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Today I want to discuss how short sellers are spreading what I consider to be rumors about Chinese microcaps for their own profit.

By definition, an undervalued company is a company that the market hasn’t valued correctly for whatever reason. I want to illustrate two examples of how investors can systematically short undervalued companies, do perfunctory research, and continue to do so until they decide to cover their shorts and disappear, in most cases. I also wanted to discuss ways that companies can combat this, as it is fairly easy to deflect but imminently damaging if not combatted head on.

1. Oriental Paper (ONP) is case one. Muddy Waters Research, a firm that I believe appeared out of thin air to profit directly from a stock price decline in ONP, visited ONP for 90 minutes and put together a very well spoken piece claiming that Oriental Paper is a scam. The idea, in my opinion, was to spread fear. Fear is an emotion that drives action --- in this case, the action to sell. Oriental Paper responded to all the allegations as promptly as possible (see here).

Muddy Waters put out another piece almost immediately, continuing to discredit Oriental Paper's response, and then within a week took down all of their “evidence against ONP”, with the claim that they were “moving on" - effectively vanishing with their profits.

I think their disappearance stemmed from the likelihood that had their left their report up, they would be disproven systematically and sued in a court of law (as I think they should be). They single handedly destroyed $80M in company valuation.

A few notes you should check out are here, here and here.

2. China Biotics (OTCQB:CHBT) is case two. Andrew Left of Citron Research asks, "Where are the stores?" That’s the core of the argument that he made against CHBT. China Biotics responded to this threat with a listing of their locations (see here).

Citron then wrote another post discrediting the China Biotics update and continued to try to discredit China Biotics. This is still in action, but Jason Nevader helped write back (see here).

A few notes you should check out are here and here.

My Point

Once the leading shorts attack, more people follow suit. I don’t believe that this is a coordinated attack, just a group of people that are aware that they can help tear apart companies for a profit, then follow the leader to the next company. I could come up with a list of people involved in each case, whether they’re blogging, writing on message boards, submitting their articles to various syndicates, or what not. The point is that it’s not worth my time because these people change.

I've developed below a general system describing the system that I posit these short-sellers use to rob companies of their market valuations:

The Illegal Short Selling Game Plan

  1. Wait for weakness in the stock market.
  2. Wait for some well-known shorter to start making accusations.
  3. Write an article/research report/blog on an undervalued stock.
    1. Point out discrepancy between SAIC and SEC filings.
    2. Point out that it's a shell or reverse merger.
    3. Question the Auditors
    4. Point out a few stocks that share a similarity that got crushed
    5. Make a very limited video that neither confirms nor denies any business activity.
    6. Emphasize relative under performance.
    7. Link to an article from a website that sounds credible (at least three).
    8. Use biased language and don’t mention any positives.
  4. Wait for the company to come up with a response.
  5. Attempt to discredit their response.
  6. At this point in time, other short sellers step in and further attempt to discredit the company in question.
  7. If they're lucky, a law firm will step in and threaten to sue the company.
  8. Realize your profits if there are any.
  9. “On to the next one.”

Why Do I Care?

I work for China Growth Partners, where we intend to work with the most undervalued companies in the world to get their story out to investors like ourselves. We are by investors, for investors. We actually invest in the companies we represent. How’s that for accountability?

Mark my words: If you buy OTCQB:CHBT or ONP at these prices, one year from now you will have a position with an unrealized profit. As a wise man once said, if a business does well, the stock eventually follows.

You can’t prevent bashers from writing their reports. What can companies do to protect themselves?

  1. Stock buybacks.
  2. Share splits that require shares to be covered and presented to transfer agents.
  3. Share dividends.
  4. Video of operations.
  5. Pictures of operations.
    1. Note that sometimes this is not appropriate as it may divulge company secrets.
  6. Seek legal action against the bashers and their supporters.
  7. Make an example of the bashers.
  8. These are just a few ideas. For more ideas I recommend contacting my friend John Lux @ lux.investor@gmail.com

A few potential resources for learning more about this are here and here.

Disclosure: Author is long CHBT and ONP

Source: My Take on the Chinese Micro Cap Debate