BARRON'S(6/25) Asian Trader: Chinese Medicine Show

(From BARRON'S) By Leslie P. Norton

Few investing concepts are as hot as China, so it's no wonder that companies are rushing to tap the well. One is Big Board-listed American Oriental Bioengineering (ticker: AOB), a Chinese herbal medicine outfit that this week plans to sell 13 million shares in a secondary offering. At last week's price around $9.30 per share, the deal would raise $140 million, equivalent to nearly a quarter of its market value. Chief Executive Shujun 'Tony' Liu will sell another 2 million shares.

Watch out. For such a small company, there are a lot of big questions, along with a history of muddled disclosures and misleading claims.

AOB is based in the city of Harbin, in China's northeastern Heilongjiang province, and began life in the U.S. stock market in 2002, when it came public via a reverse merger on the bulletin board. It moved to the American Stock Exchange in 2005, and last December, jumped to the Big Board. Off about 20% this year, it trades for just under six times its 2006 revenues of $110 million, though underwriter Brean Murray believes those revenues will jump to $193 million in '08.

If that happens, it means customers aren't looking very closely at two key product lines: a prescription soft-gel and over-the-counter adhesive patch to treat bed-wetting, and over-the-counter soy peptide products, which AOB has in the past suggested can inhibit the growth of tumor cells.

Packaging for both carry misleading claims. The 'UrinStopper Patch' package says it contains 'radioactive photons' that 'warm the acupoints.' But Maryland Heights, Missouri-based Chemir Analytical Services, which analyzed the patch for an investor, says it detected no radioactive elements. Meanwhile, packaging for AOB's SoyPeptide powder says it has 'patent technology from University of California, Berkeley.' But an official at a U.C. Berkeley's Office of Technology Licensing says, 'They are not one of our licensees.'

AOB chief executive Liu and other officials declined to be interviewed, citing the quiet period before the offering, but their outside investor-relations firm referred Barron's to relevant filings and answered some questions via e-mail. AOB confirmed it doesn't use technology from U.C. Berkeley. As for the patch, it says only that it was approved by Chinese regulators who required pre-clinical trials of the products.

AOB intends to become one of China's largest pharma outfits, and plans to use part of the offering proceeds to buy a Chinese company for up to $30 million. Yet things haven't always gone according to the plans it announces. In March 2004, it said its primary objective was 'to penetrate the U.S., European and Asian markets,' and in September 2004, that it was busy 'expanding [its] nutraceutical and pharmaceutical business in the U.S.' In earlier releases, it said it got 5% of sales from Japan and 20% from Korea, and that it had established a distribution arrangement in the U.K. and Europe. But in its June offer document, it says, 'We currently sell our products mainly in China. China will remain our primary market for the foreseeable future.'

Liu became chief executive in 1994, according to AOB, after a long career with the People's Liberation Army and as a top official with Heilongjiang province. Another top official of Heilongjiang province, Wang Xianmin, helped introduce AOB to reverse merger specialists in the U.S., and Wang Xianmin became a director of AOB in 2005. Wang was also reportedly a driving force behind the initial public offering of Daqing Lianyi Petrochemical.

In 1999, according to the Wall Street Journal, regulators found that Daqing Lianyi executives had bribed officials to facilitate its IPO. AOB's response: 'Wang Xianmin was appointed to the Board of Directors as of January 19, 2005. Based on the Company's due diligence at the time he became a director, including a review of official [people's republic of china] documentation, the Company does not believe further disclosure in its public filings is required.'

Also helping AOB in its long march to the New York Stock Exchange were a couple of characters associated with penny-stock frauds. One was Mid-Continental Securities, which received shares from and was a consultant to AOB until '04. Mid-Continental was controlled by Mark Anthony, who had been barred in 1997 from associating with brokers and investment advisers or participating in penny-stock offerings. In 2005, AOB was using CEOcast, a Website that hosted video clips and sent out newsletters about small-cap stocks, for investor relations.

As my colleague Bill Alpert reported last November, CEOcast was controlled by Michael Wachs, who in 1997 served 11 months in federal prison and agreed to be barred from the banking and brokerage industries. Wachs didn't return calls, and AOB said: 'We do not currently have relationships with Mid-Continental Securities nor with CEOcast.'

Expect the questions to keep coming.