Monthly Archives: January 2012

Market In China: Short Sellers’ Scam Is Unraveling

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In This Post:

  • MBOs
  • Company Retaliation
  • Offenders Jailed
  • Valuations Absurd

Market in China: China Stocks Pendullum Is Swinging Back

Market in China - China Market ReviewChina small cap stocks are having a great year in the early going, and I suspect it will get better as the quality survivors deliver their 2011 audited numbers. I thought last year’s audits were under the microscope- this year’s audits will be the most thoroughly performed in the history of audits. In light of all the fraud that was disclosed in 2011, the China auditors are on the hot seat, and they know it.

There are several major factors pushes these oversold stocks back up the charts.

The Market in China Is ripe.

MBOs:

First, there’s been a tremendous pick up in MBO activity- Management Led Buyouts. There are many large Private Equity funds prepared to back management teams looking to take their companies private. In an MBO, management teams up with one or more institutional investors and tenders an offer to buy out their shareholders at a premium to where the stock is trading. If the transaction closes, the companies withdraws from the public markets.

Harbin Electric (formerly HRBN) was successful in an MBO at $24 when the stock had traded as low as $7, and short sellers, who had publicly villfied the management, ended up looking foolish.

Several others have succeeded in going private, and it seems about once a week a company announces it has either received a tender offer, or has started down the path of going private.

From the perspective of the CEO of a China based company with a US listing, why not? After all, billions were raised for these companies at far higher valuations. Why not buy yourself back a lot cheaper, and take your company back? Makes sense to me.

Short sellers are getting extremely nervous as tender offers and MBOs come out regularly, and the stocks trade up on the news.

Company Retaliation: Assessing the Market in China

Market In China: Short Sellers' Scam Is UnravelingCompanies are fighting back against highly vocal short sellers with some success. Of recent note is the progress being made by Sivercorp (AMEX: SVM).

Silvercorp is actively pursuing short seller “Alfred Little”. Alfred LIttle attackers have hidden behind for sometime. Through court action, SVM was able to uncover the identities the Alfred Little group of alleged co-conspirators who launched baseless attacks against the company.

With the names of the perpetrators revealed, SVM is not actively pursuing legal action accusing the Alfred LIttle group of spreading “false, defamatory and fraudulent information about Silvercorp on the Internet and in letters to the media and regulators to drive down the price of Silvercorp’s stock to profit from their short positions in the stock.”

Deer Consumer (NASDAQ: DEER) and Focus Media (NASDAQ: FMCN) are actively engaged in law suits against short sellers, and making progress towards uncovering high levels of fraudulent activities (allegedly). The Market in China is Looking up.

Muddy Waters- the largest and most successful short seller in the space, attacked Focus Media. Since the initial drop, the stock has rebounded nicely as the company refuted all the allegations and simply declared it would start paying a cash dividend. That move cast some serious doubts on the Muddy Waters claims. Hereby giving the Market in China room to breathe.

Offenders Jailed in China:

The Chinese are very focused on appearances. They like events and occurances that make them look good, and abhor any media worthy fodder that makes them look bad regardless of what the underlying truth may be.

The high profile collapses in the China Small Cap space in 2011 made China look really bad. Chinese officials are very sensitive to these issues.

It is widely known many of the short sellers hired investigating groups in China to uncover fraud. Several of the attacks on the larger names- specifically China Media Express and SinoForest were so righteous that I felt these short sellers had to have some sort of insider information to dig in as deeply as they did.

Having studied this process, I now believe the investigators for Short Sellers bribed government officials to get their hands on non public disclosure- primarily the VAT filings, which are the equivalent of our tax returns. Discrepancies between the taxes paid and the SEC filings would lead one to a conclusion fraud is being committed.

I also believe much of the information they received was falsfied. It would not be uncommon in China for a government official to accept a bribe to produce information. The official provides falsified documents and then just keeps the money.

Short sellers, who are still deeply stuck in short positions in many of these stocks, might have been acting on false information which was illegally obtained.

I have read some reports of arrests in China of investigators who worked on behalf of short sellers. I don’t have any specifics yet.

Valuations Absurd

With stocks trading as low as 1x to 2x ’12 EPS, high cash balances, short sellers facing legal action, and their investigators being jailed, we are finally seeing the “green shoots” of a resurgent China Small Cap Market.

Particularly distressing for short sellers is the price movement on fairly light volumes. Many of these stocks are beginning to trade up on rather light volumes as there are no sellers left to be found.

In the meantime over $4 billion has moved into Emerging Market mutual funds over the past 30 days- $1 billion flowed in that direction last week alone.

We’re seeing short positions in these stocks unwind as they move up, suggesting shorts have begun covering, but are trapped as small amounts of buying push up prices.

Also, several of the very high profile short sellers have been hinting they are looking at going long some of these stocks. I believe they have simply run out of targets, and the investigators are being arrested.

We appear to be on the front end of a nice rebound in the sector. After last year’s blood bath, the pendullum is finally swinging back.

If you’d like to know my 3 favorite stocks for 2012, simply sign up for a trial subscription at www.emergingchinastocks.com. My top 3 picks are up 150%, 66%, and 40% from the October lows. All look like they have a lot more room to run.

While you’re there, sign up for my free Webinar on:

How China Companies Commit Fraud

Warmest Regards,

Larry Isen

China Stocks – Inflating Revenues

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Inflating Revenues in China Stocks and How To Avoid The Fraud

Inflating revenues is another common way fraud is being committed in China Stocks.

The most simple way is to fake the receipt of revenues. The company has to show more money coming into the bank than really has.

China Stocks - How To Avoid Fraud In China Stocks

China Stocks - How To Avoid Fraud In China Stocks

It’s a simple matter of getting a bunch of fraudulent invoices from the black market, and putting the revenues on your books.

From there, these fake revenues have to be reflected in your banks statements as well, so you need fraudulent bank statements.

This is a simple matter of creating the statements and presenting them to your examiner with the “Bank Chop” seal already stamped. Of course, you’ve obtained a fake stamp for about $200.

It’s common to claim receivables that don’t exist. You claim to have shipped a product, and the buyer is in on the conspiracy. When called by the examiner, the buyer confirms the purchase, but he has, of course, been bribed in advance to cooperate.

China stock fraud going on in the China livestock industry

There’s a lot of fraud going on in the China livestock industry where sales are double counted. For example, and pork producer might sell a whole generation of baby pigs to local farmers. They raise the pigs, and sell them back to the pork producer, who then sells them to an end buyer. The hogs were never really sold to the local farmer, and the sale of the livestock is double counted. Since this is the same animal, this is not allowed under GAAP accounting standards.

 

China Stocks Fraud And How To Avoid It

China Small Cap Stocks: Can They Come Back in 2012?

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The China Small Cap Market in 2011

The China Small Cap Market in 2011

The China Small Cap Market in 2011

It’s almost not worth reliving, but sometimes reliving the bad experiences of the past helps you move forward and identify opportunities.

Anthony Bolton, manager of the Fidelity China Special Situations Fund said he best when he described 2011 in China equities as “BRUTAL”.

Bolton’s fund tumbled 38% last year. Most people would look at this track record and assume Bolton has no idea what he’s doing.

Hold the phone. The market takes Anthony Bolton very seriously when one considers Bolton managed $12 billion for Fidelity for 28 years, and averaged 19.5% annually over his tenure. Morningstar points out a $10,000 investment in his fund in 1979 turned into $1,494,118 in 2007.

Bolton’s $208 billion fund was heavily weighted to small and medium cap stocks. This sector was decimated by three separate head winds:

  • The widespread accusations of fraud (in some cases proven accurate)
  • The real estate and food driven spike in inflation in the Chinese economy
  • The global slow down fostered by the European Sovereign debt and banking crisis

Any one of those three factors would have been enough for a weak market environment, but combining the three together led to the adjective “BRUTAL” by this seasoned veteran.

Bolton’s fund was down 38% in 2011. The China large cap market was down 22%- a dismal year by any standard. This, despite continuing fundamental progress by many of the more heavily followed China names.

China companies are doing very well- but the stocks have been dismal. The macro global picture trumped the company micro picture in 2011.

 

The Outlook for China Stocks 2012  The Outlook for China Stocks 2012

For starters, it would be hard for 2012 to be worse than 2011 for China equities. Aside from the normal stock market fluctuations off a terrible year, the macro picture in China is improving.

Q4 GDP growth in China was 8.9%. This is the slowest pace since 2009, but the median forecast of 26 economists was 8.7%. China is doing better than the economists realize.

China delivered full year GDP growth of 9.2%. The lowest estimate I’ve seen for 2012 is 7% GDP growth from Pimco, but most economists take a more moderate view in the 8% to 8.5% range.

Whether 7% or 8.5%, in this era of global crisis, China will still stand as the world’s fastest growing economy, boasting the largest emerging consumer class in the history of the world.

Economists are forecasting 12.3% industrial production growth in December ’11. While this growth is stronger than the rest of the world, it’s the smallest gain since August of 2009.

However, growth in retail sales is making up for the shortfall in the growth of industrial production. Retail sales in China are expected to grow 17.2% in December- a blistering pace.

7% to 8.5% growth in China in 2012 should actually bode well for equities. The Chinese government put the brakes on the economy in 2011 to slow down inflation, and it’s paying off.

Thanks to the cooling off of exports and the lower food costs, China inflation rate fell to its lowest level in 15 months in December, which should allow the Chinese government to ease monetary policy.

This past week, many commodities such as copper, soy beans, wheat, and oil traded to multi month highs this week which indicates a certain level of optimism concerning the global economy, spurred on by demand out of China.

In an interview with Bloomberg on Wednesday, Jim O’Neill, the Chairman of Goldman Sachs Asset Management, has some interesting observations.

O’Neill is the economist who coined the acronym “BRIC Nations”- referring to Brazil, Russia, India, and China.

O’Neill pointed out that if the Chinese economy were to grow a mere 7.5% for this entire decade (he is forecasting this), it would contribute more to world growth in dollars than the US and Europe combined.

O’Neill also forecasts a China style democracy will evolve. While the Chinese citizenry is saying the want more freedom, what they really want is more wealth.

There’s still 1 billion people in China who have nothing by modern standards, and they all want wealth. It’s the largest emerging consumer class in the history of the world.

While all this macro stuff is happening, things are shaping up on a micro level as well. I’ve studied nearly 100 small cap charts this past week, and there’s a few that are really shaping up beautifully.

There haven’t been many fraud accusations of late, and the 2011 audits of China small caps will start coming out next month.

There will be massive scrutiny from the audit firms considering the heat that has befallen the sector, so these will be the most reliable audits on China small cap to date.

It’s time to start getting engaged in this sector again if you’ve been on the sidelines.

Some Of My Best Work- A Webinar For You on Fraud In China and How To Avoid It

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Some Of My Best Work- A Webinar For You

As many of you know, the OTC Journal is only one of my publications. This is the beginning of my 14th year with the OTC Journal. As 2011 wasn’t a good year in the markets, I expect 2012 to be far better.

Fraud in China and How to Avoid It!My other newsletter, which is now going into its second year of publication, is focused on Emerging China Stocks. You can check out the web site at www.emergingchinastocks.com. Those of you who follow the sector know it was a complete bloodbath in 2011. The allegations of fraud, many of which turned out to be true, completely destroyed a sector of about 600 publicly traded companies, most of whom are perfectly legitimate.

One of the greatest fund managers of all time- Anthony Bolton, who manages the Fidelity China Special Situations fund, described 2011 as “BRUTAL” for investors.

Bolton, who has averaged 20% a year for the last 20 years in his UK Special Situations fund, believes the world’s investment community will look for growth again soon, and they’ll find it in China equities.

Bolton is continuing to accumulate China Small Caps in the $.5 billion fund, but he is focusing primarily on companies with good corporate governance policies.

I lost a substantial amount of my own personal capital in the 2011 China disasters, but I’ve learned a lot. Rather than fold my tent and disappear into the desert night, I have learned after 23 years in the small cap world that there’s opportunity in crisis.

Here’s where this is all leading. In the second half of 2011 I spent a lot of time educating myself and learning how China companies commit fraud. For investors on the long side, the China small cap companies who are publishing accurate numbers represent the values of a lifetime.

There’s 600 China small caps- 200 trading with senior US listings. About 25 have been credibly demonstrated to be committing fraud, and I believe there will be a few more.

So, the key to making money in these beaten down stocks is the ability to identify which are committing fraud to a material extent, and which are not.

I’ve written a produced an 8 Part video WEBINAR on “How China Companies Commit Fraud”. It’s free- no strings attached, and the first opportunity to attend will be next Thursday.

Lest you think these stocks haven’t hit bottom, let me point out 3 of my core ideas in EmergingChinaStocks are up 140%, 75%, and 62% respectively off the October lows.

If you’d like to attend the WEBINAR, Click Here, go to the following sign up page:

http://bit.ly/PowerOfEight

 Tomorrow’s New Idea

Tomorrow I’ll be introducing my first new penny stock trading idea for 2012.

This is a $.15 stock that no one is following and no one knows about. However, this is no start up. The company is coming off its best quarter ever. In September, this company delivered $5.6 million in quarterly revenues with 30% margins and an extremely small paper loss. The company was very nearly cash flow positive for the first time in its history. I invested privately in this company about 3 years ago at $.25, and I still hold 85% of the shares. Since the company is performing better than it ever has, you’re getting a far better entry level than I had.

This company is riding a 21st Century wave being adopted rapidly into Main Stream society. It’s a bit unusual, and promises to be very profitable. They manufacture and distribute a line of products in a specific category, and their largest customers are the likes of:

  • Amazon
  • Brookstone
  • Drugstore.com
  • Overstock
  • Walgreens

Their products are getting national recognition having recently been featured in a number of top run Hollywood Movies and one highly rated cable reality show.

Got your attention? I’m working on the initial presentation now. I plan to publish several editions on this one over the course of the next month. Tomorrow is your OTC Journal “First Look”.

Stand by to be entertained.

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