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My name is Larry Isen. I am a serial stock market investor. I am 57 years old. I've been investing in small stocks for over 20 years. I was born in Buffalo, NY and attended college at the University of Colorado. I have bachelor's degree. I publish an investment newsletter devoted to China based... More
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  • A Bipolar China Week 1 comment
    Jun 8, 2011 1:08 AM | about stocks: YONG, SNOFF, CFSG
    China Stocks Have Bipolar Week

    It was the best of times and the worst of times this week as one China small cap gets the stamp of approval from Morgan Stanley, and Muddy Waters pulls off its biggest take down yet.

    Those unfortunates who suffer from Bipolar disorder experience periods of euphoria known as "mania"', and periods of depression known as "manic depressive".

    Us China fans were forced to be Bipolar during the course of this past week. Read on........

    Yongye International (NASDAQ:YONG)

    Those of us watching the China sector were treated with a period of euphoria first thing Tuesday morning when it was announced Morgan Stanley, after a period of extensive due diligence, would be investing $50 million into YONG.

    The terms of the investment were eye opening for the market. Morgan Stanley's investors will be purchasing a Convertible Preferred security with a conversion price starting at$8.80 per share.

    As you can see from the chart, the market absolutely loved this news, and the stock traded over 10 million shares on Tuesday as shorts were forced to cover and closed out their positions. The market is willing to assume Morgan Stanley has done enough research in the current environment to be sure about what they are doing. The managing partner of Morgan Stanley Asia was even quoted as stating they had done "extensive due diligence". It's not surprising to me as YONG is in the fertilizer business, and the food supply investment theme will be very big for sometime to come. Between the 100 year drought in the North and inflation, food supplies are very tight in China, and there are a lot of mouths to feed. I'm looking at a company that sells 2.5 million baby chickens a year as a potential small cap idea for us.

    YONG had suffered from the usual attacks by Bloggers who claim the company could not possibly be doing the numbers it claims to be, and finding all sorts of discrepancies in the various filings- between SAIC, SEC, and VAT.

    This follows on the heels of China Fire and Security (NASDAQ:CFSG) announcing Bain Capital would be financing an offer to take the company private in an Leveraged Buy Out at $9- the stock had been trading at $7.20 prior to the announcement, and bumped up nicely into the high $8 range.

    Of the companies that have gnashed their teeth about going private, this has been the most believable to date with Bain Capital behind the deal.

    That was the euphoric part of the week. Contacts I have on the sell side of the institutional world informed me large investors were starting to look for value plays they could trust.

    Now, on to the other side of this Bipolar week.

    Muddy Waters Takes Down Sino Forest (TSE: TRE; OTC PK: SNOFF)

    On Thursday morning highly credible short seller research firm Muddy Waters took down large cap stock Sino-Forest which trades on the Toronto Stock Exchange as TRE, and in the US under SNOFF.

    This is, by far, the largest take down of a China based company with a North American listing. Muddy Waters compares the level of fraud to Bernie Madoff.

    This stock had its origins on the Toronto Venture Exchange 16 years ago- 1995. According to the report, Sino-Forest has raised over $3 billion from the capital markets, and sports $2.1 billion in debt at present.

    Giant hedge fund Paulson & Co held 14% of the outstanding shares of the company, which Paulson has stated is only 2% of its holdings.

    As you can see from the chart, SNOFF traded 12 million then 20 million shares on Thursday and Friday. The stock which had spent most of the last year around the $25 mark, closed Friday at $5.41.

    This was the manic depressive side of the week. The largest China stock yet falls under accusations of fraud.

    Since I'm largely on the long side of the market, you might think I view Muddy Waters as a blight on the China sector.

    Quite the opposite is true. Now that I've gotten past my big mistake- CCME, and am starting to make back some of the losses, I'm in a position to think a bit more rationally.

    Muddy Waters is performing an extremely valuable service to those of us who want to look at the long side of the China Small cap sector.

    These guys are enriching themselves in a massive way from their research, and that's the way it should be. However, they are also creating an environment that will force many China based companies who have come to the US for capital to re evaluate the way the conduct their day to day business, and adhere to strict GAAP accounting standards to survive.

    Many who don't adopt these policies will fall by the wayside, thereby lowering the supply of investable ideas.

    Muddy Waters and the like have also helped create an environment where those of us who can identify the right ideas can invest in the bargains of a life time- you just have to find the right companies.

    Going forward I'm going to vet my core ideas just like Muddy Waters- by doing extensive due diligence far beyond what many investors and auditors have done.

    The big difference- rather than try to uncover fraud and make money on the short side, I'm seeking ideas where the claims against companies are fabricated with confusing language about SAIC filings, customers, and numbers. If I can disprove those claims, we could enjoy the profits of a lifetime.

    These days any Blogger that can get an article up on Seeking Alpha can present a bunch of confusing data and beat a stock down. They did it with YONG, but Morgan Stanley saw it differently.

    Over the 24 years I've been investing in the small cap world, I've found seasonally the best time to be a buyer is between July 15 and August 15. The best time to be a seller is December 1 to Jan 30. These are generalizations, but tend to be true most years.

    I'm hoping to have completed research on two ideas by mid summer, so we can make a lot of money together going forward.

    Warmest Regards,

    Larry Isen

    Stocks: YONG, SNOFF, CFSG
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  • Chad Brown, CFA
    , contributor
    Comments (132) | Send Message
    Having read the Muddy Waters research reports on CCME and TRE, I am not very impressed with the quality of the written research. Clearly they were "right" on CCME which folded and failed to deliver promised documentation, had their auditor resign, the CFO resign, and the board member from their largest investor (Starr) resign and then Starr sued them. But the research MW published on CCME did not contain compelling evidence of fraud in my opinion. I see Sino as a case of MW claiming to have uncovered a fraud but being unable or unwilling to fully disclose the basis for their conclusions. Yes, MW has a track record of being right more often than wrong, although it is not 100%. But Sino has a track record of being in existence much longer than the fraudlent RTOs, being subject to more credible outside reviews, and being much bigger.


    MW charged Sino with being a Ponzi scheme like Madoff. Madoff was not even investing the cash in stocks. For the Madoff analogy to work on Sino, they would have had to have taken the money from investors and not invested it in any actual forests. That is a very serious charge. But I could not find any evidence to back it up in the MW report.


    With TRE.t on the Toronto, or SNOFF for the US ADRs, we have a similar situation in that Muddy Waters makes dramatic claims of FRAUD, but their report contains precious little that proves it to a typical reader. The first piece of "evidence" they come up with in the report is a trivial dispute over how to count the number of "person weeks" spent on the ground by the outside forestry experts. Who cares? They show an old bank letter confirming a customer relationship and call it suspect apparently because it was a bad translation. On that basis, we could throw out Muddy Waters research as fraudulent because we can find grammar errors.


    The fact that Muddy Waters confuses "standing timber" sales with timber that has been already cut and delivered is a pretty basic mistake that tells us Muddy Waters has limited expertise in the forestry industry.


    My personal take on this is "jury is still out". Actually, maybe that is not the best analogy. The case has not even gone to the jury yet. We are still in the "discovery" phase. Markets being what they are, we will get a reading on the jury's views daily, and the jury (market) will never actually get the case and take time to discuss it. But with unprocessed documents being spewed out by both sides, as I said, this is "discovery" and the two sides have yet to present their cases with the new evidence available.


    On the more general topic of Chinese stocks coming to North America for the bulk of their capital needs, I think given the track record that it would be better for authorities to prevent it altogether. There have been far too many frauds uncovered. The Chinese can reform their markets to allow local investors to provide capital for domestic companies. North American investors could be marginal investors, but the Chinese ought to be the main ones determining the value of domestic companies, unlike the situation now.
    8 Jun 2011, 09:15 AM Reply Like
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