Hot investment trend of 2012 a good way to lose your shirt
Beware of jumping on the repatriation of US-listed Chinese companies - there may be diamonds among them but identifying them has defeated professionals
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Beware of jumping on the repatriation of US-listed Chinese companies - there may be diamonds among them but identifying them has defeated professionals
Tom Holland
05 January 2012
According to Jim Coulter, billionaire founder of US private equity group TPG Capital, one of the most lucrative investment trends of 2012 will be bringing home Chinese companies “stranded abroad”.
It may work for him, but ordinary investors should run a mile.
The idea behind the stranded abroad trade is simple enough. There are hundreds of Chinese companies with shares that trade in US markets. A handful are well-known blue-chips like Baidu, Ctrip and Petrochina, all of which are listed on Nasdaq.
But the vast majority are companies few investors have ever heard of. Scores are listed on Nasdaq, and hundreds more trade in the over-the-counter market.
These had a dreadful year in 2011. After short-sellers led by US firm Muddy Waters Research alleged rampant fraud at a series of Chinese companies, most famously at Toronto-listed Sino Forest, investors took fright. Assuming that financial mis-reporting is endemic among smaller Chinese companies listed in the US, and that the whole sector is nothing more than a scam aimed at ripping off gullible American shareholders, investors ditched Chinese stocks indiscriminately.
Today a quick scan through the list of Chinese companies listed on Nasdaq throws up a string of stocks which have fallen by between 80 and 90 per cent over the past 12 months, and now trade on price multiples as low as one or two times their reported earnings, whether or not they have drawn any allegations of malpractice.
Coulter believes that among these companies there are some real gems trading at crazy bargain prices. He scents there are big profits to be made by buying into the soundest, delisting them in the US and re-floating their shares in Hong Kong, where investors are more likely to appreciate their true value.
No doubt he’s right. According to reports, Chinese companies worth US$3.5 billion were taken private in the US last year, with another US$4 billion of deals in the pipeline.
But ordinary investors who think they can make handsome returns piggy-backing on the repatriation trend should think again. Buying into promising US-listed companies in the expectation they will attract the attention of private equity funds like TPG might sound like a good idea. But investors are more likely to lose their shirts than to make a profit.
There may well be diamonds among the Chinese companies that trade in the US, but identifying them has defeated many professionals. After all, high-profile US hedge fund manager John Paulson lost an estimated US$550 million on his investment in Sino Forest, and private equity giant Carlyle suffered heavy losses on its investments in a series of Chinese companies last year following allegations of misreporting and fraud. If even the biggest players in the sector find it so tough to pick winners, it will be all but impossible for ordinary investors.
There are good reasons for that. Although individual Chinese companies listed in the US may be paragons of best practice with solid finances and superb business models, the sector as a whole is fundamentally flawed.
For the most part, media coverage portrays the executives of Chinese companies listed in the US as nothing better than crooks, inflating their cash holdings, inventing customers to bulk up their revenues, and in some cases even claiming to own non-existent factories and shops, all in order to milk well-meaning investors of their capital.
But that’s only half the story. In many cases the Chinese companies are as much victims as offenders. Desperate for capital and with little access to domestic bank loans or equity markets, they fell under the spell of smooth-talking but suspect American advisers, who promised to take them public in the US for a fat fee.
Many were floated in the US through reverse takeovers by shell companies in order to avoid the scrutiny that accompanies an initial public offering. The stocks were hyped up and sold to naive American investors eager for exposure to the China story, and the advisers decamped with their money, leaving both companies and shareholders high and dry.
As a result, the whole sector is suspect. There may well be good companies among those trading at knock-down prices on US markets as Coulter says. The trouble is that ordinary investors have no way of telling which ones they are.