One of the great investing tailwinds for the next few decades is the rapid growth of the Chinese economy and the great migration of China’s people into a more Western middle class lifestyle.
I don’t think that many people will dispute that this macro event is going to continue to have a big impact on the global economy and a big impact on the total level of global consumption of agricultural products and natural resources.
There will be all kinds of homerun investments in China as small companies grow rapidly for years and years creating the kind of wealth for investors that we dream of every day.
The problem that I have is that I’m terrified to invest in any Chinese company. The incidents of fraud are so frequent that I’m not sure it is worth the risk.
In May of this year the largest hedge fund manager in China presented at the Value Investing Congress. I am referring to Lei Zhang of Hillhouse Capital Management who started his firm with $30 million in now manages $4 billion. His fund has returned 52% annualized since 2005 and holds a concentrated portfolio typically adding only 3 to 5 positions a year. Part of Zhang’s investing approach involves shorting fraudulent companies. And according to him up to 80% of the Chinese companies listed in the U.S. are frauds to one degree or another.
Drink that in for a second. The largest and most successful Chinese hedge fund manager believes 80% of the Chinese companies listed in the United States are frauds. Buyer beware.
In November I wrote about a reverse Chinese merger that had been exposed:
http://www.gurufocus.com/news.php?id=115038
I found a really interesting Bloomberg article today that further digs into the Chinese reverse merger story:
http://www.bloomberg.com/news/2011-01-13/texas-short-seller-fights-china-fraud-in-20-billion-u-s-shares.html
The best parts of the story include:
Uncovered by a private investor
“Some things he takes very seriously, including what he calls the “sanctity of math.” On that afternoon it was being defiled in his eyes by the claims of China Sky One Medical Inc., a maker of slimming patches and hemorrhoid ointments. Sky One, according to its annual report, was selling out its inventory and resupplying almost every seven days. That, Bird says he knew from experience in business, was impossible. “
How they do it
“Sky One and the other companies have moved onto U.S. exchanges through a process called a reverse merger, in which a closely held company buys a publicly traded shell company -- and retains the U.S. listing as its own instead of extinguishing it, as usually happens in takeovers. Bird says that many reverse merger companies are deceptive, at best, about their numbers.”
How he found his critical evidence
“The SAIC is the Chinese government agency responsible for market supervision, regulation, and enforcement. According to a SAIC filing, Sky One’s operating unit, Harbin Tian Di Ren, had 2008 sales of 6.93 million yuan, roughly $1 million at 2008 exchange rates. Yet to the SEC, Sky One reported 2008 sales of $91.8 million, with Tian Di Ren accounting for at least 65 percent, or $59.7 million.”
And places his bet
“By August 2009, Bird was ready to place a serious bet. He logged onto his account and sold short 30,000 shares at $15.70. The natural next step of a short seller is to get the word out, and Bird posted a selection of his evidence.
He chose the Internet address waldomushman.com -- Waldo Mushman being the occasional pseudonym of the actor Steve McQueen, at least according to Bird. “
Other players joining the profit from fraud exposing game
“Bird’s approach did interest other investors, who began to use his method of checking up on Chinese-American stocks through SAIC filings. The far-flung crew included short sellers such as Andrew Left of Citron Research in Los Angeles as well as newcomers, including Muddy Waters Research, based in Hong Kong, and Sahm Adrangi, a 29-year-old Yale graduate running the hedge fund Kerrisdale Capital in New York. “
Happy ending for the short seller
“Bird did not go to New Zealand this past Christmas. Instead he was serenaded by the sound of waves in a Hawaii beach rental, and he heard only good news from his short-selling experiments. Sky One’s shares retreated 69 percent in 2010, and Bird put $500,000 of his $1 million-plus in profits into a startup cancer drug company.”
Read the entire article, it is very interesting.
Now however is another thought. I’m sure most investors have now learned to be terrified of Chinese reverse merger US listed companies. I know I’ve seen Herb Greenberg on CNBC on a regular basis waving this issue in front of the cameras. And that has to create some opportunity in the ones that are legitimate. The valuations on these small companies tainted with a dirty brush must be extremely pessimistic.
The problem is, how do you go about finding out which companies are legitimate when the business operations are situated across the world and there are also language, cultural and financial barriers between you and them ?
I don’t know. I’m not likely going to try and find out but would certainly be interested in hearing from anyone who is combing the world of Chinese microcaps and believes he/she has a method for distinguishing between the good and bad.
I don’t think that many people will dispute that this macro event is going to continue to have a big impact on the global economy and a big impact on the total level of global consumption of agricultural products and natural resources.
There will be all kinds of homerun investments in China as small companies grow rapidly for years and years creating the kind of wealth for investors that we dream of every day.
The problem that I have is that I’m terrified to invest in any Chinese company. The incidents of fraud are so frequent that I’m not sure it is worth the risk.
In May of this year the largest hedge fund manager in China presented at the Value Investing Congress. I am referring to Lei Zhang of Hillhouse Capital Management who started his firm with $30 million in now manages $4 billion. His fund has returned 52% annualized since 2005 and holds a concentrated portfolio typically adding only 3 to 5 positions a year. Part of Zhang’s investing approach involves shorting fraudulent companies. And according to him up to 80% of the Chinese companies listed in the U.S. are frauds to one degree or another.
Drink that in for a second. The largest and most successful Chinese hedge fund manager believes 80% of the Chinese companies listed in the United States are frauds. Buyer beware.
In November I wrote about a reverse Chinese merger that had been exposed:
http://www.gurufocus.com/news.php?id=115038
I found a really interesting Bloomberg article today that further digs into the Chinese reverse merger story:
http://www.bloomberg.com/news/2011-01-13/texas-short-seller-fights-china-fraud-in-20-billion-u-s-shares.html
The best parts of the story include:
Uncovered by a private investor
“Some things he takes very seriously, including what he calls the “sanctity of math.” On that afternoon it was being defiled in his eyes by the claims of China Sky One Medical Inc., a maker of slimming patches and hemorrhoid ointments. Sky One, according to its annual report, was selling out its inventory and resupplying almost every seven days. That, Bird says he knew from experience in business, was impossible. “
How they do it
“Sky One and the other companies have moved onto U.S. exchanges through a process called a reverse merger, in which a closely held company buys a publicly traded shell company -- and retains the U.S. listing as its own instead of extinguishing it, as usually happens in takeovers. Bird says that many reverse merger companies are deceptive, at best, about their numbers.”
How he found his critical evidence
“The SAIC is the Chinese government agency responsible for market supervision, regulation, and enforcement. According to a SAIC filing, Sky One’s operating unit, Harbin Tian Di Ren, had 2008 sales of 6.93 million yuan, roughly $1 million at 2008 exchange rates. Yet to the SEC, Sky One reported 2008 sales of $91.8 million, with Tian Di Ren accounting for at least 65 percent, or $59.7 million.”
And places his bet
“By August 2009, Bird was ready to place a serious bet. He logged onto his account and sold short 30,000 shares at $15.70. The natural next step of a short seller is to get the word out, and Bird posted a selection of his evidence.
He chose the Internet address waldomushman.com -- Waldo Mushman being the occasional pseudonym of the actor Steve McQueen, at least according to Bird. “
Other players joining the profit from fraud exposing game
“Bird’s approach did interest other investors, who began to use his method of checking up on Chinese-American stocks through SAIC filings. The far-flung crew included short sellers such as Andrew Left of Citron Research in Los Angeles as well as newcomers, including Muddy Waters Research, based in Hong Kong, and Sahm Adrangi, a 29-year-old Yale graduate running the hedge fund Kerrisdale Capital in New York. “
Happy ending for the short seller
“Bird did not go to New Zealand this past Christmas. Instead he was serenaded by the sound of waves in a Hawaii beach rental, and he heard only good news from his short-selling experiments. Sky One’s shares retreated 69 percent in 2010, and Bird put $500,000 of his $1 million-plus in profits into a startup cancer drug company.”
Read the entire article, it is very interesting.
Now however is another thought. I’m sure most investors have now learned to be terrified of Chinese reverse merger US listed companies. I know I’ve seen Herb Greenberg on CNBC on a regular basis waving this issue in front of the cameras. And that has to create some opportunity in the ones that are legitimate. The valuations on these small companies tainted with a dirty brush must be extremely pessimistic.
The problem is, how do you go about finding out which companies are legitimate when the business operations are situated across the world and there are also language, cultural and financial barriers between you and them ?
I don’t know. I’m not likely going to try and find out but would certainly be interested in hearing from anyone who is combing the world of Chinese microcaps and believes he/she has a method for distinguishing between the good and bad.
