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Value Bulldog
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I am a research analyst for a long/short value-oriented hedge fund. Most of my attention is focused on the tech, telecom and media sectors although I occasionally look for value (or its opposite) in other areas. Note that I take long and short positions in the stocks I discuss on Seeking Alpha.... More
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  • Potential fraud appears to be pervasive in U.S.-listed China space 20 comments
    Sep 15, 2010 12:26 PM | about stocks: CHBT, CSKI, DYP, FUQI, UTRA, CHNG, ONP
    Since Barron's published its expose on the U.S.-listed China reverse merger space August 28, seemingly every day a new China hybrid is blowing up.

    On August 30, serious fraud allegations began to surface regarding CHBT, and they have been followed up here and here.

    On September 3, CSKI lowered guidance and announced the resignation of its CFO with a very dubious-sounding explanation. The company has been publicly accused of fraudulent conduct in the past, and this announcement did nothing to help their credibility.

    On September 6, DYP shares tanked after it filed an 8-K with more red flags than a Chinese army parade, including the firing of its auditors and the resignations of top management and several board members. The company held a conference call to discuss the situation this morning and apparently did nothing to assuage investors, as shares are down another 19% as I type this.

    On September 10, FUQI announced it had recieved an SEC subpoena. This knocked the stock down from over $6.00 to less than $5.00 but for holders was merely a continuation of 6 month downtrend that started with the stock at $19 back in March.

    Today's winner is UTA, which is tanking after fraud allegations appeared on hedge fund blog Bronte Capital. Once again while the 30% decline today has to hurt investors, the stock was already down 50% YTD.

    These kind of blowups are not unkown, similar issues have arisen with CHNG and ONP to name just a couple. They seem to be coming a lot more frequently now though. The question is, how far does this go and when does it stop? I am pretty sure that among the hundreds of U.S.-listed China companies, there have to be some other frauds, especially among the reverse mergers. At the same time all this controversy also has to be depressing the multiples of some legitimate companies. As far as I know, none of the companies accused of fraud have been completely exponerated, although that could still come in the future.

    Still, given the amount of alleged fraud out there and the fact that these companies fall into a regulatory loophole where U.S. authorities have no jurisdiction and Chinese authorities don't care, I can't imagine why you would want to own any of these things. Maybe if any of them started paying cash dividends or if some were acquired for cash paid to U.S. investors the clouds will lift somewhat. Investors are probably much better off sticking with the large reputable companies Chinese companies as well as companies with a dual listing in China or Hong Kong.


    Disclosure: Short CHBT, CSKI, DYP, CHNG. No position in other stocks mentioned.
    Themes: China Stocks: CHBT, CSKI, DYP, FUQI, UTRA, CHNG, ONP
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Comments (20)
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  • Momintn
    , contributor
    Comments (3941) | Send Message
     
    What I would like to know is if these Chinese companies are included in US indices and etfs or if they are only in China etfs. You can type in the stock in Morningstar and see the mutual funds that have these stocks. I was quite surprised. Just goes to show that mutual fund managers don't spend that much time researching the companies themselves.
    15 Sep 2010, 03:07 PM Reply Like
  • Value Bulldog
    , contributor
    Comments (107) | Send Message
     
    Author’s reply » This year the Russell indexes changed methodology to exclude companies whose principal headquarters and businesses are outside the U.S., so virtually all of the US-traded China stocks were kicked out around the middle of this year. I am pretty sure there are none in the S&P and I know there are none in the Dow. All ETFs tracking the Russell, S&P and Dow indices should not have any China hybrids.

     

    As for long only mutual fund managers, of course they do not do the level of work to determine if their China names are frauds are not, they generally own hundreds of stocks and tend to buy based on broad-based themes, momentum and sell-side research. This is one of the reasons they notoriously under-perform.
    15 Sep 2010, 03:13 PM Reply Like
  • ajj53
    , contributor
    Comments (53) | Send Message
     
    I dont believe any of the shorts claims..See you in 3 months
    16 Sep 2010, 06:12 PM Reply Like
  • AhYap
    , contributor
    Comments (48) | Send Message
     
    > I can't imagine why you would want to own any of these things

     

    I want to own some of these things because I understand

     

    1. Many doesn't equal to all, do not generalize. There are more than 1 billion Chinese people in China and they have been doing businesses for more than 5,000 years, all of them are suckers?

     

    2. Because people generalize, there will be a lot of fear, legitimate stocks will be affected and have lower valuation. Investor who are patient enough will be rewards once all these drama pay off. The more you attack, the more legitimate stock will come out in better shape when they try to deal with it - getting big 4 auditor, making matching SAIC reporting, buying back shares, make sure they explain why their interest rate is "lower"...

     

    3. Did you forget that Warrent Buffett says, "Be fearful when others are greedy and be greedy when others are fearful"?

     

    4. Did you forget that John Templeton did when he buy all the global stocks in a recession? Not all of them did well, some go burst, but he makes a fortune.

     

    5. We have many criteria on choosing stocks, if you do what Warren Buffett does, avoiding business without competitive advantage (moat), you have an upper hand on these Chinese stocks. Avoid business with no moat such as paper company (ONP), battery company (NEWN) or traditional Chinese medicine company (CSKI) or company that require big contracts and big customer concentration (TSTC, CFSG...).
    17 Sep 2010, 03:21 AM Reply Like
  • Waldo Mushman
    , contributor
    Comments (384) | Send Message
     
    Do you not understand the inherent risk in a three or four layer holding company tower ? The company you have shares in owns nothing but shares in a second company which then owns shares in a third company who has the option to buy shares in a fourth company that actually owns assets in China.

     

    The assets and officers in China have no liability to the laws of the US, or Bermuda, or Grand Cayman. In other words as a shareholder you have no way to legally attach yourself to the assets you think you are investing in. The very ownership structure of the US traded VIE's and WFOE's and FIE's doom them to probable failure.

     

    And all of the China miracle is readily available through ADR's of China listed equities or directly from many brokerage houses that offer investors HK and HSE trading. The only difference is that the US traded curs have expensive PR firms convincing rubes like you to buy the garbage they are trying to sell. The real companies in China, active and completely legal, are minding the store and selling to their customers, not their shareholders.

     

    Neither Warren Buffett or John Templeton would ignore the legal realities of what they own and neither would consider using some investing legends name as an excuse not to look very closely at each investment. They bought because of proveable value, not low price.

     

    John
    18 Sep 2010, 12:54 PM Reply Like
  • Factspluslogic
    , contributor
    Comments (11) | Send Message
     
    Waldo, I'm not sure whether you were just speaking generally, but specifically on ONP, the ownership structure seems much better than you describe. As I read the filings:
    1) The British Virgin Islands holding company has been completely removed from the chain of ownership. The chain goes directly from the US to PRC.
    2) ONP (a US company) 100% OWNS Shengde Holdings (a US company), which 100% OWNS Baoding Shengde (a PRC company). Thus, a shareholder of ONP is an OWNER of a PRC entity, and thus it would seem that one would have standing to sue in china, via Baoding Shengde.
    3) Although it is true that Baoding Shengde only "controls" HBOP via the call option, Baoding Shengde OWNS the digital photo lines. So that's $13.6 million worth of assets that are 100% OWNED by ONP (and I think even you have admitted that the digital photo lines appear to be legit).

     

    Of course it would be preferable to own everything, especially the big new line which is worth tens of millions, regardless of one's beliefs about the old lines. But at least in the case of ONP, the structure seems better than most.
    23 Sep 2010, 11:25 AM Reply Like
  • Waldo Mushman
    , contributor
    Comments (384) | Send Message
     
    My comments were not specific. You clearly understand the weak link because you accurately describe it in #3... "Baoding Shengde only "controls" HBOP via the call option". It makes no difference what is downstream from that flawed link in the chain. As an American stockholder you have no standing in China to pursue the officers or assets of the company actually operating in China.

     

    Ponder for a moment what is available as a remedy if the signators of the "option" tell the parent to screw off. Who does the US traded entity sue? Since the US entity can't get into Chinese court for financial fraud, How do they sue? And since no one in China is obligated to tell anybody in the US anything, it may have already occurred and you don't even know about it.

     

    John
    23 Sep 2010, 01:00 PM Reply Like
  • Factspluslogic
    , contributor
    Comments (11) | Send Message
     
    hmm, I'm not sure we agree about the facts here. The key from point #2 was that the entity which actually holds the call option is Baoding Shengde, a Chinese company. Thus, if HBOP says "go screw", they are not saying it to a US company, they are saying it to another Chinese company, which is a wholly-owned subsidiary of ONP. Thus ONP (on behalf of its shareholders) would, through Baoding Shengde, be able to sue HBOP. They are both incorporated in PRC.

     

    Now, the reliability of achieving compensation via the Chinese judicial system is another matter, and perhaps that is a weak link (then again, how is the NJ system treating you? :) ). But I don't think the ability to bring an action is in question.
    23 Sep 2010, 02:26 PM Reply Like
  • Value Bulldog
    , contributor
    Comments (107) | Send Message
     
    Author’s reply » AhYap, I am sure you are right that some legitimate companies are being dragged down, and I do not mean to convey the impression that all Chinese publicly traded companies are frauds. I just think that the ones of a certain profile (reverse merger, obscure auditor, too-good-to-be-true financials) have a disproportionate amount of fraud and think investors would be much better off sticking with the big reputable Chinese firms (BIDU, CTRP, etc.) or stocks with a dual listing structure so you know there is local incentive for oversight.
    17 Sep 2010, 11:04 AM Reply Like
  • ajj53
    , contributor
    Comments (53) | Send Message
     
    You sound like that goofball Cramer..PE's over 100 hundred great LOL...I can find non -fraud companies growing like weeds for under 5x...And i will get 2-5 baggers on them...You probably post on Yahoo boards ,i have no doubt..Oh by the way i bought UTA at 3.55 thanks...
    17 Sep 2010, 04:35 PM Reply Like
  • Waldo Mushman
    , contributor
    Comments (384) | Send Message
     
    UTA has a completely fraudulent on-line travel site. You can personally experience the deception by trying to book a flight. They are a complete fiction.

     

    But you are so insightful that buying shares in a blatant and proveable fraud seems like a good play. What else are you enthusiastic about?

     

    Cocky pronouncements about your random guess where the price will go identify you as completely ill equipped to invest in anything more complex than a Christmas Club account.

     

    Coal for the kiddies, Dad invested in a travel scam.

     

    John
    18 Sep 2010, 12:38 PM Reply Like
  • ajj53
    , contributor
    Comments (53) | Send Message
     
    I dont give a rats ass if you have to call in cause the web site sucks...Tell me the revenues are non existent and the cash is too..LOL...UTA is NYSE listed ...How many are frauds in history....2,3,5 out of thousands you tell me...
    20 Sep 2010, 02:20 PM Reply Like
  • Jon408
    , contributor
    Comments (222) | Send Message
     
    From what I've read elsewhere the percentage of fraudulent US companies is actually slightly higher than in China, even today... Why isn't that comparison even mentioned in your article? You're singling out Chinese firms, what about UK firms, with whom we do FAR more business? Our biggest trading partner isn't China, after all, its Canada; and I do not know the stats, but I suspect we invest in Canada more than in China as well. Particularly in oil, gas, and minerals... want to buy a gold mine? This fear mongering so that people can short stocks with impunity is really bad. "If there's smoke, there must be fire." is the mantra, painting everyone with the same brush. And guess what? It's a racist brush. Not that anyone is racist against Chinese people, but that people love to lump people into groups based on race, which leads to stupid thinking. This article isn't stupid, but it is short sighted and leads to that kind of stupidity in the world (not just the market).
    21 Sep 2010, 10:43 AM Reply Like
  • Value Bulldog
    , contributor
    Comments (107) | Send Message
     
    Author’s reply » Jon, my article is not directed at the Chinese in general and I have no idea whether a higher percentage of overall U.S. or Chinese companies are fraudulent- I am talking about the high incidence of fraud in a very small subset of Chinese companies- those that have chosen to go through a reverse merger and list in the U.S. As far as I know there has been no comparable group of fraudulent U.S. companies that have chosen to raise money from the Chinese and list on their exchange.
    22 Sep 2010, 10:11 AM Reply Like
  • ajj53
    , contributor
    Comments (53) | Send Message
     
    Specifically ,what NYSE listed companies were frauds??? Please list them ...The fraud is you.
    8 Oct 2010, 09:11 AM Reply Like
  • ajj53
    , contributor
    Comments (53) | Send Message
     
    Special K's are being eaten for lunch ,for more than a month...LOL
    1 Nov 2010, 10:11 AM Reply Like
  • AhYap
    , contributor
    Comments (48) | Send Message
     
    This is a good time to write my 2nd comment here. What I want to say is I like to be in the long side instead of the short side. When I long a good stock selling at cheap price for whatever reason (like short attacks), I don't need to spend a lot of time writing seekingalpha articles, comments, blog post, forums post, etc. to tell people why a stock suck. The company fundamental will take care of everything, strong earning announcement, stock repurchase programs (CCME), privatization (HRBN)... at the end, I do read a lot of articles in seekingalpha to improve my decision making but about writing, this is probably only my 2nd comment to defend that I wrote. I don't need to respond to shortsellers. I don't need to busily write articles like mushroom and others... lol...

     

    Disclaimer: Long many shortsellers attacked stocks, never pull back, keep increasing positions last few months, pay off nicely. Please refer to my first comment above. Many Fraud is not equal to All Fraud.
    2 Nov 2010, 08:43 AM Reply Like
  • Value Bulldog
    , contributor
    Comments (107) | Send Message
     
    Author’s reply » Back on planet Earth, I've made money in every one of the China shorts I disclosed in this article. The entire group has gotten a 2 month bounce on short covering and the QE 2 risk trade melt-up, but I didn't start shorting China frauds on Sept. 15th and the group has had a dismal year up until recently. I don't understand how any serious long-term investor could be comfortable with the risks in this space but good luck. After a rash of scandals it has been quiet but there will be more blowups in the future.
    2 Nov 2010, 09:52 AM Reply Like
  • ajj53
    , contributor
    Comments (53) | Send Message
     
    Sure you did.LOL..UTA now 6.00 +
    3 Nov 2010, 12:37 PM Reply Like
  • NoHatchets
    , contributor
    Comments (13) | Send Message
     
    Special K's money making activity = short a stock then bash it on exposure at SA. Who couldn't make money with an inside setup like that. You have zero credibility in my book..
    27 Jul 2012, 02:39 PM Reply Like
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