AXTI May Be On The Brink Of Collapse – J Capital Research

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J Capital Research’s report on AXT Inc (NASDAQ:AXTI).

Chinese headlines say its local IPO has failed. Its revenue is plummeting and creditors are at the door

The Chinese reports AXTI doesn’t want you to see

  • AXT Inc (AXTI), a manufacturer of germanium, gallium arsenide, and indium phosphide (key ingredients for LED and semiconductor chips) saw a 140% increase in share price in February, following management’s enthusiasm about AI opportunities.
  • AXTI is listed in the U.S., but its business operations are almost all conducted through a subsidiary in China. AXTI wants to list that subsidiary in Shanghai to capture new financing. But the listing prospectus attracted unexpected scrutiny and unveiled a plethora of undisclosed issues in China. Our research has found those issues are only the tip of the iceberg.
  • The listing vehicle raised $49 mln from private investors at a sky-high valuation in 2020. AXTI expected to capture much more investment at the time of the IPO. But it has been 18 months since the last IPO update, and U.S. investors haven’t been told that the IPO has apparently been blocked by Chinese regulators.
  • In March 2023, Chinese press reports said: AXTI’s subsidiary, Tongmei, saw its “IPO blocked: The U.S. semiconductor ‘shell company’ was split off for [a local] listing, related-party transaction prices were unfair, and the authenticity of company performance was questionable.”
  • We have uncovered a deluge of reasons why Chinese regulators potentially blocked this IPO, including falsifying data, tax evasion, improper storage of hazardous chemicals, suspicious related-party transactions, IP litigation, and defaulting on wages to employees.
  • Sales have collapsed by over 50%, and there is no reason to believe that AXTI can revert to its formerly reported margins and sales numbers, despite the claims that they make about AI demand.
  • We learned from interviews with former managers in China that production volume is down by at least 50% and sometimes up to 90%. They said production efficiency has also plummeted. Formers we spoke with see no end in sight to the low production.
  • When AXTI applied for its Chinese IPO, related-party purchases and sales were over 50% of revenue. Chinese regulators have expressed deep concern about those transactions.
  • AXTI’s production has been halted more than 10 times for environmental problems over the last five years. Chinese reporters depict this behavior as “puzzling” and point out that the company’s attitude toward regulation is almost one of disregard. There is no clear pathway for AXTI to fix these issues and get the Shanghai IPO, which is needed to fund further expansion.
  • Among the environmental woes: a government report points to arsenic contamination in the groundwater. We also learned in interviews of a 2020 fire at the Beijing factory that has not been disclosed to U.S. investors. That and the use of hazardous chemicals forced AXTI’s factory to move half its production to facilities 300 miles away, meaning production involves shipping materials on a 7-plus hour truck ride.
  • We show that the $99.3 mln at cost in buildings reported by AXTI is very unlikely. The buildings consist principally of a ramshackle factory in Beijing and a lot of dormitories in a tiny rural county in Liaoning.
  • We think AXTI’s inventories— which have soared to 1.3 years while sales fell – may not be there or may be dramatically overstated in value.
  • We have also uncovered potential nefarious activities related to the IPO by AXTI’s Chinese underwriter, Haitong Securities. Two related parties of Haitong Securities invested in the AXTI IPO, potentially to drum up interest and inflate the orderbook. Not only has Haitong Securities had 16% of its IPOs withdrawn, but it has been sued numerous times and warned by the CSRC. Haitong was forced to disgorge ¥28.6 mln in illegitimate profit and fined ¥86 mln.
  • If the IPO were to officially collapse, AXTI would owe more than $49 mln to Chinese investors. AXTI cannot handle this, as the company has only $40 mln in unrestricted cash and short-term investments. AXTI also had $53 mln in shortterm debt at end 2023 and limited operating cash flows for the last three calendar years.
  • These reporting gaps are unsurprising, given that AXTI’s CFO and audit chair, Gary Fischer, was previously banned for 5 years from acting as an officer of a listed company. While Gary Fischer was a board member of Integrated Silicon Solution, he was charged by the SEC for options fraud for backdating. He settled with the SEC and repaid over $500,000 in profits and penalties. Fischer was previously CFO of ESS, where two credible activist investors alleged undisclosed related-party transactions.
  • A Chinese export ban that took effect in December 2023 could affect half of AXTI sales.
  • The company has had plenty of troubles in its 20-year past: in 2004, AXTI settled a lawsuit that alleged “material misrepresentation concerning AXT’s operations and performance.”
  • AXTI’s business is in commodities. It is low-margin and cyclical. The company competes with large conglomerates like Sumitomo and is susceptible to even the slightest competition. We even see in AXTI’s filings that a former employee copied AXTI’s process and started his own company to compete.

Problems have rained down on AXT Inc. (AXTI) in China – where the company has nearly all its operations, but U.S. investors know little of the peril. AXTI sales have crashed, production plummeted, and environmental problems forced the company to move hazardous chemical operations to a rural county 300 miles from the factory.

AXTI raised about $49 mln from private Chinese investors who thought they could cash in on a Shanghai IPO of AXTI’s main operating subsidiary. But now sales are just 48% of what they were in the IPO prospectus,4 and operational problems plague AXTI’s Chinese operations.

The sales collapse plus multiple operation problems stranded the Chinese subsidiary’s IPO attempt. That gives Chinese investors an out. They invested at a valuation of $673 mln, over 3x that of the parent company’s current U.S. market value. A “gamblers clause” in the IPO documents gives the private investors the right to demand that AXTI return their $49 mln . With unrestricted cash and short-term investments of $39.9 mln as of December 31, 2023, $52.9 mln in short-term bank loans, and limited operating cash flows, we do not think AXTI can survive without a substantial dilutive equity issue in the U.S.

A confusing network of related-party companies supply AXTI with raw materials, lend money, issue dividends, sell AXTI bits of equity, and swap equity among themselves, mostly in a rural Chinese county far from the U.S. offices of the company’s highly questionable auditor and CFO. We question whether the U.S. executives have the ability from Silicon Valley to track operations at 12 subsidiaries, three equity-investee suppliers, 25 related-party companies, and many more Chinese entities that are loosely affiliated with AXTI.

The U.S. executives may prefer to keep one eye closed. The founder, the CFO, and at least one director have troubling histories: the CFO was charged with options fraud, the founder has been involved in multiple lawsuits, a board member was CFO of a company when it settled fraud charges, and the underwriters of both Chinese and U.S. listcos have been subjected to enforcement actions by exchange regulators. A legal opinion on the Chinese IPO offers the lukewarm comment: “AXT has not committed any major illegal acts in the past three years.”

We interviewed three former employees of AXTI China, who all said that production since early 2023 has been at no more than 50% of capacity, and a glut of competition means that sales will not recover. Chinese export and purchase bans on the materials AXTI trades in add a layer of geopolitical challenge that the company may not survive.

AXTI is a commodities company that engages in AI washing

AXTI manufactures ingredients for electronic items such as LED and semiconductor chips, including those used for AI. The company was founded in 1986 and went public in 1998, riding on the tech wave.

In February 2024, AXTI claimed that indium phosphide demand for AI chips could be the new driving force of the AI revolution, and AXTI shares skyrocketed 140%.. We think investors are in for disappointment, as we uncover what appears to be a short-term share-pump scheme in this company’s 20+ year history of being a small-time, journeyman materials supplier.

On AXTI’s February 22, 2024 Q4 2023 call, ATXI management hawked the AI dream:

We view AI as an emerging new application for indium phosphide that will develop in exciting ways over the coming years.

Morris Young

And what I think is surprising to us, I think, is the AI application. It first started something like 6 months ago, and we thought it was — well, first, the customer wouldn’t tell us it’s AI. And then they come back again and they want more in Q4, and they now give us yet another bigger order in Q1. So cumulatively [indiscernible], it’s in the millions of dollars of range. So — and this time, they also admit to us that it’s AI-related.

Yet AXTI sales have been collapsing.

AXTI revenue by quarter

Read the full report here.

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