Glaucus Research issues "sell" for China Medical Technologies (CMED, LLEN, GURE)

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Glaucus Research California has issued one of its now-infamous "sell" ratings for China Medical Technologies Inc. ( CMED , quote ), arguing that the diagnostics maker committed outright fraud by paying too much for assets previously owned by its CEO.

As detailed in a previous article on , Glaucus Research California focuses on shorting Chinese stocks on the grounds that many are fraudulent.

For China Medical Technologies (CMED) from the official statement:

Glaucus Research Group California, LLC ("Glaucus Research") engaged a team of 13 independent consultants (located both in China and the United States) with expertise in law, finance, medicine and accounting to examine CMED and the Chinese medical device sector over the last 12 weeks. Our consultants reviewed and analyzed the Company's SAIC filings, conference call transcripts, press releases and SEC filings.

In this report, we present compelling evidence that leads us to conclude that CMED committed fraud by overpaying for an acquisition from an entity that appears to be secretly related to CMED's founder, CEO and Chairman. Beyond this there is a host of other red flags to support the notion that CMED is a fraud. We believe that in light of the evidence presented in this report that CMED's independent directors have a fiduciary duty to conduct an independent investigation into the company, and that the Company's auditor has a duty to investigate the evidence identified in our report when conducting the audit of the company for fiscal year 2012. Below is a summary of our findings:

  • CMED paid $28 million for an acquisition from a seller who we believe was secretly related to CMED's chairman. Evidence also shows that CMED radically overpaid for the acquisition: a few months before selling the company to CMED, a company controlled by parties related to CMED insiders bought out minority shareholders at prices suggesting that the business was worth $5-$8 million, not the $28 million paid by CMED for the acquisition. In our opinion, CMED's chairman orchestrated an acquisition to embezzle roughly $20-$23 million from the public company.

  • CMED sold its primary business segment, responsible for the majority of the firm's sales since inception, to the Chairman at less than 2x trailing EBITDA. We believe that this suspicious looking transaction was designed to cover up that the Chinese FDA was about to (or already had) suspended CMED's permit to sell HIFU products, thus rendering CMED's core business segment worthless almost overnight.

  • Despite a purportedly profitable business, CMED is a serial capital raiser and it has not generated free cash flow for most of its history. The company has spent twice as much on "investing activities" as it has purportedly generated from operations, so much like a typical Chinese fraud, it relies on debt or equity financing as its primary source of cash generation.

  • CMED's balance sheet presents numerous highly suspicious red flags. CMED's receivables account for almost three times higher percentage of net revenues than its Chinese competitors and its Day Sales Outstanding are on average 141.9 days longer than a leading Chinese competitor, despite the fact that both companies sell similar products to similarly situated customers.

  • In 2009, an anonymous letter to the audit committee accused senior management of committing fraud with respect to the company's financials and its acquisitions. After an investigation by the audit committee, CMED's auditor KPMG, resigned.

The trajectory of the stock price of CMED has certainly rewarded those with a short position. The stock is down more than 26% for the week, more than 40% for the month, more than 50% for the quarter, and more than 77% for the year. At present, there is a short float of almost 15% for CMED -- remember, any short float of 5% is considered troubling.

Other Chinese stocks that Glaucus Research California has issued "sell" recommendations for are performing poorly. Gulf Resources ( GURE , quote ) is down more than 79% for the year with a 11.35% short float. L&L Energy ( LLEN , quote ), another Glaucus target, has fallen more than 71% for the year and has an 11.18% short float.

As pointed out in a Wall Street Journal article , analysts covering Chinese stocks tend to be overly bullish -- as detailed on in " Trust dividend income history, not the analysts ."

For China Medical Technologies, Deutsche Bank issued a "Buy" rating in August 2010 and Brean Murray upgraded the stock to a "Buy" in August 2008 with a target price of $55.

China Medical Technologies (CMED) is now trading around $2.90, which means for Brean Murray to be on the money, this battered stock needs to deliver something like 1,800% in upside.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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