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PDFJust a few years after reinventing itself as a Chinese coal-mining company, L&L currently boasts higher margins than virtually any player – including Chinese giant Yanzhou Coal Mining (NYSE: YZC) and U.S. veteran Peabody Energy(NYSE: BTU) – in the red-hot sector. L&L also touts a remarkable growth rate, filings show, with revenue soaring from $23.4 million to $109 million -- and profits skyrocketing from less than $1 million to $32.9 million -- over the course of two short years.
In other words, those numbers suggest, L&L has managed to pull off an outright miracle.
Under the leadership of founder and current CEO Dickson Lee, an accountant and tainted ex-broker with no obvious coal-mining experience, L&L has spent the past few years buying cheap Chinese coal mines and then somehow transforming them into lucrative money-making machines. L&L paid just $4 million last year for the newest of its three coal mines, for example, and then released pro forma numbers suggesting that the mine – which posted a meager $362,545 profit the year before its sale – would have delivered more than $8 million in 2010 profits if the company had overseen its operations for all (rather than just half) of that fiscal year. If so, L&L struck quite a bargain by paying less than 0.5 times future earnings – in a sizzling industry with generous price-to-earnings ratios – for that valuable coal mine.
The company, based in Seattle despite its Chinese focus, worked similar wonders with its first two coal mines as well. In public statements, however, the company has offered a rather simple – and incredibly vague -- reason for that success.
“L&L acquires small mines that lack the capital and management expertise to expand to the 300,000-tons-a-year minimum production required” by the Chinese government, the company explains. Then “we assign our U.S.-trained management team, including CPAs from the Seattle office, to monitor and control the coal operations …
“We have found that, post-acquisition, we are able to organically expand coal mining assets to a much greater degree by utilizing Westernized management and mining philosophies.”
As noted earlier, L&L has managed to achieve heftier margins than industry powerhouses in both China and the U.S. in the process. The market, impressed by L&L’s explosive growth and magical success, has rewarded the company accordingly.
L&L’s stock, which just moved from the lowly OTC Bulletin Board to the Nasdaq exchange last year, has enjoyed anincredible run. The volatile stock, priced at $1.50 a couple of years ago, now fetches more than $10 a share.
To skeptics who have combed through L&L’s regulatory filings, however, the company’s amazing numbers – the obvious fuel for that big rally – look too good to be true. In order to achieve its reported revenue, they say, L&L would have to not only record an astounding spike in coal production but also sell its low-grade coal at the generous prices normally assigned to premium coal instead.
By last summer, with L&L touting huge revenue gains and forecasting even better numbers to come, the company was already starting to field some tough questions – that largely went unanswered – about the value of its coal.
“When U.S. coal companies report, we hear a lot more about coal pricing,” Castlebury Advisory analyst Kenneth Pounds noted during a quarterly conference call hosted by L&L in the middle of last year. “Maybe you could give us an idea about the prices for your coal and … (some) color that would help us believe in your projections.”
L&L never offered a direct answer to that question, critics note, choosing instead to highlight the price assumptions – ranging from $110 a ton for raw coal to $200 a ton for “coke” derived from premium metallurgical coal – used to calculate the very “pro forma” numbers that reflect the inexplicable gains achieved by its newest Chinese coal mine. The company then went a step further by portraying those assumptions as “conservative,” they add, by citing the higher prices fetched on the spot market for premium metallurgical coal.
Last week, TheStreetSweeper sent L&L a list of questions – covering everything from its production rate and coal prices to its tainted CEO and outside auditing firm – but never received any responses from the company. It had by then uncovered a slew of troubling issues at L&L, with the most serious of those detailed below.
Regulatory Crackdown
Founded by Lee 15 years ago, filings show, L&L originally began operations as Lee & Lam Financial Consultants and spent a decade hunting for a lucrative business strategy before entering the hot coal-mining space.
Lee often doubled as a registered broker during those early years, records show, landing at J. Alexander Securities – a notorious outfit linked to numerous penny-stock scams – before later establishing his own firm. Federal authorities took steady aim at J. Alexander, records indicate, throughout Lee’s two-year tenure there. By the time that Lee’s registration there ended, records show, the U.S. Securities and Exchange Commission had executed seven different enforcement actions – and helped obtain four criminal convictions – stemming from just one penny-stock scam involving J. Alexander and its alleged accomplices.
Meanwhile, Lee & Lam evolved into L&L International Holdings and – together with its founder – soon came under regulatory fire itself. Between May of 2003 and July of 2004, government authorities claim, L&L raised $2.3 million through private placements by deceiving investors with baseless financial projections and concealing the generous commissions paid out for that fundraising activity. Notably, records indicate, L&L had not even settled on a specific business strategy – let alone launched actual business operations – at that point.
Nevertheless, regulators claim, L&L issued private placement memorandums (PPMs) that featured bullish profit forecasts for the company. In its first private offering, regulators say, L&L boldly predicted that its earnings would soar from $500,000 in 2003 to $5.6 million in 2004 and ultimately reach $19.7 million by 2005. (In reality, corporate filings show, L&L never even approached that final target until its coal sales suddenly exploded during the recent fiscal year.) In two additional private offerings carried out the following year, regulators say, L&L issued new profit forecasts that – while lower – still lacked justification as well. In all three cases, regulators say, L&L also intentionally concealed the fact that it would be spending 35% of the money it raised on broker commissions and fees.
Over the course of the next few years, records indicate, those offerings triggered sanctions from at least five different regulatory agencies. The Financial Industry Regulatory Authority (FINRA) focused directly on Lee, the company’s original founder and current CEO, slapping him with a $65,000 fine and a one-year suspension from the securities industry. Four states cracked down as well, records show, taking aim not only at Lee but also at L&L itself.
While most of those states simply issued cease-and-desist orders banning the defendants from future violations, records show, Connecticut originally went much further by barring L&L from selling any securities it its state for 10 full years. Connecticut enforced that ban for more than two years, records indicate, before finally agreeing to lift it at L&L’s request in late 2009.
Meanwhile, regulatory filings show, L&L spent those years busily reinventing itself and ultimately emerged as a Chinese coal miner with an explosive growth rate and an impressive record of success.
Coal-Fired Growth
According to those filings, L&L took its first step toward becoming an energy player in 2006 – the same year that regulators began targeting the company – by obtaining majority (and later full) control of a new subsidiary that would go on to purchase its first Chinese coal mines. But L&L spent a few more years dabbling in non-energy activities, filings show, before fully transforming itself into a pure-play coal company in early 2009.
By then, records show, L&L clearly recognized the market’s attraction to the lucrative coal industry. In May of 2008,records show, L&L loudly touted the fact that it had recently entered the “high-margin coal-mining business” when hiring CCG Elite Investor Relations – a firm popular with Chinese penny-stock companies looking to hit the big time – to manage its publicity. L&L portrayed itself as an accomplished operator already, records show, generating an estimated $32 million in revenue and $2 million in profits a year.
L&L issued that announcement one week after completing its 2008 fiscal year, records show, which would look somewhat less impressive – with actual profits coming in 30% lower – in official regulatory filings covering that period. But L&L soon found a cheap solution, records indicate, that could satisfy investors hungry for outstanding results.
Within weeks of that corporate filing, records show, L&L officially issued 400,000 shares of company stock valued at $4 a share to cover a 60% interest (later increased to 80%) in its first two Chinese coal mines. Based on that $1.6 million price tag, the total value of those mines came to less than $2.7 million at that time. When L&L closed the books on its fiscal year eight months later, however, those coal mines would look far more valuable.
With generous help from those two mines, corporate filings indicate, L&L saw its revenue almost double to $41 million – and its profits increase tenfold to $9.9 million – over the course of a single year. L&L’s stock, boosted by those numbers, was enjoying some explosive gains as well.
As 2009 drew toward a close, L&L proudly announced that it had won a RedChip Elite Company award for its “outstanding sales growth and stock price appreciation” for the recent 12-month period. The company pointed out that its stock had rocketed from $1.50 to $5 a share – recording a 330% gain – over the course of the past year and, even after that run, continued to gain more steam.
Armed with a new name and another Chinese coal mine, L&L then set out to deliver its best year ever.
Family Ties
By the first week of 2010, L&L Financial Holdings had officially changed its name to L&L Energy in a strategic move designed to better reflect its focus on the lucrative coal-mining business. Before the month ended, records show, L&L had finalized the purchase of its third coal mine as well.
From there, the flurry of activity continued. In mid-February, L&L finally escaped from the penny-stock arena bysecuring a coveted listing on the Nasdaq exchange. The company would later credit that move with providing “a significant boost to (its) volume and visibility” throughout 2010.
Within weeks of securing that listing, corporate filings show, L&L had already chosen a new leader for its Chinese operations. On March 9, filings show, L&L inked a deal with Paul Lee – the CEO’s brother – to serve as its general manager in China. Under the terms of that deal, filings show, L&L agreed to pay $5,000 a month to Paul Lee’s “insurance company” to cover a replacement so that he could focus primarily on his new job at L&L instead. L&L would then begin paying Paul Lee himself for his new duties when the fiscal year began on May 1, filings show, with his compensation set at $120,000 in cash and 30,000 shares of stock a year.
The value of that L&L stock, by itself, came to almost $325,000 on the day that Paul Lee became a paid employee. Going forward, filings show, he can score even bigger stock awards – some 100,000 shares over the next three years -- as bonus payments as well.
He is not the only relative of the CEO receiving money from the company, either. According to L&L’s corporate filings, Robert Lee – yet another brother – joined the company’s board at some point in 2008. Last year, filings show, he received $80,000 in cash and stock-based awards for that role. (His credentials look rather vague in company filings. His brief bio states that he "studied engineering and mathematics at Michigan State University," for example, but stops short of claiming that he secured an actual degree.)
Of course, as founder and CEO of the company, Dickson Lee pocketed the biggest payout by far. All told, corporate filings show, Lee received a compensation package worth $1.24 million for his service in the 2010 fiscal year. With his compensation set well above the industry average, those filings indicate, Lee ranked among the most highly paid CEOs in his entire peer group.
L&L’s compensation committee cited the company’s massive increase in revenue and profits – while specifically highlighting the fact that L&L’s stock had “more than quadrupled” in price – when justifying Lee’s generous 2010 paycheck. It then went a step further by stating that “this breakout performance culminates many years of work” by the company’s top leader.
As illustrated earlier, both L&L and its chief also came under serious regulatory fire on the path to that success. Since then, filings show, L&L has fielded dozens of questions – also focused on the company’s fundraising activities – from the U.S. Securities and Exchange Commission. At the time that L&L filed its latest quarterly report on Dec. 10, the company had still yet to fully address 38 of those 63 questions.
L&L had yet to remedy weaknesses in its internal controls – mandatory safeguards designed to ensure the reliability of financial statements – at that time as well. The company also continued to rely on an outside auditor, hired near the beginning of its gigantic growth spurt, with a notorious record of overlooking financial issues that could lead to material misstatements.
Painful Lesson
In late 2008, records show, L&L proudly announced that it had “upgraded” its auditor by hiring Kabani & Co. to review the company’s books. It described Kabani as a “top 30 SEC auditor” at that time.
By then, records show, Kabani had already weathered the first of two negative reviews by the Public Company Accounting Oversight Board (PCAOB) for its audits of other companies. In a report published earlier that year, the PCAOB noted that it had uncovered significant deficiencies in two of the four audit reports examined during a formal inspection of the firm. In response, records show, Kabani voiced a strong commitment to “achieving the highest level of audit quality” possible and indicated that it had already taken steps to remedy perceived shortfalls.
A month before its appointment as L&L’s new audit firm, records show, Kabani underwent a second inspection. This time, records show, Kabani fared even worse. When the PCAOB published the official results of that visit last July, it revealed that it had found significant deficiencies in five of the eight audits reviewed by its inspection staff. It flagged Kabani’s audits for a number of potentially serious issues, records show, including failure to sufficiently test revenue and identify/address deviations from generally accepted accounting practices.
Since then, Barron’s has spotlighted Kabani as a “popular auditing pick” for Chinese companies – many of them risky – that trade on U.S. stock exchanges. Barron’s pointed to Bodisen Biotech (OTC: BBCZ.OB), portrayed as “one of the earliest China blowups,” as a major ill-fated example. Once a red-hot Chinese winner, Barron’s noted, Bodisen soared to almost $20 a share before reversing course and ultimately plunging into penny-stock territory. The stock, now thinly traded, currently fetches less than 50 cents a share.
Less than two years after Bodisen’s spectacular crash, records show, L&L went on to hire the company’s former auditor as its own. At the same time, records show, L&L tapped Bodisen’s former audit chairman – attorney/accountant Patrick McManus (now deceased) – to serve as a “corporate advisor” to the company as well.
Like Bodisen before it, L&L has caught the attention of a veteran investigative reporter with a long track record of exposing risks at publicly traded companies before their stock prices collapse. Now the senior stock commentator for CNBC, Herb Greenberg recently highlighted potential red flags at L&L – including the CEO’s checkered past – in his bearish coverage of Chinese stocks.
By now, records show, Greenberg has been warning investors about risky Chinese stocks for years. In fact, records indicate, he ranked among the first to expose problems at Bodisen before that company crashed.
Afterwards, Greenberg delivered a haunting message that still resonates to this day.
“Next time you get the urge to invest in a Chinese company with a hot U.S.-traded stock and equally sizzling story, remember the name Bodisen Biotech,” he wrote in a March 2007 column that appeared in The Wall Street Journal. “Not all these small Chinese companies,” he emphasized, “are what they appear to be.”
* Note: No member of TheStreetSweeper’s staff or advisory board has ever taken a financial position in L&L Energy (LLEN) or received any compensation from others who have positions in the stock. As editor of the site, Melissa Davis will never take a position in any of the stocks that she covers. To contact Ms. Davis, the author of this story, please send an email to editor@thestreetsweeper.org.
