Chinese Reverse-Mergers: Do Companies and Investors Both Lose? - Barron's
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Barron's posted an article this weekend about the impact of Chinese reverse-merger companies in order to become listed on an American stock exchange. A reverse merger is when a Chinese business that is active, merges into the shell of an American business that was formerly active and was in-line to list on an exchange. Barron's notes that the stocks that come in to fill the void rarely surpass $1 billion in market capitalization, but over 350 companies merged over the last several years make up a movement of about $50 billion.
Barron's did a study on 158 of the most recent companies, and found that they underperformed the Halter Index by about 75% over their first three years trading. The Halter Index is "composed of U.S.-listed Chinese companies, ranging from the American depositary shares of well-known names like Internet giant Baidu.com (Nasdaq: BIDU) and telecom power China Mobile (NYSE: CHL) to small-cap reverse mergers." Losses are shared by both Chinese entrepreneurs and American investors; the entrepreneurs think that they're raising capital in a fair way, and American investors think that they're getting a piece of the burgeoning Chinese economy.
Reasons for the losses may be many, but for the most part their financial filings with the U.S. Securities and Exchange Commission differ from those that they file with the Chinese government. Many operations appear to be better off than they are on filings rather than what the realistic operations would lead one to believe. Operations simply cannot produce what the company is saying that they will produce.
But not many companies are checked on. Chinese authorities have little incentive to monitor a company traded on an American exchange, and the SEC's enforcement staff can't subpoena evidence of any fraudulent activities in China.
Although many companies in China begin the process to become listed on an American exchange, few actually make it. Barron's notes that one, China Green Agriculture (NYSE: CGA), is still active today, even after its late-2007 reverse-merger with Discovery Technologies. To become listed, the company had to jump through several hoops, one of which was to combine with a New Jersey corp.
The article also notes that there are many "promoters" in the game of reverse-merging, which has a supply chain of company's ready for the process, not unlike any other black-market industry in China. Two of the main promoters are Du Qingsong and Kit Tsui. In 1999, Du had been jailed, allegedly from "fraudulent investment schemes," and barred from by the Chinese securities regulator for illegal dealings.
Tsui's reverse-mergers include Gulf Resources (Nasdaq: GFRE) and Orient Paper (NYSE: ONP). Notably, Orient Paper came into some trouble recently when Hong Kong-based Muddy Water's Research published a report showing that what the company reported doing, and what the actual operations looked like, different significantly. Muddy said that, after a visit to the factory in January, they found it "idle and dilapidated." Muddy Water's believes that their SEC filings overstate asset values by ten-fold and revenues by 40-fold. An internal investigation is being undergone by Orient Paper currently. A money manager that spoke with company officials did say, however, that they blame Tsui for the irregularities.
Benjamin Wey is another promoter who has had run-ins with securities regulators. After Barron's reported his work with AgFeed Industries (Nasdaq: FEED), shares dumped from $15 to $2.50, and has missed production targets ever since mid-2008. Wey has also had contact with Deer Consumer Products (Nasdaq: DEER) and CleanTech Innovations (Nasdaq: EVCP). CleanTech, whose shares have tripled to $9.50 after a July private placement, is trading at 220x FY09 earnings.
Barron's warns that investors should be wary of private placements of public equities (PIPEs). For example, several PIPE deals involving Andrew B. Worden's Barron Capital came in below expectations; 11 with a year's worth of returns lagged the Halter Index by 30% and 7 with three-years’ worth of returns were short by 75%. Additionally, hedge funds that provide PIPE financings have substantial sway over the company in terms of who will be their auditor, investor-relations firm and chief financial officer.
Additionally, all of the reverse merger companies seem to hire the same auditors that certified the financials of companies that sank into the deepest depths. Two companies that have had recent accounting problems include China Natural Gas (Nasdaq: CHNG) and RINO International (Nasdaq: RINO).
The bottom line in the article, it seems, is that many of the PIPE stocks have decent short-term growth, which may be based on pure speculation and momentum, but a three-year look at most firms finds them head-over-feet in enough accounting issues and corruption that it makes Enron look like Walt Disney world to a four-year old...nothing short of magical.
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Barron's did a study on 158 of the most recent companies, and found that they underperformed the Halter Index by about 75% over their first three years trading. The Halter Index is "composed of U.S.-listed Chinese companies, ranging from the American depositary shares of well-known names like Internet giant Baidu.com (Nasdaq: BIDU) and telecom power China Mobile (NYSE: CHL) to small-cap reverse mergers." Losses are shared by both Chinese entrepreneurs and American investors; the entrepreneurs think that they're raising capital in a fair way, and American investors think that they're getting a piece of the burgeoning Chinese economy.
Reasons for the losses may be many, but for the most part their financial filings with the U.S. Securities and Exchange Commission differ from those that they file with the Chinese government. Many operations appear to be better off than they are on filings rather than what the realistic operations would lead one to believe. Operations simply cannot produce what the company is saying that they will produce.
But not many companies are checked on. Chinese authorities have little incentive to monitor a company traded on an American exchange, and the SEC's enforcement staff can't subpoena evidence of any fraudulent activities in China.
Although many companies in China begin the process to become listed on an American exchange, few actually make it. Barron's notes that one, China Green Agriculture (NYSE: CGA), is still active today, even after its late-2007 reverse-merger with Discovery Technologies. To become listed, the company had to jump through several hoops, one of which was to combine with a New Jersey corp.
The article also notes that there are many "promoters" in the game of reverse-merging, which has a supply chain of company's ready for the process, not unlike any other black-market industry in China. Two of the main promoters are Du Qingsong and Kit Tsui. In 1999, Du had been jailed, allegedly from "fraudulent investment schemes," and barred from by the Chinese securities regulator for illegal dealings.
Tsui's reverse-mergers include Gulf Resources (Nasdaq: GFRE) and Orient Paper (NYSE: ONP). Notably, Orient Paper came into some trouble recently when Hong Kong-based Muddy Water's Research published a report showing that what the company reported doing, and what the actual operations looked like, different significantly. Muddy said that, after a visit to the factory in January, they found it "idle and dilapidated." Muddy Water's believes that their SEC filings overstate asset values by ten-fold and revenues by 40-fold. An internal investigation is being undergone by Orient Paper currently. A money manager that spoke with company officials did say, however, that they blame Tsui for the irregularities.
Benjamin Wey is another promoter who has had run-ins with securities regulators. After Barron's reported his work with AgFeed Industries (Nasdaq: FEED), shares dumped from $15 to $2.50, and has missed production targets ever since mid-2008. Wey has also had contact with Deer Consumer Products (Nasdaq: DEER) and CleanTech Innovations (Nasdaq: EVCP). CleanTech, whose shares have tripled to $9.50 after a July private placement, is trading at 220x FY09 earnings.
Barron's warns that investors should be wary of private placements of public equities (PIPEs). For example, several PIPE deals involving Andrew B. Worden's Barron Capital came in below expectations; 11 with a year's worth of returns lagged the Halter Index by 30% and 7 with three-years’ worth of returns were short by 75%. Additionally, hedge funds that provide PIPE financings have substantial sway over the company in terms of who will be their auditor, investor-relations firm and chief financial officer.
Additionally, all of the reverse merger companies seem to hire the same auditors that certified the financials of companies that sank into the deepest depths. Two companies that have had recent accounting problems include China Natural Gas (Nasdaq: CHNG) and RINO International (Nasdaq: RINO).
The bottom line in the article, it seems, is that many of the PIPE stocks have decent short-term growth, which may be based on pure speculation and momentum, but a three-year look at most firms finds them head-over-feet in enough accounting issues and corruption that it makes Enron look like Walt Disney world to a four-year old...nothing short of magical.
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