China MediaExpress: Stocks to Watch in the Wake of This Scandal

by: Ian Bezek

It's been a bad week for Chinese companies formed by reverse mergers. China Agritech (OTCPK:CAGC) announced the formation of a special committee to investigate allegations against the company and it also dismissed its auditor. China MediaExpress (OTCPK:CCME), whose stock has been halted since Friday, announced Monday afternoon that its CFO has resigned and that its auditor has quit.

Both of these stocks have been vitriolic battlegrounds between longs and shorts. I previously warned investors to avoid China Agritech (OTCPK:CAGC) and I noted the huge skew in the options market suggesting that the smart money thought (correctly) that China MediaExpress was a fraud. Now it is time to look at other Chinese reverse-merger birthed companies that will receive special attention in the wake of the problems with China Agritech and China MediaExpress.

China Biotics (OTC:CHBT) -- Citron Research (who correctly called CCME too good to be true) also has been on China Biotic's case for the past year. Citron and other short sellers' research has appeared to show that most of China Biotic's 100+ retail stores were in fact figmentary. After Citron revealed that the stores most likely didn't exist, the company suspiciously and hurriedly closed the stores.

In addition to Citron's research, SA contributor Matt Berry noted additional problems with China Biotics. These include the fact that the company is earning way too little interest on its cash balance, the company's SAIC and SEC filings do not match, and that Chinese forensics accounting expert Zheng Zhaohui doubts the veracity of China Biotics' filings and cash balance. China Biotics shares are down more than 15% since Thursday's close and are down an additional 4% in Monday's after hours trading.

Oriental Paper (NYSEMKT:ONP) -- Muddy Waters, the short-selling research firm, now has a 2 out of 3 track record. It correctly called that something was wrong at both RINO and CCME and its only other report lambasted Oriental Paper, calling it wildly overvalued and a fraud whose purpose was to "raise and misappropriate tens of millions of dollars." Since Muddy Waters has been right on the other two bold calls it has made, it figures to reason that investors will assume Muddy Waters is also correct about Oriental Paper. Muddy Waters issued a price target for Oriental Paper of <$1 per share.

China Shen Zhou Mining & Resources (NYSEMKT:SHZ) -- Shares of this supposed rare earth metals play soared from 60 cents to more than 10 bucks in the past year. Lately, however, they've been in steep decline. This drop accelerated after Absaroka Capital put out this withering report (.pdf) on the company. Absaroka said that Shen Zhou is misrepresenting itself, its forward estimates are untrustworthy, it has had a string of low-quality auditors, and that it is misrepresenting its mined product, fluorite, as a rare earth metal when it is not one. Muddy Waters was sufficiently convinced by the report to tweet that it is shorting Shen Zhou's shares. The stock dropped more than 30% last week before a sharp recovery Friday.

In addition to these three specific highly-watched companies that will specifically receive attention due to China Agritech and China MediaExpress' issues, it is also worth keeping an eye on a few other Chinese companies this week. Citron Research also released negative reports about SinoCoking (NASDAQ:SCOK), and China New Borun (NYSE:BORN). Both SinoCoking and China New Borun are both well off their 52-week lows and could be vulnerable to selling pressure given that Citron's credibility regarding Chinese companies got a major boost in the wake of China MediaExpress' capitulation.

Also, it's worth noting that the aura of invincibility surrounding Chinese companies audited by Big Four auditors will be diminished. Other high-profile Deloitte clients that have been criticized by short sellers include: Feihe International (NYSE:ADY) and ChinaCast Education (OTCPK:CAST). In addition, China Agritech was audited by Ernst & Young. However, a quick glance through Ernst & Young's list of other clients doesn't reveal any stocks that short sellers have found interest in criticizing recently.

Regardless of your view of Chinese small-cap equities in general, pay close attention to the sector this week. In the wake of China MediaExpress' and China Agritech's disappointing news, there will be tons of indiscriminate selling across the sector. There will certainly be some bargains to pick up (my personal Chinese small-cap favorite, Actions Semiconductor (NASDAQ:ACTS), is down 20% in the past week on no news). There will also be some stocks that will make good shorts.

Remember, above all, that if a story sounds too good to be true, it probably is. Before trading a Chinese equity, either on the long or short side, do an extra round of due diligence.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.