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U.S.-Listed Chinese Stocks - Gravely Mistreated & Far Undervalued (Part 2)

A vast array of communication tactics have been used to unfairly characterize the U.S.-listed Chinese stock sector and the stocks within it.  Below are some of the more prevalent tactics.

(1) Comparing numbers reported to an SAIC entity(s) in China with SEC financial reporting and claiming that, since the numbers don’t match, the company must have exaggerated its revenue or the like.

In brief, it has become fairly common knowledge among investors in the sector that, for many reasons, these numbers shouldn’t match, and, sometimes, they should not match by a lot.  (For more information:  http://china.fixyou.co.uk/2010/07/on-saic-and-sec-filings.html)  If the numbers don’t mismatch by enough to sufficiently scare investors, a short-side communicator can simply pretend that the numbers for one or a limited number of a company’s subsidiaries in China should match the SEC numbers for the company as a whole.  In defending itself after being unfairly criticized by Muddy Waters, Orient Paper (NYSEMKT:ONP) explained that a company Muddy Waters referenced in its report in regard to SAIC numbers was not its actual subsidiary, but instead a company with a similar name.  (Source:  http://www.streetinsider.com/Corporate+News/Orient+Paper+%28ONP%29+Responds+to+Report+That+Muddy+Waters+Has+a+Short+Position+in+Companys+Stock/5771103.html)  (Muddy Waters did not issue a related retraction.)  Of course, a short-side communicator does not have to get this fancy, they can suffice with “counterfeiting SAIC documents”, as John Bird (aka Waldo Mushman) was said to have done.

(2)  Claiming that “reverse merger” means “poorly-vetted” and, therefore, too risky.

This was a significant issue before “U.S. regulators tightened the rules for reverse mergers in 2005, forcing companies to disclose more information after merging into shell companies.”  (Source:  http://www.reuters.com/article/2010/04/15/us-chinesereversemergers-analysis-idUSTRE63E4TW20100415?pageNumber=1)  Also, once a company does a public shares offering or lists on or uplists to the AMEX, NYSE, or NASDAQ, this becomes even more of a non-issue.  The company did nothing wrong in using the reverse merger process to establish itself as a U.S.-listed stock.  In fact, the process should have enabled them to list more quickly and may have enabled them to do so more inexpensively.  Companies from many countries, including the U.S., use this technique to list.  In fact, Berkshire Hathaway and The New York Stock Exchange “became publicly held corporations by virtue of a reverse merger”.  (Source:  http://www.halter.com/)  Short-side communicators like to make it seem like “reverse merger” is a dirty little backdoor that only Chinese companies use to list in the U.S.  As you can see, this is in no way true.

(3)   Claiming that the Chinese companies that listed in the U.S. listed in the U.S. because they could not list in China due to inferiority.

Actually, the opposite is often true.  Some of the best Chinese enterprises have listed in the U.S.  At least once, China simply did not approve any new stock listings for a while.  China did not launch a growth enterprise market (NYSEARCA:GEM) until October of 2009.  Many of the Chinese companies listed in the U.S. listed in the U.S. before October of 2009.  Even now that China has a GEM, an investment can be a great opportunity and not meet the listing standards for the Chinese exchanges.  (Source:  http://www.businessweek.com/magazine/content/10_48/b4205059211793.htm)  Also, China has overall bank lending limits and tight controls on international currency flows.  This further serves to push good companies toward the U.S. markets.

(4) Claiming that there is more fraud in China.

There may be more fraud, about the same amount of fraud, or less fraud in China.  If you don’t believe this, it may be because you don’t know, or won’t admit to yourself, enough of the truth about the U.S. and like countries.  There are many ways in which people try to get you to believe that there is more fraud in China.  One I have been hearing recently is that the Chinese companies have two sets of books, one that they show to the tax authorities and one with the real numbers thereon.  This may have been the case when these companies were smaller.  The more they grew, the less likely it became that this was the case.  How do I know?  Because this is how it is in many countries, including the U.S.  In fact, I worked in a couple of small U.S. businesses.  For one, I do not know whether they had one or two sets of books.  For the other, I know for certain that they had two sets of books, specifically to avoid paying any taxes.  If you need or desire further enlightenment, here is a link to an article regarding Canada that will help.  (Link:  http://www.canada.com/calgaryherald/news/calgarybusiness/story.html?id=aba83332-d0ee-4887-b37c-8dbbfbc44aa9&p=2)

(5)  Inundating the stock message boards with negative posts.

Yes, stock and stock service pumpers are also an issue on the stock message boards; but this problem is not nearly as severe as the numerous unfair negative posts that are appearing.  It has become clear to many of us that many posters have been paid to cry “fraud” and the like over and over again regardless of the facts and sound logic.  Not all of the paid or other negative posters are this obvious.  There are many different unethical communication strategies used.  One is to pretend that you are long on the stock (The purpose of this part is of the strategy is to get people to like and trust you.); but then you say you sold because, now, you have learned more.  Then, you claim you are not short on the stock (The purpose of this part of the strategy is to get people to continue to like and trust you.); but you participate on the message board for months more, even though you supposedly hold no position in the stock.  While participating, you support many, if not all, negative comments made regarding the stock, and make many negative comments of your own—regardless of whether these comments are supported by the facts and sound logic.  It is easy to tell that these people are short on the stock and/or being paid to harm the stock price for two reasons.  (1) They supposedly went long with what was, apparently, inadequate due diligence; but now we are supposed respect what they have to say.  (2) Far more importantly, regardless of what they say, they would not still be participating on the message board if they did not have a hidden, illicit agenda.

(6)  Saying that “if it sounds too good to be true, it probably is” when this saying is not applicable.

In the two and a half years that I have focused on this stock segment, I haven’t heard or seen any of these companies make a claim that was “too good to be true” (although I have heard and seen them make some claims that weren’t exactly true, just like other companies from around the world, including the U.S., do).  I have seen them grow at rates that only the best young companies from around the world grow at, et cetera.  It’s not “too good to be true” if it has been done and is being done by many other companies.  Young, successful companies do, sometimes, double, triple, quadruple, or more their revenues.  The idea behind this tactic is to get less-than-fully-knowledgeable investors to not buy or sell because, for instance, they don’t understand that, given the company’s specific circumstances, their margins can or should be that high (e.g., Harbin Electric [HRBN]) or that research from around the world performed over the course of decades supports the efficacy of the company’s products (e.g., Yongye International [YONG]).  Be wary; but be aware that Chinese companies, as well as companies from other parts of the world, sometimes make things better or do things better than companies in the U.S.

(7) Presenting people with a (sometimes very long) string of misinformation.  If/when they finish debunking the misinformation, you can simply present them with more misinformation in response.  In so doing, you rarely, if ever, admit that any of your information was debunked.

This can be done via a single very lengthy report or a string of smaller communications, like message board messages.  It takes relatively little effort to publish misinformation.  It can take a lot of effort to properly research and expertly word things.  The point here is to try to get you to say or think something like:  “It’s taking too much time and effort to make certain that this investment is safe enough, so I am simply going to pass on buying it.”  Or:  “Gee, I know that’s false and that’s false; but I am not certain about that.  I better just sell.”  A trick you can use to overcome this technique is this:  If, during the communication(s), the communicator displays a pattern whereby you know that they know, or very well should know, that multiple pieces of information they are presenting are false or misleading, view the remainder of what has been or will be communicated as not-necessary-to-view-or-hear.  To simplify, if someone lied, grossly exaggerated, or misrepresented two or three times, it’s not important for you to read their next point.  Even if a following or preceding point(s) does not seem to be false or misleading, assume that it is somehow.  At best it’s a truth being used to get you to believe a falsehood.  If you are going to spend any of your time on this stuff, spend it debunking and, ideally, making it clear that the author cannot be trusted.

If/when any of the many short-side people who lie, exaggerate, or misrepresent respond to this article, I may simply ignore them.  It is only worth spending a limited amount of time responding to falsehood after falsehood after falsehood.  If, on the other hand, you are not one of these people, and you think I was significantly inaccurate with something I wrote above, you think that something I wrote above should be enhanced, or the like, please do point this out to me.

Disclosures:  I am long YONG and HRBN.  Otherwise, I do not have a position regarding any of the companies mentioned in this article.



Disclosure: I am long YONG, HRBN.