Small-cap Chinese companies continue to leave a sour taste in the mouth of investors as uncertainty remains rampant over the validity of their financials and auditing practices. As the reverse merger scandal placed into question the sector as a whole, money has flowed out of these small-cap companies at a rapid pace. Not only has this hurt equity holders, but has deterred others from venturing further. It's also made it possible for a few otherwise unlikely scenarios to occur.
Perhaps one of the more interesting situations was the controversy over Harbin Electric (HRBN) which waged a war of trust between the company and short-seller firm Citron Research. In the most unlikely of scenarios, Citron had come out with a research piece asserting fraud at Harbin that proceeded to cut the share price in half within a day. Soon after, the company announced a buyout of the company’s stock that sent the market soaring the opposite direction but coming nowhere near the buyout price. Over the next few months, even with much affirmation by the company, the share price only ever so slowly gained confidence in the buyout’s reality despite continued protest from Citron. Eventually, the buyout occurred and the company was taken private.
In another ongoing instance, we see the case of China Advanced Construction Materials Group, Inc (CADC). Also hit hard under the sentiment over Chinese reverse mergers, this company with a book value double the current share price, has managed to entertain and pass a buyout offer from the CEO to acquire the company for $2.65/share. With a book value of $4.89/sh according to Yahoo Finance, many would decry this as being far from fair. Yet even after its announcement, the reaction by the investor public was but mildly responsive. Shares at one point managed to trade back down to $1.50 despite the ongoing buyout procedures. One could easily blame the board of directors' poor handling of the offer for allowing this to occur. However, in another sense, with the amount of time given for the market to react, the market's poor reception to the idea can be seen as proof enough that the buyout was the best offer available.
For many shareholders in such Chinese companies, these situations are proving to be disappointing at best. Many had bought shares at much higher prices before these companies had fallen out of favor. Practices that wouldn’t normally be tolerated had the sentiment been different are leaving these small-cap investors vulnerable from two sides: Bears (as was the case with HRBN) and Management (as is the opportunistic case for CADC).
Many of these companies continue to remain severely undervalued from the sense of book value. As most Chinese reverse mergers had listed onto the US market to raise capital (witnessed by the number that committed at least one shelf offering), there is the ongoing threat of why a wealthy CEO wouldn’t pursue a buyout at such low prices that investors are willing to place on the companies.
Here’s a quick look at a few reverse merger companies in terms of market capitalization (12/26/11), net tangible assets (most recent quarter), and insider ownership (according to Yahoo Finance):
|China Automotive Systems (CAAS)||$100.5 M||$163.4 M||73.94%|
|Fushi Copperweld (FSIN)||$293.8 M||$369.6 M||44.98%|
|Feihe International (ADY)||$55.5 M||$183.9 M||51.15%|
|Yuhe International (YUII)||$15.2 M||$113.2 M||39.32%|
|Yongye International (YONG)||$196.6 M||$277.0 M||22.18%|
|Zhongpin (HOGS)||$323.3 M||$407.6 M||37.07%|
|Skystar Bio Pharmaceutical (SKBI)||$20.1 M||$79.4 M||19.90%|
|SmartHeat (HEAT)||$13.0 M||$118.4 M||37.29%|
|China Natural Gas (CHNG)||$41.4 M||$189.8 M||28.99%|
|China Marine Food Group (CMFO)||$38.3 M||$104.6 M||60.12%|
|China Sky One Medical (CSKI)||$20.1 M||$106.1 M||37.12%|
Additional note: In perhaps an astonishing vote of confidence in the board’s ability to keep management under check, Fushi Copperweld (FSIN) successfully rejected a buyout offer by the CEO on December 5, 2011. Perhaps there’s hope yet for shareholders who have already so little trust in the companies they hold.
Disclosure: I am long CMFO.