If you're looking for proof that we are in the midst of a stock market bubble, look no further than VisionChina Media (VISN). The stock has produced a stunning 1300% return over the last 3 months! Clearly Wall Street isn't being fazed by its deteriorating fundamentals, such as a string of losses, decreasing revenues and negative cash flows. Instead, a brazen group of momentum traders - with a gross disregard for valuation models - has turned VISN into the hottest stock of the 4th quarter. This type of fevered trading is emblematic of a market gone wild, flooded by cheap money and a shortage of common sense.
Nothing about VISN has improved, except the stock price
For most of 2013, VisionChina Media was a comatose $2-$3 stock, with measly market cap of about $10M. With already one reverse-stock split in hand, the stock was destined to be delisted from NASDAQ and slowly fade into OTC oblivion. In fact, it was averaging less than 20,000 in daily volume. Then suddenly all hell broke loose on October 7th! That day, the stock vaulted 85% on no news whatsoever, with more than 1 million shares changing hands. And that's on a stock with barely 5 million shares outstanding!
VISN remains a mess of a company
VisionChina Media operates a network of TV displays in Chinese subway cars and buses, where it bombards commuters with its ads (or as the company bluntly puts it: "compulsive viewership inside enclosed spaces"). What can be better as an investor than getting in on the ground floor of a burgeoning industry, with a captive audience, in a country quickly embracing capitalism? Although the pitch is compelling, the sad reality is that VisionChina Media isn't the ticker to bet on! Regardless, the company is hoping that if it can keep talking about how attractive the overall market will become, it can distract investors from the company's own inability to capitalize on this opportunity thus far.
What can explain this insanity?
VisionChina Media now has a market cap of more than $150M. That means $140M of "wealth" has been created over the last 3 months by traders, without even a peep from the company itself. To understand why, let's first look at few plausible explanations:
- A takeover attempt? While there was early speculation that Focus Media Holding could be interested in acquiring VisionChina, this rumor never panned out. The same goes for any talk of a take-private offer from one of the company's insiders. Nothing has materialized despite the fact that the company could have been bought 12 times over by now, given its ridiculous volume in Q4 alone. Clearly, if someone wanted to make a move, they could have done so already. We therefore have to rule out any M&A activity as a possible catalyst for this surge.
- A short squeeze? True, VISN is now nearly impossible to short. While this may give the impression of a scarcity of supply, it's actually the result of a dramatic increase in the number of new short positions. According to NASDAQ data, the number of shares held short skyrocketed in early October, from 9,298 to 554,528 today. (By the way, my heart goes out to the courageous investors who are still short VISN. There's no doubt they will ultimately be proven right, but they might go broke long before that day finally arrives.)
- An earnings surprise? In November, the company reported earnings slightly worse than the one lone analyst following the stock had forecasted. So it stands to reason, an earnings blowout is not what is fueling this stock's meteoric rise.
- A resolution to a pending legal case? You'll remember that in 2011 a New York judge ordered the company to fork over $60M to former investors for breach of contract. Basically, VisionChina Media made the first payment on an acquisition, but failed to make the last two after taking ownership of the company. Oops! The judge has even held the company in contempt of court. And yet to this day, the company hasn't paid a dime. Instead, the VisionChina Media claims to be "negotiating" with the plaintiffs. Most likely, management knows that the court is powerless to enforce the ruling, since the company has no American assets and is incorporated in the Cayman. But being in clear violation of U.S. law hasn't stopped investors from trusting VisionChina Media with their money.
- Sympathy buying? Lately, small-cap Chinese stocks have been recovering from a guilty-by-association sell-off that occurred two years ago. That's when several of their peers were exposed as reverse-merger pump & dumps, built on nothing more than fraudulent accounting and the naivety of American retail investors. Now that the dust has settled, perhaps the Mr. Market is finally realizing what gems the surviving companies truly represent? Yes, a string of equally beaten-down Chinese companies have been riding a wave recently (e.g. Daqo New Energy Corp - which shares a common director with VisionChina - tripled in value during the same period). However, none of these run-ups have even come close to being a 13-bagger like VISN. Therefore, it's likely that VISN's price isn't purely a reflection of sudden and renewed confidence in Chinese accounting standards.
- Improved fundamentals? Keep in mind, this is a company that has diluted shareholders in the past, hasn't turned a profit since 2009 and has a trailing gross margin of -40%. Over the last year, it burned through $27 million in cash. Plus it has that legal obligation to pay over $70M in damages and court fees, or about twice the amount of cash on hand. It has another $31M in debt. And its book value is less than $4. Enough said!
- Insider information? In a country not known for its transparency, it is hard to determine if there are any insiders profiting from the recent volatility. But from the absence of Form 4s filed with the SEC, we are forced to assume insider ownership hasn't budged and still represents about 12% of existing shares. Then again, this isn't a company that believes in prompt filing of SEC paperwork. Remember that VISN wasn't able to file their last annual report on time. Despite announcing their non-audited results to investors on April 8th, it took nearly 2 months and a few deficiency letters from NASDAQ to finally file their GAAP financials.
- An analyst recommendation? There's only one analyst still covering VISN and they currently have a 'sell' recommendation on the stock. In fact, they are expecting the company to lose almost $8 per share this year and about $5 next year. Clearly, the company's prospects are far from stellar.
- Good press? The only people that are writing about the stock are equally perplexed about the market's reaction. For instance, SA contributors 'Investor RockieK' and 'Christopher Drose' wrote a pair of well-reasoned articles questioning the rally when the shares were still trading in the high single digits.
- Momentum traders? Most likely, chartists and day traders are completely enamored by this stock. In its most recent run, VISN never dropped below its 50-day or 200-day moving averages, while the MACD line didn't cross back below zero. However, these technical indicators are totally detached from reality. The true test of a bull market run amok is the prevalence of the 'greater fool theory'. It doesn't matter if the company is overpriced, as long as you can find someone else to buy your shares at a higher price, why worry about valuation? Well, VISN is the perfect type of stock to inflate without having to worry about it bursting. It has little analyst coverage, a small float, strong shorting constraints and a lack of tradable options.
What could justify these exponential returns?
It turns out the irrational exuberance of momentum traders is only plausible explanation of VISN's recent valuation aberration. This type of positive feedback loop is predicated on the scarcity of reliable and impartial information about the company. VisionChina Media isn't quite the household name, even in China. Compounding the problem is the foreign language barrier and its complicated ADR structure, making it hard for investors to conduct their due diligence. (Though if anyone can provide an alternative explanation as to why the market is trading up this shady stock, please feel free to share).
VISN could double again before market efficiency is restored
Sadly, there's no easy way to profit from this madness. Even though most brokerages won't let you short a stock with a 3.88 beta, a few like Interactive Brokers are more trusting. But unfortunately, they too have no shares to loan. In late September, IB had about 60,000 shares available at a decent 5% rebate rate. Indeed, those shares dried up in the October run-up and now their inventory stands empty, with a prohibitive 80% plus loan rate, if ever shares could be located (which I wouldn't recommend anyway). On the arbitrage side, the stock belongs only to 1 ETF, a NASDAQ small cap fund (PQSC), which means you would need to go long on 876 other stocks to be able to short the ETF, not a very practical or profitable strategy.
Buyer and seller beware
Don't let the $30-or-so stock price fool you; VISN is a penny-stock at heart! VisionChina Media has always been more concerned about touting its company to investors than selling its service to paying customers. Why the SEC or NASDAQ allows this joke of a stock to keep trading is beyond me! While I suspect some sort of price manipulation is taking place, without being in the loop, I can't be certain. But one thing is for sure: VISN will eventually fall and it will fall hard. And when the music finally stops, a bunch of unlucky momentum traders will be left holding the bag!