Recommendation: Tibet Water Resources Limited (1115 HK):

Strong Sell A Shit Show!

Tibet Water Resources Limited (Tibet Water) produces branded

Price (as of 10/6/2017): premium bottled mineral water and barley beer in Tibet, China.
HKD 3.06 On Oct 4th 2017, Iceberg Research, an independent research firm,
released a brief note accusing Tibet Water of multiple financial
frauds. At Flaming Research, while we find the report to be overly
Market Cap:
simplified, we consider its allegations anything but false, malicious
HKD 7.9 billion and misleading. We are by no means associated with Iceberg but
we share the same vision of exposing fraudsters who have plagued
the Hong Kong market for too long. In this spirit, we feel the urge
Price Target:
to lend a helping hand this time to Iceberg and bring an extra set
of independent opinion to public investors.
DELISTED
Our research found the following incremental facts

- Tibet Water has overstated the revenue of its premium water

business

- Historical financials of Tibet Galaxy indicated that Tibet Waters

beer businesss financials are unreliable and profit is overstated

- Tibet Water has repeatedly acquired bogus businesses from

related parties to get rid of the overstated profit and nonexistent
cash

Our analysis shows the company generates no free cash flow and is
loss-making. Given its poor corporate governance, we consider the
equity value of the Company to be zero and should be delisted by
HKEx. We call for PwC to resign and SFC to commence a formal
investigation immediately.
 1. Tibet Water has overstated the revenue of its premium water business

Below is a breakdown of Tibet Waters water segment sales. They have two water products
on offer: the premium 5100-branded and the mid-range Gesang-branded.

2016 disclosures
Reported water segment sales (RMB m) 441
Packaging material sales (RMB m) 46
Water sales (RMB m) 395
- Gesang Spring (RMB m) 40
- 5100 (RMB m) 355
Source: Company filings and presentations

What interested us first is this highly suspicious item: Packaging material. Why would
anyone procure through Tibet Water, a plant located in the remote Tibet area? As far as we
know, Tibet Water doesnt own any plastics manufacturing plant and why would anyone
buy from the company rather than directly from the source? Aside from the commercial
considerations, 46m worth of packaging material can package a huge amount of water. Our
enquiries to plastic bottle distributors learnt that a 500ml PET bottle costs no more than
RMB 30 cents, which is consistent with what we found online1. 46m of packaging sales
therefore corresponds to 77,000 tons of water to be packaged by Tibet Waters customers.
We note that Tibet Water itself only manufactured 52,000 tons of water in 2016. It is very
perplexing to see why a premium consumer goods company has a side business supplying
larger amount of raw material to undisclosed customers.

A second question we have is on their 5100 water sales. Our research found that Tibet
Waters 5100 sales on JD and TMall are much less than Evian and Perrier.

On TMall, 5100 has three SKUs included in the top 20 best-selling premium water SKUs
(defined as ASP RMB100+). 5100s best-selling SKU is ranked 10th, way behind Evians. The
table below summarizes the sales in the past month on TMall for the three brands. Clearly
5100 sold much less than Perrier and was only a fraction of Evians sales.

ASP Volume sold in the previous Value in RMB

month
SKU1 139 1,238 172,082
SKU2 112 1,003 112,336

1
https://www.alibaba.com/product-detail/500ml-PET-water-bottle-plastic-
drink_60520002095.html?spm=a2700.7724838.2017115.57.790075102BmiQS
 SKU3 149 994 148,106
5100 total 432,524
SKU1 169 1,098 185,562
SKU2 170 1,153 196,010
SKU3 199 865 172,135
SKU4 200 838 167,600
Perrier total 721,307
SKU1 189 3,401 642,789
SKU2 219 2,376 520,344
SKU3 189 2,036 384,804
SKU4 169 1,558 263,302
SKU5 139 7,885 1,096,015
SKU6 189 1,147 216,783
SKU7 262 875 229,250
SKU8 119 672 79,968
Evian total 3,433,255

TMall Result Page (Oct 5th 2017; 5100 SKUs highlighted)

On JD, 5100 has three SKUs included in the top 20 best-selling premium water SKUs.
5100s best-selling SKU is ranked 8th, way behind Evian and Perrier. 5100s three SKUs have
much fewer comments (12,000 comments), a direct indication of sales, than Perrier
(65,000 comments) and Evian (38,000 comments).

JD Result Page (Oct 5th 2017; 5100 SKUs highlighted)

We believe the three brands online sales performance is a good proxy of their overall sales
in retail channels in China because

- Premium bottled water is mostly sold in tier cities where E-commerce is a

dominant channel for packaged consumer goods
- 5100 is equally, if not more, savvy in online marketing: 5100 has been a pioneer in
forming an E-commerce Alliance with over 10 leading E-tailers including JD, 1 Hao
Dian and Amazon2. 5100s online sales efforts, therefore, are very robust.

So how much do Evian and Perrier sell in China? Well, not a lot.

Euromonitor found that in 2015 the combined sales of Perrier and San Pellegrino in China
were only RMB 25m3. We interviewed a former sales of Evian who told us that at its very
peak, before China cracks down on corruption, Evian was selling 10,000 tons (~RMB120m)

2
http://www.zhuomaspring.com/news/show_148.html
3
http://www.chinairn.com/news/20160909/165519405.shtml
per year. Therefore we believe at its very best 5100s real retail sales are in the
neighborhood of RMB20 30m which correspond to roughly 2,000 tons of volume.

Management represented in its FY16 results filing that the revenue of our water products
from retail distribution channel accounts for more than 60% of the total revenue of our
water products. If what they represented is reliable, we believe the actual 5100 sales was
no more than RMB50m versus reported figure of RMB 355m. There is a shocking RMB
300m of sales missing.

The Company may well refute our claim that the online data itself is not representative of
overall sales. But we want to remind the management the risk of making such assertion. An
industry article we found specifically addressed the margin difference of different channels4.
It found that general retailing remains the most profitable channel and on-premise channels
can barely make money. If the majority of 5100 sales are not made through commercial
channels but through corporate clients or on-premise channels, the margin contribution
could be substantially below those from retail channels.

We request the management include a detail reconciliation of your eye-popping high

margin in the water segment in your counter argument. The reconciliation should detail
Tibet Waters by-channel distribution and by-channel margin. For a business that has
considerable amount of raw material, mid-end product margin dilution and limited
mainstream retail channel presence, we are scratching our head to understand why you
can record a 57% EBITDA margin!

4
http://www.ifooday.cn/news/food/20170920/76532.html
 2. Historical financials of Tibet Galaxy indicated that Tibet Waters beer
businesss financials are unreliable and profit is overstated

We believe Iceberg (maybe due to language barrier?) has not dug into the Chinese filings
of Tibet Galaxy (parent company of Lhasa Beer). We have summarized the key findings and
statistics below

2014 2015 2016

TIBET GALAXY
BEER SALES IN RMB M
398 390 357
BEER COGS IN RMB M
284 283 269
BEER SALES VOLUME IN TONS
92,229 88,768 81,242
BEER PRODUCTION VOLUME IN TONS
76,050 70,193 81,851
DISCLOSED PROCUREMENT FROM TIBET
WATER IN RMB M 110 107 122
IMPLIED OUTSOURCED PRODUCTION IN
TON 16,179 18,575 0?
ASP PER TON - OVERALL
4,315 4,393 4,394
AVERAGE COST PER TON - OVERALL
3,074 3,184 3,305
AVERAGE COST PER TON - OUTSOURCED N/M
6,811 5,782
AVERAGE COST PER TON - INHOUSE
2,279 2,496 1,786

TIBET WATER'S BEER BUSINESS

REPORTED BEER SALES IN RMB M
330 392 388
IMPLIED BEERS SALES FROM NON-GALAXY 220 285 266
CUSTOMERS IN RMB M
REPORTED BEER COGS IN RMB M
193 214 200
REPORTED BEER VOLUME IN TONS
54,453 62,467 60,456
IMPLIED BEER VOLUME SOLD TO NON- 38,274 43,982 60,456?
GALAXY CUSTOMERS IN TONS
ASP PER TON OVERALL
6,058 6,272 6,418
 ASP PER TON - NON-GALAXY CUSTOMERS 5,740
6,480 4,395
AVERAGE COST PER TON - TOTAL
3,539 3,418 3,313

Sick of seeing the lazy response from Tibet Water, we believe it would be mutually
beneficially for us to provide a detailed question list so that they can systematically address
the concerns of investors. Below goes our list:

- Was Tiandi Green Beverage Development Limited (the beer subsidiary of Tibet
Water) an OEM for Tibet Galaxy/Lhasa Beer in 2016 at all? If yes, why the disclosure
of Tibet Galaxy suggested there was very limited outsourced production in 2016?
What did you sell to Tibet Galaxy? Packaging material again?
- If the disclosure from Tibet Galaxy was reliable, your ex-Galaxy sales grew massively
from RMB220m in 2014 to RMB285m in 2015. As far as we know there was no
particular event in 2015 in Tibet that could contribute to your growth. Judging from
the lackluster sales performance of Galaxy in 2015 it didnt seem the market was
growing much either. Can you point to what geographies or channels that
contributed to the growth?
- Did you raise your product pricing for non-Galaxy customers by 13% in 2015 and
then slash it by a shocking 32% in 2016?
- Did you supply to Tibet Galaxy at RMB 6000+ a ton? Why did your outsourced
production service achieve higher pricing (RMB 6,811) than your non-outsourced
beer (RMB 5,740)? Why did Tibet Galaxy choose to outsource from a vendor whose
cost per ton was 3.0x/2.3x of inhouse cost in 2014/2015?

We find the high margin of Tiandi Green highly suspicious. If we compare Tibet Galaxys
revenue and gross profit in 2016 to those in 2009 when Green Barley was founded and
became a supplier, the revenue declined slightly but gross profit shrunk by RMB40m. Even
if we exclude all the negative external competition landscape (expansion of Budweiser into
Tibet for example), the maximum value leakage from Lhasa Beer to Green Barley should be
capped at RMB 40m which theoretically should be the gross profit generated by Tiandi
Green. Hence, we believe the real EBITDA of Green Barley is no more than RMB
40m and at least RMB 184m of profit was fabricated. A 40m profit is much more
sensible for an OEM!

2009 2010 2012 2012 2013 2014 2015 2016

Lhasa Beer sales (RMB m) 364 414 436 475 450 399 391 357
Reported gross profit (RMB m) 131 132 126 138 140 116 108 89
Gross margin 36.0% 31.9% 28.9% 29.0% 31.1% 28.9% 27.7% 24.9%

Our literature search online also finds some very confusing information on the relationship
between Tibet Galaxy and Tiandi Green. For example, an article in 2011 published on China
Commerce News5 mentioned that Barley Beer was an integral part of Lhasa Beers
premiumization strategy to drive revenue growth. To us this suggests that theres limit
division between the two companies.

Separately we notice that Tyee Capital, a private equity fund managed by Mr. Frankie HE
Chengzhang 6, invested HK$525m in Tibet Water in the form of private CB in Jun
2016. The same Mr. He was the legal person of Tibet Tianyi Longxing Investment Limited
until Mar 2017 which is the largest shareholder of Lhasa Beer. Therefore, we have every
reason to believe that Lhasa Beer and Tibet Water are indirectly connected but Tibet Water
chose to hide all the sketchy connections behind the scene.

Executive Changes

# Date Date
Before
Date After

HE Chengzhang, WANG Dong WANG Chengbo, GUO Kunkun

Responsible Person Changes

# Date Before After

HE Chengzhang WANG Chengbo

Source: Tianyancha; translated

All these findings push us to wonder: Does Tibet Water really own Tiandi Green?

5
http://www.zhifang.com/news8/3951.html

6
http://tyeegroup.com/en/ceo_message/
 3. Tibet Water has repeatedly acquired bogus businesses from related
parties so as to get rid of the overstated profit and nonexistent cash

If you dont have the free cash flow, you dont have anything.

- Leon Cooperman, Omega Advisors

Mr. Cooperman couldnt have summed it up more nicely for Tibet Water: As a Company
that fails to generate free cash flow since 2013, we genuinely question if Tibet Water is
worth anything. Tibet Waters negative free cash flow proves our thesis that Tibet Waters
profit was fake and had to be get rid of by fake acquisitions.

Over the past four financial years, the management flushed over RMB2bn of profit down
the toilet in two highly suspicious transactions: Tiandi Green (Barley Beer) and Highland
Natural Water. We found that they share a few common traits:

o Founded with modest initial investment from its exiting shareholders

o Expensive valuation multiples
o Acquisition of shares from related parties
o Windfall profit for the exiting shareholders

800

600

400

200

-200

-400

-600

-800
2008 2009 2010 2011 2012 2013 2014 2015 2016
Cash from Investing (33) (48) (17) (601) 71 (438) (614) (488) (608)
Cash from Ops. 27 60 93 157 520 365 555 438 215

Cash from Ops. Cash from Investing

Source: Capital IQ

As mentioned in the previous chapters, Tibet Water barely generated any profit after
adjusted for the overstated revenue and understated cost. To get rid of the excess fake
cash on the balance sheet, Tibet Water paid a very high price for the two companies which
reduced the cash balance at hand. Because the sellers were related parties (which Tibet
Water intentionally did not disclose), they would not moan about the fact that they never
received the reported consideration. Such tactic is commonly employed by Chinese frauds
such as China Hongqiao (1378 HK), Shenguan (829 HK) and Rexlot (555 HK).

The Tiandi Green acquisition

Since Iceberg has provided analysis on Tiandi Green acquisition, we will just add one
anecdotal detail we uncovered: An interesting name change for one of the exiting
shareholder Guangdong Hanteng. In 2015 its registered name changed to 5100 Cosmetics
a clear sign that it was somewhat related to the Company.

Changes in registration

Date Item Before After

Co Guangdong Hanteng Economy Guangdong 5100 Cosmetics

name Development Limited Company

Source: Tianyancha; translated

The highland natural water acquisition

Tibet Water completed another bogus investment later in 2014 in a low-end natural water
producer called Tibet Highland Natural Water Limited (THNW). THNW was in many ways
similar to Green Barley:

- A short operating history: 4 years, same as Tiandi Green at the time of acquisition
- High valuation: 42x current year net income, which was much higher than listed
comparables, not to mentioned the fact that Tibet Water itself was only trading at
mid-teen multiples
- Windfall profit for exiting shareholders: Tibet Water acquired the first 20% interest
in Highland Natural Water from Tibet Ruiyufeng Enterprise Marketing & Planning
Co., Ltd.* (). Tibet Ruifeng was founded in 2013
 with a total paid in capital of merely RMB10m. This 60x return in one year is simply
too good to be true!
- Cooperation with SOE: Like the CRE water procurement deal, Highland sells
exclusively to Sinopecs convenient stores on highways

RMB m 2012A 2013A 2014E 2015A 2016A

Revenue 3.0 19.0 150.2 297.0 472.0
Net profit 0.5 8.1 71.2 68.0 82.0
P/E 6000x 370x 42x 44x 37x

First 20% stake consideration 600

Second 13% stake consideration 390
Third 7% stake consideration 210
Implied equity valuation 3,000

Source: Company filings

 4. How much is Tibet Water worth?

The table below summarizes the adjustments we apply to the reported financials. We believe
the Company is loss making which is consistent with the free cash flow of the Company
analysed above.

RMB M FY2016
REPORTED PROFIT BEFORE TAX 391
UNDERSTATED MARKETING COST (ICEBERG) -100
OVERSTATED WATER REVENUE -300
OVERSTATED BEER PROFIT -184
ADJUSTED PROFIT BEFORE TAX ~-200
 5. Why should SFC take immediate disciplinary action?

We are very sick of seeing SFC taking its usual bureaucratic stance on such blatant criminal
offenses. The incompetence of the regulator is spelled out in every single previous case
where they stepped in only when the loss to investors was permanently irreversible. HKEx
is probably by far the most unregulated market among developed economies and SFC is
the most powerless, or maybe retarded, regulator we have ever seen.

For example, SFC started its investigation on Hanergy on May 28, 2015, two weeks after
the collapse of the stock. For such an obvious, level-one market manipulation that had
been going on for almost a year and drawn international attention, it is puzzling to see why
the officials at SFC needed so much time to take any legal action. What is pathetic is that
after two whole years the case has not concluded and the stock remains suspended but not
delisted. Mr. Li, the mastermind of Hanergy, remains the chairman of Hanergy instead of
doing his time behind bars. Ironically, he recently re-emerged in front of lime lights and
vowed to rebuild Hanergy.7

Apparently SFC has some good manpower to prevent Hanergy from happening. It currently
employs 202 enforcement officers and 50 supervision officers to deal with such incidences.
Are these officers under-paid? Not really because not only the average compensation per
SFC staff was well above HK$1m but also that in its 2016/2017 budget some HK$31.56
million was specifically set aside to handle an increasing number of enforcement and
litigation cases and maintain adequate supervision of a growing number of intermediaries
within the Hong Kong market. We definitely hope such vast amount of public money will
not be flushed down the toilet.

7
http://news.91.com/content/s59cf6489d658.html
Tibet Water is a sophisticated market manipulator. It has employed a long list of brokers
including China Industrial Securities, BNP Paribas and BOCI, to place large-size buy orders
to stabilize the pricing right after the release of Iceberg report. The same China Industrial
Securities and BOCI offloaded their positions quietly in the afternoon on Oct 4th, exploiting
the deficiency of T+0 settlement in Hong Kong. Before the market closed on Oct 6th, the
brokerage firms jacked up the closing price from $2.95 to $3.03 at 4pm and eventually to
$3.06 at closing cross. From the chart below there has been 73m/111m shares changed
hand on Oct 4th and Oct 6th, which are dramatically above daily average volume of 3.6m
shares in the past 12 months. Our concern is that the individual investors are up against a
consortium of market manipulators and SFC needs to step in more forcefully and timely.

Tibet Water daily price/volume traded in the last twelve months

Tibet Water intraday share price/volume traded on Oct 6th

Even before the release of the Iceberg report, Tibet Water had been manipulating the
market price with the same tactic mentioned above. The following chart shows the intra-
day share price of Tibet Water in September 2017 where significant price movements
appeared on high frequency in the last 30 minutes of trading. As mentioned in an analysis
of how Hanergy manipulated the share price on Financial Times, this sort of regular pattern
is not random but manually intervened. For readers easy reference, we have included the
same chart for China Dongxiang (3818 HK) which shares a similar market capitalization and
daily liquidity. Clearly for an unmanipulated stock, China Dongxiangs daily trading activity is
much more smooth without swings within the day.

Tibet Water share price movements in Sep 2017

China Dongxiang price movements in Sep 2017

Unlike some recent frauds (Huishan most notably) where the shares were closely held by
friends of the mastermind, 60% of Tibet Water is now held in the hands of non-institution
investors, ie individual investors. If SFC again takes a wait-and-see approach, chances are
some HK$5bn worth of shareholder value would evaporate ultimately. Should that happen,
SFC officials may be greeted by groups of disgruntled individual shareholders on their way
to office every day.

Shareholding structure of Tibet Water

Source: Capital IQ

Investor protest after 2002 penny stock crash

 6. Why should PwC resign immediately?

Judging from the dwindling audit fee of PwC in the past three years, we believe that their
ability to conduct extensive assurance work was increasingly handicapped over the past three
years. There can be two hypotheses here:
- Tibet Water is cutting cost because the main business is bleeding, or
- Tibet Water is limiting the scope of work for PwC

Audit fee in RMB m

8.0

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0
2014 2015 2016

Audit fee in RMB m

We challenge PwC to answer the following simple questions:

- Have you checked if the amount of beer packaging material matched the volume
they claimed to be selling? Have you checked if the amount of beer packaging
material from Lhasa Beer matched the procurement amount disclosed?
- Have you inquired Zhejiang TV on the advertising fee of their program sponsorship?
- Have you talked to their distributors of 5100 and ensured the relationship was
commercially legitimate?

If you cannot answer the above questions, it may be in your best interest to resign!