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Shorting China Loses Luster
Jim Trippon: Chief Investment Analyst

Last year saw a lot of hot and cold trends for investing, but one of the hottest was shorting China stocks. A number of factors played into this, but none more than the drum beating by various short sellers about Chinese firms. These weren’t just reports or analysis that opined that the prospects of some Chinese stocks weren’t positive, there were often accusations of downright fraud and other abuses. While much of the short selling proved to be dramatically profitable for those who did it, some of the stocks of the companies whose reputations were attacked didn’t recover. In some cases, the attacks on the companies appeared justified, as questions about their operations and accounting uncovered a lack of convincing evidence to refute the charges. In other cases, the situation is far less clear. It looks as though some companies were attacked, yet the allegations against them were at best unconvincing.

The Waters Muddied

The most celebrated short seller has been Carson Block, whose firm Muddy Waters LLC famously called out Sino-Forest (TRE: TO), in June of last year. Block maintained that Sino-Forest, a Hong Kong and Canadian-based timber plantation operator, had misstated its holdings. Sino-Forest could not subsequently prove it owned the land it claimed to. Sino-Forest’s market value plunged by more than $3 billion after Block’s report and the stock hasn’t traded since the end of summer last year. Famous hedge fund investor John Paulson took a $100 million loss on Sino-Forest. The company still denies Block’s allegations. Block’s firm had also singled out China Media Express Holdings (Nasdaq: CCME) as inflating profits. China Media Express now trades on the pink sheets, with shares recently priced at $0.11.

Carson Block of Muddy Waters, LLC

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More Troubling

There were roughly 300 Chinese firms listed on American stock exchanges, and at times as many as 150 or more of these firms were under attack. For every successful or seemingly successful callout of questionable firms—and remember, most of the firms shorted do not agree with the allegations against them—there were other more troubling cases. The attacks by reputed hedge fund Absaroka Capital Management LLC and others on Chinese firms were often highly disputed. Evidence of fraud was sketchy at best, non-existent at worst. Yet other short sellers piled on. Some observers have raised serious questions about the qualifications of many of the firms putting out the supposed research on the stocks they attack. Some Chinese companies have even fought back by suing.

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More On Block

Less successful has been Block’s attack on Focus Media Holdings (Nasdaq: FMCN). Block alleged in November, 2011 that Focus, based in Shanghai, had exaggerated its advertising network. The stock was driven down nearly 40 percent. A survey conducted by an Ipsos, SA’s subsidiary, however, conncluded that Focus Media’s number of advertising screens was 99 percent accurate. Focus Media strongly disputed allegations of fraud. The stock has since risen more than 50 percent.

While Block and other short sellers maintain that there are fraudulent Chinese companies, the problems with the allegations are at least twofold. One, there’s often sketchy evidence or no evidence for the charges against the companies.Two, the allegations need not be proved for damage to ensue for the stock. Number two is particularly troubling, as a legitimate firm can have a difficult time refuting an allegation of fraud against it when evidence isn’t presented. How does one refute an attack for which there is scant or no evidence furnished in the first place? The reputation of legitimate firms can be unfairly damaged as the market usually doesn’t wait for a company to defend itself.

Focus Media 1 Year Chart

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Investor Cautions

There have been several negative currents which have run against China stocks in the last year. The attacks and frenzied short selling seemed to have had a symbiotic effect on wider attacks on Chinese stocks, such as the extreme—and unproved allegations—that many Chinese stocks listed on the Nasdaq were potentially fraudulent businesses simply because of their variable interest entity, or VIE, structure. There have clearly been problems with many of the Chinese RTOs, or reverse merger stocks which have bypassed IPOs, but the most damaging thing has been the poisoned atmosphere from negative attacks which have painted all Chinese stocks as fraudulent. Clearly, better regulation on Chinese firms and from the SEC to prevent fraud will ultimately be a good thing. Yet where is the regulation on the short sellers, who can assert anything, with or without proof, and face no consequences? In a bitter irony, Carson Block said in a recent interview he’s looking for Chinese stocks to go long with.

Click HERE to know more about the China Stock Digest: China Stock Market Research & China Stock Analysis

Committed to your Global Profits,

Jim Trippon

Chief Investment Analyst

Recent China Stock Market Posts by Jim Trippon:

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Global Profits Alert (GPA) is published by Trippon Financial Research, Inc. a financial media organization with offices in the United States, Hong Kong and Mainland China. GPA is written by Jim Trippon in conjunction with George Wolff, Sunny Wang, Todd Shriber, Kelley Damiani and J. Daryl Thompson.

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