Are Chinese Firms Done with America?

Jim Trippon Editor-in-Chief, China Stock Digest

First European companies delisted in the US because of tedious oversight restrictions, and now it looks like Chinese firms are moving in a similar direction, after waves of attacks on good and bad stocks, reports Jim Trippon of China Stock Digest.

With the recent announcement that China’s major electronic advertising and display company, Focus Media Holdings (FMCN), was entertaining an offer to go private, observers are asking whether or not this will be the beginning of a stampede of Chinese companies getting out of the US and Canadian stock markets.

The potential deal, which is said to value Focus at $3.5 billion, is said to include the company’s chairman, Jason Nanchun Jiang, as well as private equity firms Carlyle Group and others. While a company spokesman said the move is because the company is undervalued, Focus has been a target of accusations of accounting irregularities by research firm Muddy Waters

Muddy Waters has made a highly visible practice of calling out many Chinese public companies due to what it alleges are questionable business and accounting practices, something that also has led to extensive short selling in some of the stocks. It accused Focus Media of overstating the number of display panels it had. These display panels are the heart of its advertising business, and the company denied the accusation, insisting instead that it had accurately reported their number.

Independent research agreed with Focus’ contention. Yet the stock plunged on the allegations, from just under $26 a share to around $15 a share on high volume (see chart below), attracted a flurry of short selling, and took roughly six months to recover.

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Focus management expressed two constant complaints regarding the allegations by Muddy Waters and its founder, Carson Block. One, that the share price had been damaged by unproven allegations, and that the climate of attacking the integrity of Chinese companies without benefit of proof was keeping the value of company shares on the US exchanges artificially low.

There has been a spate of such accusations against Chinese companies in the last couple of years, some with dramatic effect. One of the most widely heralded attacks, against Canadian-listed Sino-Forest (Toronto: TRE), famously a John Paulson hedge-fund holding, alleged fraud, accusing Sino-Forest of deliberately misleading regulators and investors with its overstatement of assets and its accounting practices.

Subsequently, after heavy short selling, the company was delisted and filed for bankruptcy. Despite being accused of fraud by the Ontario Securities Commission, Sino-Forest management still denied the accusations, however, and threatened to sue Muddy Waters.

Other, smaller Chinese companies, against the backdrop of a dispute between the US and China over the amount of accounting oversight required of Chinese companies by the US that list on US exchanges, are leaving the markets instead.

The Chinese companies have complained of the onerous burdens of too-heavy regulation placed on small cap, micro cap and newly public companies, and deny that accounting irregularities or fraud is taking place. So instead, many have opted to de-list their companies in the US or Canada.

While the feeling with many China critics is that all Chinese companies have questionable accounting, a view expressed by Hong Kong fund manager Marc Faber, this is hotly disputed by management of most Chinese firms.

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There have been other allegations, often vague, which have gone unproven against companies, yet their stocks have been damaged. Investors may remember the attacks on Chinese fertilizer company Yongye International (YONG), as well as attacks on many other larger Chinese firms, including but not limited to Spreadtrum Communications (SPRD) and Zhongpin (HOGS). Here is where the issue becomes cloudy, even muddy, no pun intended. The stocks were damaged but the allegations were unproved.

Issues of Fairness
Investors who have followed the series of attacks on Chinese companies can notice a pattern. For every Sino-Forest or poorly run obscure micro-cap, there are legitimate companies being attacked, and even when they point to their accounting and earnings reports, or even SEC filings, they’re simply not believed.

The short sellers are opportune, and they are clearly more than just talking their book with their aggressive attacks. A disturbing facet of this is that after Focus received independent correlation of its display outlets, this refutation of the allegations did nothing to stem the attacks.

Also, the insidious broad-brush attacks on an entire class of stocks when the VIE, or variable interest entity structure, was attacked by China critics, temporarily tarred a lot of Chinese companies that had done nothing wrong, via indiscriminate and irresponsible attacks. This included large Internet players such as Baidu (BIDU), Sohu (SOHU) and others.

Yet there are never any consequences for the short sellers who so brazenly attack so many companies. While there are Chinese companies that no doubt have accounting and reporting issues, the China shorts and the China bears take that opportunity to condemn them all, then profit. And that might be the bigger problem.

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