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This is the second article in a three part series detailing fourteen high conviction short ideas for a market on the verge of a significant breakdown. See Part 1 » and Part 3 »

China Shen Zhou Mining (SHZ)

There has been no better short-side trade than shorting Chinese reverse mergers in the past few months. While China Shen Zhou Mining has already seen its shares fall sharply, more downside lies ahead. This company is a particularly compelling short opportunity because it is not only a Chinese RTO, but also an in-name-only rare earths miner.

The rare earth mining sector has seen a tremendous run in recent quarters, leading all companies in the sector to higher price levels. However, some illegitimate companies tagged along for the ride. In Shen Zhou's case, it is not even a rare earth miner. Its produce, flourite, is not a rare earth resource.

As Absaroka Capital manager Kevin Barnes wrote:

SHZ's main product is fluorite (a.k.a. Fluorspar or CaFv(2)): Despite a common misconception in the market, fluorite is not a rare earth nor does SHZ have any exposure to the rare earths business.

I highly recommend reading all of Kevin's report, as he highlights numerous other problems with the company that strengthen the short thesis even further. Needless to say, a Chinese RTO that has been falsely represented as a rare earths miner will do very poorly when investors start moving out of their weaker holdings in exchange for positions in stronger companies. Shen Zhou is a great short for a market that is retreating away from risky assets.

Cogo Group (COGO)

Continuing in the Chinese RTO space, Cogo Group offers investors another nice short opportunity. Cogo is one of the very few companies within the scandal-plagued Chinese RTO sector trading at more than 10x trailing earnings. This is particularly troubling as the company's net income, adjusted for one-time events, has fallen successively each year since 2007, meaning that investors are paying a high multiple for steadily shrinking earnings. Cogo, a middleman within the technology space, appears to have lost its edge, as its profit margins continue to fall. As its core business struggles, signs of trouble are mounting; accounts receivables have been surging to hit almost two quarters worth of revenue now (taking into account factoring transactions), and inventories also continue to rise.

One of the company's top supporters, Ticonderoga Securities, recently threw in the towel as it downgraded the stock and removed its price target. On top of all this negativity, I documented a few specific red flags, including troubling insider dealings in some of Cogo's acquisitions, seemingly unpaid taxes within its Viewtran subsidiary, and a weird employee compensation expense in which Cogo gave away 30% of the equity in its largest subsidiary to a single employee. Investors continue to ask more and more probing questions of Chinese companies, and I suspect that as investors continue to analyze Cogo's business, the stock will trade lower. (My previous articles which substantiate the above commentary about Cogo can be found here and here.)

Allied Irish Bank (AIB) and YRC Worldwide (YRCW)

For the next two picks, I must give a tip of the hat to Seeking Alpha contributor Studioso Research, who has diligently researched the upcoming dilution of shares in Allied Irish Bank and YRC Worldwide. In Allied Irish's case, the company is creating 500 billion (yes billion with a "b") new shares at 0.01 euros (1.4 American cents) each. Given that the stock was trading at 0.14 euros each at the time of the dilution announcement, the dilution was priced a cool 93 percent below the then market price. Adding lunacy to an already ridiculous situation, Studioso noted that Allied Irish is trading at 10x the valuation of rival Bank of Ireland (IRE) on a price-to-book-value basis. Valuing them equally, AIB should be trading somewhere in the neighborhood of 16 cents. It is highly likely that Allied Irish shares will trade down to Studioso's 48 cent target in fairly short order.

YRC Worldwide also has announced a massive dilution, as it is converting its debt into billions of shares of stock rather than paying it off with cash. While this is preferable to sending the company into bankruptcy, the result is still not good for shareholders. YRC's outstanding share count will balloon, according to Studioso's calculations, from 48 million to 3.5 billion!

In other words, current shareholders had to give up nearly all of their equity position to save the company. At YRC's nearly $1/share current price, the market is assigning the company an absurd post-share conversion market cap of more than three billion dollars. YRC's business hasn't been valued at that level since at least 2008, and this valuation is obviously way too much. As the market begins to fully realize the size of the dilution, shares will trade much lower. I think Studioso's price target of 28 cents a share will be reached quite quickly.

Sirius XM Satellite Radio (SIRI)

I may be a quarter of two early in calling for the end of Sirius' rally, but the inevitable fall is growing ever closer. Already, the much-anticipated pre-earnings rally has failed to materialize, with the stock dropping nearly ten percent in recent trading sessions. Sirius has had a track record of running upward into earnings, but this quarter, it has limped lower instead, indicating that the long-running upward trend in Sirius shares may be finished. The stock briefly broke the two-dollar mark to the downside last week before stabilizing. And unless the company delivers strong results in the face of a rapidly decelerating economy, the stock will quickly head back to sub-two dollar levels. The company's more than eight billion dollar market cap simply makes no sense given its massive debt load and poor record of earnings and cash flow generation.

With much bullish enthusiasm built into the company's large market cap, earnings must deliver, or the company's shares will enter a sharp decline. While Sirius may be able to remain overvalued for a quarter or two more, the company's growth will almost certainly stall out as auto sales fall and consumer's discretionary income fall as the economy begins to contract in coming quarters. Sirius is doubly levered to the economy, as it relies on both strong auto sales and consumer discretionary spending to grow its revenues; since both of these levers are being thrown into reverse, the stock will soon follow.

AOL Inc. (AOL)

AOL's merger with Time Warner (TWX) has been hailed as one of the worst mergers in American corporate history. Things have not gotten much better since that ill-fated deal for AOL, with the company continuing to slowly destroy its brand name as its balance sheet continues to erode. While the company still has a few good web properties such as TechCrunch, the company as a whole continues its inexorable decline into irrelevancy. With analysts already writing off the company's deal with the Huffington Post as a flop, it is hard to see what will revive AOL's fortunes. Even with its share price already depressed, the shares are likely to continue sinking lower.

Presently, the market is paying 19x next year's earnings for a company whose revenues dropped 17% year over year. That is still too high a price for the struggling company. Don't be afraid of shorting a company whose stock is at a 52-week low if its underlying business is poor and revenues are shrinking. At this point, AOL is still a falling knife, rather than a value play.

See Part 3 »

Source: 14 Compelling Shorts for a New Bear Market (Part 2)