It's been almost a year since the Chinese reverse merger crisis began to hit the mainstream markets. In an invasion of the American stock exchanges, mainland Chinese companies gained access to American investors via the backdoor process of the reverse takeover. By acquiring worthless companies that were trading on the OTC market, cleaning them up, and uplisting onto a higher exchange, Chinese companies gained access to an American audience. Once listed on a senior exchange, the companies would often dilute shareholders with a secondary offering, thereby squeezing precious capital that could stimulate their businesses.
Then in early 2011, the mischief began to arise. Short-seller firms such as Muddy Waters and Citron Research became the beacons that brought to light irregularities that were often muddled amidst the jargon of financial filings. Fraudulent accounting practices began to emerge. Auditors resigned. The very same short-oriented research firms themselves became targets of poor practice speculation. Many Chinese reverse merger companies like China MediaExpress Holdings (CCME.PK), NIVS Intellimedia (NIVS.PK), and China Electric Motor (CELM.PK) just ceased to exist as viable trading investments.
Some companies, like China Natural Gas (CHNG), remain frozen in time like an eerie portrait of one carbonite-encased Han Solo warning investors to tread carefully. Those already scathed by a falling share price faced the reality of being unjustly violated by an opportunistic management team and a failing board of directors that looked the other way.
Yet despite all the warnings, all the signs, and all the history that can be so easily summed up in distrust, there remains an adventurous lure that continues to pull at the heart of every rational investor when it comes to small-cap Chinese companies that continue to trade on the American exchanges. "They can't all be frauds." That's the motto, and perhaps the very speculative hope that pounds the hearts of the most reckless investors in this present day.
It is to this audience that I present my 5 favorite "investor-be-warned" small-cap Chinese investments (which perhaps we should call "gambles" in light of the overall depressed class of equities), and the simplistic rationales for why I continue to hold positions in them:
- Longwei Petroleum Investment Holding (LPH). The company specializes in the distribution of finished petroleum products in mainland China. Operating an oil storage facility on the mainland, the company serves as a strategically-located petroleum distributor in a country growing ever reliant on oil products. Fellow contributor Kevin Chen has dedicated multiple articles in a defense towards his belief in the legitimacy and undervaluation of the company's operations. For myself, I see expensive oil-related infrastructure, a management team that hasn't gutted investors by funding their new project through further dilution, and a story that makes sense working itself out in the heart of China.
- American Lorain Corporation (ALN). The company originally specialized in chestnut-related products and has since grown into an international food distributor. Now a supplier of ready-to-eat meals, convenience foods, kim-chi products, and frozen foods, American Lorain offers investors an indirect pathway to the growing middle class in China. For myself, I see the international expansion of the company as an encouraging sign for legitimacy. I remain cautious over the lack of communication of late and the real risk of being taken private by management.
- CD International Enterprises (CDII). The company specializes as a consolidated magnesium conglomerate, consulting firm, and commodity trader. Based in America, the company has made extensive PR maneuvers to attract a following and shore up its image. With over 5000 likes on its Facebook page (due to several iPhone sweepstakes contests), such little efforts say a lot in an environment of overall distrust. With many strategic acquisitions, the company has slowly evolved into one of the largest suppliers of magnesium in the world.
- China Marine Food Group (CMFO). The company offers another promising Chinese food play worthy of a speculative investment. With the sale of seafood snack foods and a brand of algae-based beverages, the sheer popularity of the company's products has me keeping a small portion on hand. This remains another investment able to tap into the rising middle class and their evolving choice of foods.
- China Yida Holding (CNYD). The company serves as a tourist location manager and entertainment media advertiser. Striving to become the "Disneyland of the East" in regards to being a high-margin tourist attraction manager, China Yida's synergy as its own promoter has made this company a unique investment opportunity. Unlike in America where the national parks and monuments have been defended from private company exploitation, the rules are different in China. The distinct opportunity to invest directly into a UNESCO World Heritage Site (where cokes and hot dogs can be sold a double their worth to a steady supply of tourists) provides an irresistible value proposition in itself regardless of the risks.
These days there appears to be no real safe havens in small-cap Chinese companies. Even "seeing" can't really be equated with valid "believing," as some of the most notorious cases of fraudulent activity involved companies that had plenty of identifiable assets that were clearly displayed throughout many of the company's picture galleries and videos. In the end, the entire market is waiting for some kind of end to this ongoing sentiment of distrust surrounding these foreign entities. Much of the fraud has stopped popping up like popcorn, but the class as a whole has yet to show any sign or catalyst towards a firm recovery. As a result, whatever innocent and "valid" companies there are left standing amongst a flock of wolves may just continue to trade with a lowered head for a long time to come.