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We’ve heard the warnings over and over on CNBC and on the internet: Beware of reverse merger Chinese stocks! Research firms, bloggers, some anonymous and short-selling hedge funds have done a number on many of these stocks. In too many cases the allegations have been proven correct, as Chinese company after Chinese company has imploded over the last year. Even the SEC finally got in on the act, belatedly as usual, issuing an Investor Bulletin warning the public about reverse mergers.

However, what if a completely legitimate Chinese company was to come to the U.S. markets through a reverse merger, simply to take advantage of the efficiencies of the reverse merger transaction? What if that legitimate company just wanted to save time and money and get a U.S. listing in an efficient and expedient manner? Sounds like what a smart company would do, right?

So if this legitimate company was to come under attack from short sellers, primarily due to the nature of its genesis, how could it possibly defend its reputation and separate itself from the “muddy waters” when so many companies in the reverse merger universe have fallen hard and the phrase “shoot first, ask questions later” has become the mantra for many shell shocked investors? The answer is: It’s really hard.

China Green Agriculture (CGA) is one of those many Chinese companies that used a reverse merger to gain access to U.S. markets, but one of only a handful that listed on the New York Stock Exchange. For the last year and a half, it has been in a desperate struggle to fend off short sellers. From bloggers to small research firms, the attacks have been relentless. The stock price has fallen from a closing high of $18 on December 9, 2009 to its current price of $5.30. Yet despite the barrage of attacks, the company continues to plug ahead with impressive revenue and EPS growth and hasn’t budged in its own defense like many others.

China Green Agriculture, registered in the state of Nevada, produces and distributes humic acid liquid compound fertilizer, blended fertilizer, organic compound fertilizer and mixed organic-inorganic compound fertilizer throughout 22 provinces, four autonomous regions and three municipal cities in China, in a country that must feed 1.3 billion mouths every day. It doesn’t take a rocket scientist to figure out that the fertilizer business in China is a growth industry. CGA’s gross margins (40% in the quarter ended March 31) are impressive. Maybe too impressive, according to some bloggers who don’t believe, or at least say they don’t believe, that the numbers are real. According to the Nasdaq website, CGA trades at a price earnings ratio of 6.2 on June 2010 earnings, 3.9 on estimated June 2011 earnings and an incredible 2.8 on estimated June 2012 fiscal year EPS.

Unfortunately, putting up great numbers is not enough when the basic credibility of the numbers themselves has been put into question. So what is a company to do? Well, CGA has taken a several steps:

  1. In September 2010, it directly responded to allegations of improprieties with regard to PRC Tax and SAIC filings and a land purchase and acquisition of Beijing Gufeng Chemical Products Co., Ltd.
  2. In November 2010, CGA hired Big Four accounting firm Ernst & Young to assist with internal auditing and Sarbanes-Oxley compliance.
  3. In January 2011, CGA voluntarily provided a comprehensive report on selected issues that were of interest to the SEC to the Los Angeles Office of the SEC.
  4. In February 2011, CGA directly responded to allegations of a “research report” that accused China Green Agriculture of misrepresenting information relevant to market share and sales.
  5. On page 25 of a May 2011 presentation, it reiterated its intention to upgrade its public external auditor to a Big Four firm although it still hasn’t completed this change.
  6. Just last month, CGA hosted a group of investors and research analysts at its Gufeng production plant to counter recent bloggers and “research firms” who posted unflattering pictures purported to be taken on CGA’s premises and made many allegations of CGA’s legitimacy.

Despite all these steps to defend its reputation and existence, CGA shares continue to trade at a valuation indicating that its credibility continues to be under serious doubt. The question to be asked is whether all these moves indicate that CGA is the baby that has been thrown out with the bath water.

Admittedly, I am in no position to independently ascertain whether CGA, or any other company for that matter, is on the up and up ... and neither are most other investors and analysts, as history has repeatedly shown. I haven’t visited the company and don’t plan on undertaking an audit of its books. However, if the company does finally prove its legitimacy to the market (and this is obviously where a big risk still exists) and it turns out that it was simply tainted by its reverse merger-fallen brethren, it could be the most undervalued emerging market fertilizer play in the agriculture space.

Source: China Green Agriculture: What if It's Legitimate?