China Ideas: Not All Chinese Reverse Mergers Are Created Equal
(By Becca Lipman. List compiled by Eben Esterhuizen, CFA. Institutional data from Fidelity, shorts data from Yahoo! Finance.)
Sahm Andrangi, age 30, is the founder of a small $20 million hedge fund that specializes in sniffing out and short-selling "flimsy" Chinese companies listed on US markets. By doing so, he has increased his funds revenue six-fold.
There are "about $20 billion worth of small- to medium-size Chinese companies listed on U.S. exchanges," all of which The Washington Post says have grabbed the attention of U.S regulators and eager investors. And for many "fearful Chinese executives," a growing number of funds like Andrangi's, which are quick to cry foul, can mean a painful downfall for their company.
Washington Posts reports on some of Andrangi's recent "scathing assessments" that give some clear examples of the types of "hoax" companies on the market.
To start with, China Education Alliance, a Chinese for-profit education company, is a perfect example of a stock that holds no water. "The company’s Harbin “training center” — which CEA said had “17 modern classrooms” for 1,200 students — had no desks and was all but empty, Adrangi said. It boasted of online revenue, but its Web site didn’t work." The company's $150 million in market value is now worth $25 million.
Then there's China Biotics, which "claimed to have more than 100 outlets for its nutritional supplements; Adrangi said he hired researchers who checked all the company’s business addresses and found only four outlets."
There's also China Marine, "a maker of snacks and an algae drink, reported revenue to China’s State Administration of Industry and Commerce that was 85 percent lower than what it reported in U.S. filings."
If you're wondering how fraudulent companies like these infiltrate American stock exchanges almost unregulated in the first place, it's through an exploitation of a loophole called a reverse merger.
It works like this: By buying up a small company that's fallen on hard times and listed on a stock exchange, fraudsters can enter the exchange while bypassing much of the regulatory investigation that comes with the traditional route. The purchased company, referred to as a “shell,” usually retains its organizational structure, but its executives and board members are replaced by its new owners.
Stories like these make investors nervous, as well they should. If anything, it should propel investors to take a much closer look at where they place their money.
Of course, it would be a big mistake to say that all U.S.-listed Chinese companies are scams. And the fact that so many people are running away from these names create an opportunity for those willing to take a closer look.
To create the following list, we started with a universe of about 92 Chinese companies that obtained listing on U.S. exchanges through reverse mergers. From this universe, we identified the names that have seen significant institutional selling during the current quarter.
We also collected data on short seller trends, and identified which Chinese reverse merger listings are seeing significant short covering (i.e. a bullish trend, contradicting the bearish sentiment from big money managers).
In other words, institutional investors have rushed to dump the stocks mentioned below (maybe because everyone is concerned about Chinese reverse mergers?), but short sellers think the upside potential of these names outweigh the downside. Which side are you on?
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List sorted alphabetically.
1. China Natural Gas, Inc. (CHNG): Engages in the distribution and sale of natural gas and gasoline to commercial, industrial, and residential customers in the Peoples' Republic of China. Net institutional sales in the current quarter at -872.4K shares, which represents about 4.92% of the company's float of 17.72M shares. Shares shorted have decreased from 1.06M to 874.36K over the last month, a decrease which represents about 1.05% of the company's float of 17.72M shares.
2. China Valves Technology, Inc. (CVVT): Engages in developing, manufacturing, and selling low, medium, and high-pressure metal valves for customers in the electricity, petroleum, chemical, water, gas, nuclear power station, and metal industries in China. Net institutional sales in the current quarter at -1.6M shares, which represents about 7.79% of the company's float of 20.53M shares. Shares shorted have decreased from 2.40M to 2.19M over the last month, a decrease which represents about 1.02% of the company's float of 20.53M shares.
3. Harbin Electric, Inc. (HRBN): Engages in the design, development, manufacture, supply, and service of electric motors in the People's Republic of China and internationally. Net institutional sales in the current quarter at -3.0M shares, which represents about 20.72% of the company's float of 14.48M shares. Shares shorted have decreased from 8.29M to 8.14M over the last month, a decrease which represents about 1.04% of the company's float of 14.48M shares.
4. SkyPeople Fruit Juice, Inc. (SPU): Produces and sells fruit juice concentrates, fruit beverages, and other fruit related products primarily in the People's Republic of China. Net institutional sales in the current quarter at -588.5K shares, which represents about 5.15% of the company's float of 11.42M shares. Shares shorted have decreased from 969.52K to 754.88K over the last month, a decrease which represents about 1.88% of the company's float of 11.42M shares.