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I am not afraid to admit when I am wrong, and I definitely appear to have missed the boat on China MediaExpress Inc. (OTCPK:CCME). Barring any ground breaking information or chest of gold hidden within the confines of the CCME compound, it looks like CCME has severely overstated many aspects of its business and simply conjured many cash balances. Despite warnings from Citron, Ian Bezek, Muddy Waters, Bronte Capital and pretty much every short on the planet, I was convinced that the stock was just an easy target. My convictions, as I was unable to fly to China on my own, were based on several factors that supported CCME as a legitimate company. I’m going to go over them, and see if we can potentially use them looking forward to avoid other scams.

Big 4 Auditor: What has Deloitte Touche Tohmatsu been doing all this time?

This is the biggest question mark for me. Remember, Deloitte signed off on the 2009 financial results. How did they manage that? Its involvement in auditing this company was one of the main reasons I felt the company was legitimate. And yet, it simply walked away from CCME after fifteen months (hired in Dec 2009 to replace the smaller Denver, Co., based firm A.J. Robbins PC) because of some concerns about representations by management? How did it go so long without having doubts about CCME’s earnings, cash balances or anything else? Did it have concerns and simply choose to ignore them?

The letter from Starr director and former CCME board member Dorothy Dong points out some accounting regularities that Deloitte apparently noticed on March 3rd. Deloitte stated that they were:

No longer able to rely on the representations of management, and recommended that certain issues encountered during the audit be addressed by an independent investigation. These issues may have adverse implications for the prior periods' financial reports… [and] further investigatory procedures would be required to determine whether the prior periods' financial reports are reliable.

Further investigatory procedures? You mean, like being the auditor and going through the books? Did it do any due diligence? If so, it wasn’t good enough. Deloitte was performing auditing services for months, yet it never protected shareholders in a reliable way. This serves to discredit this branch of DTT as an auditing firm, and potentially the ability of any firms to reliably audit in China. If Deloitte can’t tell an apple from a hand grenade, who can? If there was something going on, there should have been more transparency and communication with those who had the most to lose: CCME shareholders.

Large Investors: What sort of analysis did Starr do?

Dorothy Dong recently resigned as a board member of CCME. You can see her letter (here). In it, she points out some of the issues the auditor has with CCME and questions her ability to provide any value for shareholders while on the board.

Now, Starr is suing the CEO Zheng Cheng and former CFO Jacky Lam of CCME for misrepresenting various aspects of the business. They claim that CCME:

Significantly overstated the company's financial results in the period leading up to the purchase of shares.

If this was 8.8% of my fund, I would try to do some work on the ground to ensure the investment was sound. Did they visit the company? Check the contracts? Find the buses? Why would they be so certain of this company as a vehicle for millions of their dollars if they only relied on the papers they were sent and the numbers they contained? Starr has a duty to investors, and while they are suing CCME, I wouldn’t be surprised to see some uproar from people that have money invested in Starr’s fund. With the resources to invest $13.5 million into a company, I would expect they also possessed the resources to fly to China and do some legwork.

If you’d like to get some more of the details, the current case is re Starr Investments vs China MediaExpress et al, Case No. 1:11-cv-00233-UNA, U.S. District Court, District of Delaware. I will be interested to see how this case proceeds, given the history of legal differences between the United States and China. Whether or not there is any sort of consequence for such a blatant fraud for the Chinese perpetrators will play a big part in determining if Chinese investments are even riskier than we’d assumed.

On the Ground Research: Where did Global Hunter find information?

Global Hunter released an analyst note on February 17th that went over pretty much every red flag CCME had. I read the note and it seemed more specific and reliable than the notes released by other short firms that made seemingly broader accusations. The analyst, Ping Luo, traveled to the company headquarters, investigated relationships and more. It seemed to support my buy stance.

However, the misinformation contained in that report (which has been removed from the site) is the reason that Ping Luo left the firm last week. Whether she was fired or decided to fly the coop is irrelevant; her analysis of CCME induced many people not able to make the trip to China to feel more comfortable with the red flags surrounding CCME.

So, the questions for me remain: what sort of controls did Global Hunter have on her research? Was she the only one to make the trip and was there any sort of firm review of her conclusions? Why wouldn’t there be more due diligence performed by superiors on such a lightning rod stock? The fact that she was able to skirt such an obviously false report out the door at Global Hunter is disconcerting at best and criminally negligent at worst.

Class Action Suit: Shareholder information

If you have lost over $50,000 as a result of the situation with CCME, then I would urge you to look into the class action lawsuit currently under way by Hagens Berman LLC. This is one of the top class action firms in the nation, and you have until April 5th to participate in this suit. The email for this case is CCME@hbsslaw.com.

Conclusions

This stock should serve as a lesson not only for me, but for many investors who enjoy investigating risky assets. The presence of a Big 4 auditor is no longer a free pass. Although Deloitte did have a part in finally revealing CCME as a sham, it was slow on the uptake and not much help to the common investor. Its participation in approving 2009 results also served as a good sign in a sea of red flags. Furthermore, investors like Starr might be in the same boat everyone else is in. Assuming it has done any due diligence might be a leap of faith. For those of us who cannot travel to China to investigate, research reports in the area also seem more unreliable than not.

However, there are still plenty of great opportunities in China, and small caps will rebound. Eventually big research firms will start covering some of these companies and serve to “clean house.” I still stand by my belief that saying every Chinese company is a corrupt fraud is ignorant and borderline racist. If you invest in ten stocks and one of them turns out to be a scheme, you’ll still come out ahead. If this is something that has startled you, then Chinese investments might not be the best idea for you. As I’ve always said, these are high risk assets not for the feint of heart.

Disclaimer: This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.

Source: CCME: It's the End of the Line