Sunday, February 13, 2011

Chinese Reverse Merger Stocks

There is a ton of debate regarding reverse merger Chinese stocks. It is a relevant debate to Magic Formula investing as NEP, CNET, GPRC, JGBO, NEWN and SCEI from the list are all reverse merger stocks. Toss in LIWA, UTA, CSKI and CEU as other recent listees (not to mention CCME, which is not on the list as it is strangely categorized as "Finance stock", despite being in advertising) and you can see why we should care.

Here are a handful of stocks and how they have performed since November 8th:

Stock 11/10/2010 Current Change
CCME 18.82 11.92 -37%
NEP 7.17 4.70 -34%
CNET 4.33 3.77 -13%
GPRC 3.86 2.94 -24%
JGBO 6.29 5.49 -13%
NEWN 7.19 6.22 -13%
SCEI 8.56 7.02 -18%
LIWA 11.9 10.16 -15%
UTA 5.42 7.17 32%
CEU 5.06 2.23 -56%
CSKI 8.54 4.65 -46%
CMFO 5.75 3.76 -35%
CHOP 6.05 5.57 -8%
VALV 6.62 5.76 -13%


Down 21% on average. In the same time frame, the Russell 3000 is up 12%. So, I ask you gentle reader, are these stocks now a tremendous opportunity, or something to be feared? Obviously it is a prime driver in the fact that I have underperformed in the past three month.

It is easy to say, "don't buy". Certainly that feels safer. Certainly any of these stocks may go under a vicious short attack tomorrow. So if you're buying a stock for one day, you should not go there. But has the market gone a little "nuts" on these stocks? Should we be greedy when others are fearful?

Of course no one can know until we know. I have of course made my investments and have added a bit recently as the continual dropping of price makes a few of these difficult to resist. Now for a final bit of fun, here are some of the recent headlines:

Read All About It!

The China Market Has Gone Mad
U.S. Listed Chinese Stocks: Mistreated and Undervalued
YONG Too Risky?: China Watch Mail Bag
2011 China Investment Guide: Think Small
Reverse Takeovers: The Poor Man's IPO Deserves Some Respect
Why Chinese Value Stocks Get No Respect On Wall Street
China Small-Caps for the Attentive Trader
What Are the Top China Small Cap Picks of 2011?
With China Small-Caps, It's Shorts vs. Auditors
Shorting China Stocks: IPOs, Reverse Listings, All Or None Of The Above?
27 Red Flags for Chinese RTO Stock Investors to Look For
China's Companies Dump U.S. Stock Listings


Homer315 said...

They're only deals if the financials that are disclosed are true (and at a minimum, not overstated. I think it's hard to be confident about that.

Marsh_Gerda said...

do you think that companies audited by big 4 auditors are likely to have materially misstated financial statements? I think the majority of bad news is priced in if you get a basket of the companies.

Paul said...

I'm much more inclined to just skip these stocks. I don't trust that the financials are accurate. Auditors aren't perfect, and there is a raft of examples (Enron, Madoff, and others) to show this.

I've gotten burned on one Chinese stock (UTA) and I'm pretty leery about getting involved with any others.

Plus, part of the MFI theory is to not buy ADRs, but how is buying a Chinese company's stock any different? Shouldn't we be avoiding foreign based stocks trading on the US exchanges?

Homer315 said...

Take a look at that CCME thread on VIC again. You'll see that some auditors, like Deloitte, are really just an amalgam of subsidiaries who can be located entirely in China. That makes going after their information practically impossible. Read the second link I've pasted below about how plaintiffs can't enforce judgments, or even get discovery on the Chinese company financials. The first link shows that even enormous PE funds like the Carlyle Group can be caught by the frauds.

I'm not sure that if you think that these companies can be sketchy or high risk that you can negate that risk by just buying more of them. I'm not saying that every chinese company listed in the US is a fraud of course, but who knows how many are? 10%? 5%? 20%? Perhaps the process of reverse mergers selects for companies that are more inclined to be playing fast and loose with information.

Marsh_Gerda said...

Paul and Homer - of course you both make great points. Can we trust the financials? Should we buy foreign stocks?

My point is that there does exist a price where it is worth the risk. Perhaps your price that risk is worthwhile is a dime. But that price point does exist and to me they are there.

Of course auditors can be fooled, that is why I am suggesting a basket. I do not think they are all, or even the majority, are frauds. Secondly, the book does say to avoid ADRS, but I think that is more because the accounting is different. These stocks use US GAAP and MFI has actually rolled out a platform for an international version.


Paul said...

Marsh Gerda,

I'd say no, no price is worth this risk.

Watching CCME for the past few weeks has made me even more cautious of chinese based companies trading on the NYSE.

I'd rather invest in junior mining companies ;)

Jessa said...

Hi Marsh,

I have a question--how do you compile a list of these stocks? I was interested in researching the space, but I found it hard to replicate your list!