Short Sellers: Good Medicine For China

| About: Montage Technology (MONT)

Semiconductor chipmaker Montage Technology (NASDAQ:MONT) could soon become the latest Chinese firm to de-list from New York after it accepted a buyout offer last week not long after its shares were hammered by a short seller attack. Like many of its US-listed Chinese peers that have also recently privatized, Montage learned the hard way that publicly-traded firms are often helpless in the face of short sellers that prey on weak and poorly governed listed companies.
While such short sellers are purely opportunistic, earning money when a company's shares fall, they also play an important role in developed stock markets by weeding out low-quality companies that might still attract unsophisticated investors. China should do more to promote a vibrant short-selling community as a more natural and effective way to clean up its own stock markets, where such weaker companies strongly resist regulatory pressure to de-list.

Shanghai-based Montage's history as a publicly traded company has been both brief and rocky following its listing on the Nasdaq last September. Its shares initially got a lukewarm reception due to skepticism about Chinese firms, but then surged toward the end of last year when Chinese technology shares suddenly became an investor favorite.

The company's shares jumped as high as $26 early this year, more than double their IPO price of $10, as a number of other Chinese tech firms also made successful IPOs after a two-year lull. But Montage's fortunes suddenly changed in February after a short seller accused it of inflating its sales by distributing products using a company it controlled.

Montage shares plunged as much as 40 percent following the accusations, though they later regained some of that ground after the firm denied the report. Still, memories of the attack were bad enough to convince Montage's board to accept a $700 million buyout offer that came late last week from Shanghai Pudong Science and Technology Investment Co, an asset manager owned by the Shanghai government. (company announcement, English article)

Montage shareholders must still vote on the offer on a date to be determined. If they accept the offer, Montage would become the latest in a long string of Chinese companies to de-list from the New York and Nasdaq stock exchanges over the last two years. Like Montage, many of those firms de-listed after coming under short-seller attacks. The biggest of those, Shanghai-based Focus Media, privatized last year in a $3.7 billion deal, after its shares plunged twice in the wake of assaults from notorious short-seller Muddy Waters in 2011 and 2012.

While short sellers have helped to keep Chinese companies honest on US stock exchanges, such predatory market players are nearly non-existent in China. Short selling was largely banned on China's two main stock markets until early last year, when the regulator expanded a trial program to allow a small group of brokerages to offer short selling services. But short selling was only allowed for shares of a small group of companies, meaning many of the firms most deserving of attacks remained invulnerable.

In the meantime, China's regulator has been struggling to find ways to de-list many of the poorest performers on the nation's two main stock exchanges. Rules exist for such de-listings, but companies often find ways to avoid such a fate by using accounting tricks to hide their losses.

The regulator made a modest breakthrough earlier this month when it finally succeeded in de-listing Nanjing Tanker, ending the company's 17 years as a publicly listed firm. Nanjing Tanker had already become a penny stock by the time of the de-listing, and the regulator was only able to make the move after the company reported four consecutive annual losses.

Had Nanjing Tanker been vulnerable to short sellers, it might have de-listed long ago after becoming regular fodder for attacks. Many of China's other poor performers that resort to accounting tricks to hide their losses may have also voluntarily de-listed to avoid such attacks.

Obviously China should move carefully in fully opening its stock markets to short sellers, since such traders are highly opportunistic and often rely on rumors, misinformation and even outright lies to harm companies that may otherwise have no problem. But a bigger role for such market predators could become an effective tool for cleaning up China's stock markets of underperformers, succeeding at a task where the regulator has largely failed.

Disclosure: None.