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China-biotics: Investors Shaken up by Summer Grass -- news for short sellers

|Includes:China-Biotics, Inc. (CHBT)

News for Short-sellers:

China-biotics investors were in a panic Friday.  A blog had been picked up by a reporter, Lu Jinyuan, who then followed through with his own investigative reporting.  His article was widely distributed through the Chinese news media.  

At one point China-biotics' share price dropped as low as 25%, firming back up and then settling with a 20% decline for the day.  The price dropped from a high of 17.71 to a low of 13.02, before climbing back to 14.16.  Approximately 3.4 million shares traded Friday compared to the three month average of 400,000 shares -- more than eight times the usual volume.

I contacted one of my fellow Seeking Alpha members, who just happens to be from China, and he gave me some leads and confirmed some points.  As it turns out the blog was written by a well known financial sleuth, nicknamed "Summer Grass" (translated from Chinese).  His real name is Zheng Zhaohui.  He is an author in China with a reputation for spotting fraudulent companies.  At, the online translation service put on the screen titles like, "Away from financial scams: summer grass teach you to avoid earnings risk" and "Emphasis financial fraud: financial fraud Shanghai National Accounting Institute Research Center 2005 annual report."

Part of the reason for the panic last Friday was that both the article and the blog were written in Chinese, leaving many investors at the mercy of a computer generated translation. Some of it was quite humorous; other parts were no laughing matter.  

As an example of how different computer generated translations can be from what we are used to hearing, the company we refer to as China-biotics is called "Double Gold" in the texts.  There is some logic to this however.   China-biotics is technically an American shell company and the assets are held in China under two subsidiaries, the older Shanghai Shining Biotechnology Co., Ltd. and the younger Growing Bioengineering Co. Ltd.  The blog and the news article refer to the company through the Chinese Characters for the older subsidiary, "Shining," which is translated by computer into English as "Double Gold."
Here's another example.  This one sparked some humorous dialog on bulletin boards,

"Eva Yan said the company has not yet signed a contract with the Queen, and the light is the moon cake in 2007 when the development of probiotics have had cooperation."
There was justifiable criticism of the reliability of an automated translation.  Nonetheless, the translations were read by investors.  There was nothing else to go on. And this sent panic throughout the trading day.  

Here's a passage that wasn't so humorous. China-biotics has been criticized for claiming a very large cash balance while receiving very little interest. In the blog, Summer Grass quotes an American investor who examined bank statements during China-biotics' "Investors Day."  Then Summer Grass comments ...

"This shows the company's bank balance and book balance or discrepancies, in fact, inflated assets of Chinese overseas listed companies, the most common way is inflated bank deposits, bank deposit statements and letter of inquiry is very easy to fake, especially the units Confirmation of bank deposits in time deposits."

Summer Grass also picked up another question that critics in the USA have raised: why a company with such a large cash balance would need to sell shares to raise money.

"Double Gold biological October 2009 raised $ 74,910,000, but the fact that there is no need, because the company early next year there are 70 million U.S. dollars the book (if these deposits are real), and the company recently is the largest capital expenditure the second phase of the construction cost of Qingpu $ 18,000,000, also proved that the company is currently carrying over 150 million U.S. dollars on the cash in the bank to sleep (if the deposit is true.)" 

The blog finished with, "In summary, I suspect huge profits double gold bio-fiction abnormal result in faster inventory turnover, and therefore fictional large fictitious taxes and huge cash."
Lu Jinyuan picked up the blog and included his own investigative work, sending the resulting article through the Chinese media. Like the blog, the article included the Citron's Research claim that China-biotics retail outlets were fiction. Then the article moved on to the issue of product moving through distribution channels:

"However, some stores on the newspaper said, shopping malls do not sell off with the 'Double Gold' brand products; and Tesco claimed, department store sales had double-Jin Youyi bacterial protein powder, but the sales volume is too low, in July 2010 had to stop the purchase, only recently re-entered the number of goods."  
There was apparently an interview with, "Danisco (China) Company, Guangzhou headquarters marketing department said, compared with Danisco, double gold bio-available probiotic milk prices for the market share of 'little.'"  

Then there was an ominously brief and simple sentence structure, with a sense of finality to it: "Shelf salesman said 'very few people buy this product.'"
The newspaper promised a follow up.

See links to news organizations that carried Lu Jinyuan's story on CHBT,here.
Readers can check for daily CHBT news stories in China, here
See the blog which sparked the news article, here.

Disclosure: I am short OTC:CHBT.
Stocks: CHBT