Natural Health Trends Corp. - C (NASDAQ:NHTC)

Monday, January 7, 2019

Research

Natural Health Trends Corp. (NASDAQ:NHTC) ($19.77; marked down ~12%; $223.7M market cap), a direct-selling and e-commerce company that markets premium quality personal care, wellness, and “quality of life” products under the NHT Global brand, appears to be back in the Chinese media, as state owned CCTV aired a scathing piece that argued NHTC is running a deceptive pyramid scheme based on false product claims in China. As a reminder, we have previously written about NHTC, noting in 2016 that we believed its offices in China had been raided by the SAIC and subsequently shut down. Furthermore we provided evidence to back up our belief that the company was operating an illegal pyramid scheme. NHTC gets upward of 90% of its revenue from China.

A recent CCTV exposé followed in the steps of a major report in China on a company called Quanjian, which wound up being labeled a pyramid scheme by the government and seeing 18 of its members, including the company’s controller, being detained by authorities. Quanjian actually has a direct selling license in China, NHTC does not.

On January 5, 2019, CCTV Channel 13 (China Central Television is the predominant state television broadcaster in China) aired an 18 minute program that alleged NHTC was a pyramid scheme in China. The program interviewed people who had experience as members of NHTC and who subsequently lost money or saw their lives reach points of turmoil, including divorce, as a result.

The program also aired conversations where senior members of the company exaggerated the effects of the company’s products, including one called Noni Juice. According to the program, NHTC’s Noni Juice does not have domestic approval and registrations related to wellness foods.

People can become members of NHTC by purchasing about RMB 18,000 worth of products, and based on an online conference held by senior members of NHTC, members’ income is directly linked to how many new members they recruit. The senior member in the online conference called NHTC’s income model as “World’s 8th Miracle”.

The CCTV program also went through NHTC’s history in China. In 2004, NHTC was reported on by another CCTV program for being a suspected pyramid scheme (its company back then was called Lexxus International Co., Ltd). One month after that, NHTC registered another company to conduct similar business. In 2007, the State Administration for Industry and Commerce announced 17 pyramid scheme organizations, including NHTC’s Hong Kong branch. In the same year, NHTC changed its name again to the current name ???? (NHT Global), according to the CCTV program. NHTC’s stock was decimated and went to pennies as a result of the regulatory intervention. The stock subsequently rose in ensuing years as business in China again picked up “under the radar”.

The law expert on the CCTV program stated that NHTC’s business activity in China is a pyramid scheme because its business appears to be selling juice, but it actually makes money through recruiting members. The law expert further stated that if the activity is serious enough, it can be criminal.

Before the NHTC exposé aired on CCTV, there was a major report in China on a company called Quanjian, which was accused of promoting its products of being able to cure many diseases and operating a pyramid scheme in China. Quanjian has a direct selling license (NHTC does not even have a direct selling license in China), and according to the most recent update, 18 criminal suspects related to Quanjian have been detained for further investigation.

Back to NHTC, we believe this pyramid scheme investigation/reporting trend in China is directly from the central government and now that national TV and media are all putting their eyes on it, it is highly possible that regulators will step up to deal with suspected pyramid scheme companies, i.e. State Administration for Industry and Commerce Department, state and local police, etc.

Yesterday, NHTC put out a press release regarding the program aired on CCTV on January 5, 2019. In the release, NHTC:

“…rejects the claims made that Natural Health Trends is operating illegally in China. The Company believes short sellers arranged with associates at CCTV to create a deceptive exposé about the Company and its products attempting to misleadingly portray the business as a pyramid scheme.”

We believe, due to the current pyramid scheme investigation/reporting trend in China, the impact of this CCTV program to NHTC’s business in China could be profound, despite NHTC’s denial of any illegal business conducted there. It is obvious that reporter(s) in the CCTV program already know certain senior members of NHTC in China, so it is likely regulators would question those members or trace them to even higher-level members for investigation.

In addition, SAIC might go to NHTC’s China offices/branches for investigation. These investigations could negatively impact NHTC’s business operations in China, because people that were originally planning to become members of the company will likely hesitate and current members of NHTC might consider withdrawing their memberships based on the CCTV program. Furthermore, people that lost money as previous members of NHTC might step up and file complaints to local regulators, which would give regulators more incentive to investigate the company.

Another thing that investors need to pay attention to is that according to SEC filings, one of NHTC’s board directors, George K. Broady’s family trusts are sizeable NHTC’s shareholders, and collectively they pledged 2 million NHTC’s shares to secure a line of credit. The details of the share pledge agreement remain unknown and whether the share pledge has been released or not needs to be updated on the next proxy statement. If the share pledge is still effective, that means 64% of the total shares owned by Broady’s family trusts are pledged and 17.6% of the total shares outstanding of NHTC have been pledged. If the stock price of NHTC drops sharply due to this CCTV program and the share pledge is still effective, it is possible that whoever received NHTC’s shares as a pledge might be forced to sell the shares once certain conditions are triggered (i.e. a margin call).

To sum up, we believe there will be a dramatic negative impact on NHTC’s business in China due to this CCTV program in the immediate future. It is also possible there could be more bad news coming up, i.e. regulatory investigation, for the company.