Chinese RTOs Covertly Going Private

Includes: CMEDQ, ZSTN
by: Adam Gefvert, CFA

Through using the mosaic theory, I had created the hypothesis that China Medical Technologies (CMEDY.PK) and ZST Digital Networks (NASDAQ:ZSTN) are in the process of being taken off the US exchanges and taken private.

My hypothesis suggests that both of these companies are staying silent about taking themselves private so they can buy back shares at a much cheaper price. Instead of explaining what they are doing, they have hired AER Advisors, a small investment company, to systematically accumulate shares over time. AER Advisors will continue scooping up a small amount of shares every month, until it owns the majority of shares in the company, or until the share price gets too high, at which point the company will announce a buyout for the remaining shares. There is no rush on the companies to do this, it could take years. In the meantime, the Chinese companies are running their businesses as usual.

Keep in mind this is all speculation on my part and I don't know the details or the reasons. However, whether my hypothesis is correct or not, AER Advisors is certainly buying millions of shares for a third party. Part of their agreement with their clients are to not divulge who they are or their motives, so please don't bother asking them. I think my previous articles have given them much more attention and phone calls than they wanted.

ZST Digital Networks

ZST Digital Networks was halted on March 26, 2012, as its auditor resigned. The company was having a hard time reporting its 10-K on time, and had disagreements with the auditor. The board of directors then determined that it was in the best interest of the company to voluntarily delist the common stock from the NASDAQ market, and move to the pink sheets. ZST began trading on the pink sheets on April 26, 2012.

Before the company had been delisted, on 1/30/12 AER Advisors had filed a 13G claiming it held 629,750 shares or 5.43% of ZSTN.

Then on 4/6/12, while the stock was halted, AER Advisors claimed it held 743,496 shares, or 6.459% of the outstanding shares. During that three month period before it was halted, ZSTN was trading between $2-$3, so I'd guess AER Advisors probably shelled out around $1.9 million for that position.

Then, after the stock began trading again, AER Advisors filed a holding of a whopping 1,297,396 shares of ZSTN on 5/2/12 making it a 11.56% holder. AER had immediately purchased about 550K shares of ZSTN after the stock got unhalted. During the period from 4/26 to 5/2, when AER purchased the 550K shares, the stock traded between $0.31 and $1.15. Currently, the stock is trading at $1.45. I predict that in the next couple months the stock should go above $2.00 and then $3.00, similar to what happened with China Medical.

China Medical Technologies

Check my previous article on China Medical to see the updated filings of AER Advisors up to 4/5/12. At that point, AER's holdings of CMEDY.PK had reached 19.95% of the outstanding shares. Seeking Alpha reader Cristi C, who also is following this strange story, brought up the concern that perhaps AER is stopping its purchases at under 20%. After that, the firm is no longer a passive stakeholder and supposedly must file a 13D instead of a 13G. This is explained here on Investopedia. I didn't think that AER would stop at a 20% stake however, because I didn't understand the point of that and I guessed they would go all the way. If they did stop, then I assume CMEDY would hire another investment firm to continue the buying spree.

Sure enough, on 5/7/12, AER for some reason had filed another 13G form instead of a 13D form, claiming a holding of 6,833,873 shares
which amounts to 21.17%. Since that filing, the stock has rocketed from $2.20 to $3.55, for a 61% gain.

This "going private covertly" hypothesis hit me all at once as I was writing about CMEDY and digesting so many confusing facts.

This new strategy that China Medical and ZST are using is, in effect, thumbing their noses at the US markets. These companies are taking advantage of the public's negativity. Instead of announcing a buyout price of way above the current market price, like Harbin Electric's CEO did for example, these companies are keeping quiet and using the market's negativity as an advantage.

These companies are also fed up and insulted by the scrutiny and avoidance of US investors. Sentiment has reached an extremely negative pitch for Chinese RTOs, and rightly so, with the large amount of scams that have been perpetrated.

Many highly respected Chinese fraud experts are short CMEDY.PK. Kerrisdale Capital have stated that CMEDY.PK is worth 0 and is heading there. Ben Axler of Sprucepoint Capital shares this view. Bronte Capital's John Hempton recently wrote an article claiming a short position. I know a trader who has increased his short position in CMEDY.PK as the price has risen. However, I also know some big players who are long. Khizer Schon of Schon Properties (here's a video of him) told me:

I actually bought CMEDY after following it for one year. I have also been working with some big brokers in the U.S. who have told me about it and they share the same views as yourself and I. They hinted that the current volume (buyback) should take the share to $9 then $12 and when the company declares profitability, it may go somewhere between $18-20.

I predicted a bit of a short squeeze this week, and it is happening and I believe it will continue. However, I believe a big short squeeze will probably happen when AER advisors files once or twice more. They'll probably own 25%-30% of the outstanding shares in two months, effectively decreasing the float even more. They bought about 400K shares this last month or about 1.5% of the outstanding shares.


Going long or short CMEDY.PK and ZSTN.PK are extremely speculative plays, and you are at risk of losing a big chunk of your investment. I can't advise going short or long. If you want to gamble and go long, I would keep an eye on AER Advisors. They have consistently updated their holdings every month with their SEC filings. If they continue, which I think they will, then I'd assume your investment is pretty safe. However, if they go two months or so without filing an increased position, it might be time to get out. And expect lots of volatility.

Disclosure: I am long CMEDY.PK.

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