industry works in China.

They claim that the $20 million paid for the Lingbao Yuxi Natural Gas Co., Ltd. acquisition was from funds diverted from the construction of the LNG plant.  That statement is completely false. 

FACT: The $20 million used to pay for the acquisition was raised from a Hong Kong fund through a debt financing and the fund knew exactly what the proceeds were being used for. In January 2008, CHNG raised $20M and an additional $20M in March of 2008 from the Abax Lotus Fund. The founder of the fund is Donald Yang. He sits on the board of directors of China Natural Gas.  Let’s be clear: The founder of the fund that provided the $20 million to purchase the Lingbao Yuxi Natural Gas Co., Ltd. sits on the board of directors of CHNG. He approved every part of the transaction. 

The bloggers call it a fraudulent acquisition.  Pray tell, what exactly does that mean?  CHNG bought a company that serves residential customers by providing the equipment and the pipeline for natural gas into their homes.  The investment made by the company from which they bought the plant had already invested millions in the pipeline. The bloggers state that there are only 2000 customers.  That is another false statement.  The Lingbao Yuxi Natural Gas Co. has 7000 residential customers and is growing.  The Lingbao Yuxi Natural Gas plant generated approximately $4 million in revenues in 2009 (see 10-K) with gross margins in excess of 50%.  The potential customer base is 200,000 households in Lingbao not the 18,000-20,000 the bloggers suggest.  Again, the Worthless P bloggers are wrong.

Moreover, the company has permanent exclusive operating rights for the natural gas pipeline in Lingbao through the acquisition so the long-term value of the Company both from an earnings and revenue standpoint far exceeds the cost of the acquisition.  Again, the bloggers are wrong on this point as well.

As for disclosure issues regarding the transaction, all items were fully disclosed. See the 8-K filed regarding the transaction. The 8-K clearly states the funds were wired to the Sanmenxia Yuxi Investment Co., Ltd. of which Mr. Qinan Ji is the legal representative.  The suggestion that he paid himself $20 million is as ridiculous as it is false.  China Natural Gas does not own Sanmenxia Yuxi Investment Co., Ltd.  As a private company CHNG did invest in the company, but it is a separate entity altogether. 

FACT: The transaction was executed exactly as described in the 8-K. No one is hiding anything.  The sellers sold the company to CHNG. The purchaser, CHNG, paid $20 million to the sellers.  Again, the acquisition was funded and approved by the founder and manager of the Hong Kong Fund: Abax Lotus Fund who provided the cash for the transaction.  The sellers of the Yuxi plant used what is similar to a 1031 real estate transaction in the United States to avoid excessive tax liabilities. They used a vehicle for this transaction for which Mr. Qinan Ji was legal representative, which made perfect sense to the sellers, as they trust and know Mr. Qinan Ji.  For anyone that understands the Chinese business culture, using a vehicle that all parties in the transaction agreed to, including the funder, in order to mitigate a tax liability is not unusual.  Below see a description of a 1031 exchange.

A 1031 exchange is a transaction that allows a party to roll up the proceeds from selling a property, or properties, into buying new ones without being taxed upon the gains. It is one of the many ways investors can maximize tax advantages set forth by the IRS. A 1031 actually refers to a section of the IRS code and allows real estate investors to defer taxes on gains from the sale of investment properties as long as they put the money into investment properties of equal or greater value.

Source Perri Capell, “Avoid These Tax Errors in 1031, Exchanges,” RealEstateJournal.com (published by The Wall Street Journal), July 2005

Summary

In sum, we have a transaction that was fully transparent to and approved by the fund that provided the $20 million for the acquisition.  All components of the transaction were fully disclosed in the 8-K mentioned above.  As for the related party transaction, again the name of the company the funds were sent to was fully disclosed and the name on that company’s registration was Mr. Qinan Ji, which was available for anyone to see who bothered to look.  The acquisition added approximately $4 million in revenue in 2009 with 50% gross-margins. The market size for the services that Yuxi Natural Gas provides is 200,000 households and they have permanent exclusive rights to serve this market.  The acquisition was a smart one.

To suggest double-dealing here is not only unfair it is irresponsible.  There is simply no evidence for their claims.  We have demonstrated clearly that the bloggers have gotten even the small things wrongs about CHNG and how the natural gas industry works in China (see my first blog on this issue).  There is a proverb that says, “Those you cannot trust in small things should not be trusted with big things.”  

Again, let’s be clear about the motives of the bloggers.  They are shorters; they blog for a fund that stands to lose millions as the short breaks.  The short is breaking and the fund is starting to pay. Shareholders will benefit immensely.

Now, let’s review the facts of China Natural Gas’ 2009 performance and what we can expect in 2010 and beyond.

• 2009 Revenue increased 19.7% over 2008  to $81.1 million.
• Gross profit was up 22.7% to $40.2 million, while gross margin increased 120 basis points to 49.5%.
• Income from operations increased 19.0% to $25.1 million from 21.1 in FY08.
• 2009 Net income was $18.8 million, up from $15.2 million in 2008, a 24.0% increase over 2008 or $1.12 per diluted share.
• Net Margins were a strong 23.2% in 2009.
• The Company stated that its LNG plant will come on line in June 2010.
• The revenue and earnings potential for this plant is substantial (see RedChip Initial Research Report).

Dave Gentry
RedChip Companies

Disclosure