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Recent accusations against Chinese companies dented confidence, but now their shares are bouncing back and shorts have had to take losses
Reuters in New York and Toronto
10 November 2011
Investors betting against Chinese companies listed in North America have wielded a big bat in the past year, bringing many of their targets to their knees with allegations of fraud and wiping out billions of dollars of shareholder value.
In the past few weeks, though, the grip of the short sellers - who borrow stocks and then sell them in the hope they will decline so they can buy them back at a lower price - lessened.
The shares of some companies accused of having accounting issues or other problems have soared and short sellers have had to take losses or have reduced their bets.
On October 29, shareholders of Harbin Electric voted to accept a buyout by its CEO, Tianfu Yang, and private equity firm Abax Global Capital at US$24 a share. That was more than four times the US$5.82 the shares touched in June after Andrew Left of Los Angeles-based Citron Research raised questions about Harbin’s management and how Yang had obtained a loan in the past. Harbin denied the accusations and Yang completed the acquisition last week.
Shares in Toronto-listed Chinese silver miner Silvercorp were pummelled in September after the company said it received an anonymous letter accusing it of fraud and as financial blog alfredlittle.com weighed in with allegations of accounting irregularities. But the company insisted the claims were false and the stock rebounded to above its price before the controversy.
And in another case, shares in mobile-handset chipmaker Spreadtrum Communications, are trading near all-time highs, more than triple a 52-week low hit in June after Carson Block’s short-selling firm Muddy Waters raised questions about the company’s financial reports in an open letter to management. The company said the allegations were groundless.
The turnaround suggests that while a number of Chinese companies clearly did have dubious accounting or other major problems, there may have been others unfairly tarred with the same brush.
The successful Harbin deal showed that short sellers would have to “raise their game”, said Bill Bishop, a Beijing-based consultant and analyst. He said that up until now if a short seller put out a negative report on a Chinese company, the assumption had been “to shoot first and ask questions about whether or not it is a correct report later”. That might now change, he said.
In a number of high-profile cases shareholders would have benefited from listening to the short sellers.
Some big name investors, including hedge fund manager John Paulson, lost heavily on Toronto-listed Chinese forestry company Sino-Forest, whose shares are now suspended after Canada’s main securities regulator, the Ontario Securities Commission, said preliminary results of its own probe determined fraud accusations by Block’s Muddy Waters appeared to have merit.
It marked the biggest Chinese company takedown by a short seller. The company was valued at C$5 billion (HK$38.3 billion) before the report and when trading was halted its value was just C$1.18 billion.
There were also big losses for investors in financial technology company Longtop Financial Technologies, whose shares were delisted by the New York Stock Exchange and which is the subject of a probe by the US Securities and Exchange Commission into accounting irregularities. Its auditor quit and its chief financial officer resigned in May after its finances were called into question by Citron and others.
A series of other Chinese companies listed in the US and Canada have had their shares halted or delisted and face various probes.
Of the six companies Block has written on, only two - Oriental Paper and Spreadtrum - are currently trading, with only Spreadtrum rising since his comments. The short sellers dispute their effectiveness has dimmed, and say they are not having as big an impact because a lot of Chinese stocks have already been marked down because of the increased scrutiny.
“At this point the Chinese RTOs have been beaten down. They are over,” Left said. “There are a few left standing and people who own them know the inherent risks. My goal is to explain the risks and fraud in the company. If a shareholder wants to own these stocks, so be it.”
Dan David, vice-president at Geo Investment, which has also sold Chinese RTO stocks short, said Harbin’s shares rallied because of the takeover, not because investors thought the short sellers’ views were wrong.
However, at Silvercorp, one catalyst for the share rebound was a rebuttal of the charges. For example, after short sellers questioned sales figures, the company said a report from KPMG Forensic confirmed its revenue, although it did not address allegations about asset quality.
“We have demonstrated that there is no fraud at Silvercorp, that we have been unfairly targeted, and that we are the victim of a classic ‘short and distort’ scheme,” said Silvercorp chief executive Rui Feng.
When they are wrong, the short sellers may not only be vulnerable to legal action - such as defamation lawsuits - but if they get a call wrong they are subject to unrestricted losses when a stock rises above the level at which they borrowed it.
In the past, companies launched their own legal action in US courts against short sellers and analysts they claim conspired to issue misleading research reports that drove down their stock prices.
Financial firms and short sellers fought such lawsuits by arguing that companies are trying to blame them for their poor stock performance.
US online retailer Overstock.com has been in long-running litigation over what it called a “massive, illegal stock market manipulation scheme” by Goldman Sachs and Merrill Lynch, now part of Bank of America, to drive down its stock. It is preparing for trial in next March against the firms, which deny wrongdoing.
The SEC can take action if it can be proved that a short seller fraudulently manipulated the market, whether by hyping or distorting it with intent.
One sign that the short sellers are in partial retreat is that some have pulled back from the market.
Still, they have not lost all influence. Left’s assault on Harbin appears to have failed, but he continues to attack other companies with accounting or governance problems.
On November 1 he issued a negative report on Qihoo 360 Technology, saying the internet company’s management had a “disturbing record of deceit”. After the report, the stock slumped 10 per cent on its heaviest volume since April.
“I’d do the same thing on Harbin again,” Left said. “What am I supposed to do, give up and go home? I move on.”