The last two months have been quite challenging for long investors holding positions in both China and United Sates equities. ChinaHybrids are under pressure as the growing number of proven frauds in this space are finding it increasingly difficult to hide their improprieties from sleuthing investors. On the U.S. front, U.S. companies are finding it difficult to attract investors willing to commit to growth stories in the midst of economic uncertainty.
Last week, many ChinaHybrid enthusiasts rejoiced over a story released on Briefing News Wire claiming that the SEC was suing Muddy Waters and several other entities. Although we can’t be sure, we believe that this news inspired many investors to begin to pile back into the China names. Hopes of a sustained rally were soon dashed as the law suit was confirmed to be a falsely spread rumor.
The GeoTeam found the initial reaction to the news to be quite startling. Many investors hailed the alleged SEC suit as a long time coming event. It just shows the ignorance of many players that still navigate this space. When reading the message boards, we basically witness the continual cry for legal action to be brought against the bearers of bad news or what we now call truth pieces. After the unveiling of numerous proven frauds, the plights to seek action against the companies and their representatives are far and few in between. The second the fake news hit the web, investors who I thought had a true vested interest in cleaning up the space hailed the alleged SEC move.
Investors really need to understand the gravity of what is going on in the China universe. Recently, it was uncovered that CHBT created a banking website that, unbeknownst to its auditors, published what we now know were fake documents. In another instance, we found out that YUII, a seemingly legitimate company who many trusted, stole from the piggy bank . In the case of LFT, banks have been accused of colluding with the company in its fraud case. If you have been watching these and other stories unfold, you know that this dark chapter in ChinaHybrid fraud is far from over.
Although we have come a long way to help purify the space, more work has to be done before we can trust the companies representing it. Through our investigations, we are still coming across companies that seem to be misrepresenting operations. Amazingly, even in the face of this apparent fraud, we are still witnessing money come into some of those names at current market levels. Presumably, investors are beginning to make bets on which companies will escape the carnage or promoters have stepped up their game in companies with small floats.
Also fueling optimism in the ChinaHybrid space are indications that the PRC regulatory bodies are willing to work with the U.S. to address known problems. This type of news can lead to irrational fits of buying sprees and make the short game somewhat nerve racking . We are taking the talk of regulatory reform in stride as it will have more of an impact (if any at all) on future companies rather than on those that have already abused the current system. Regardless, the existence of complacent irrational investor behavior will force us to be somewhat cautious in the near term with the size of our short positions unless we have strong evidence of foul play. Sharp price surges in shares of ORS and SGOC are examples of how fast some of these stocks can move. Still, we have begun to create a wish list of companies to revisit in hopes of perhaps initiating positions once shares have reached a level reflecting market inefficiency and as the space nears purification. We are also seeking companies that may be ideal candidates to go private. In the end, we do want to once again be long China names if they become investable. But for now we see ourselves eventually “shorting the pops.”
Our most recent investigatory report was on ORS. The company’s small float, overhyped web chatter and an inability to short ORS shares have enabled the stock to maintain its positive momentum despite our findings that the company appears to be just a shell. It is ironic and frustrating that of all ChinaHybrid companies to weather the storm, ORS is the one that seems to have fallen through the cracks. We do think there is risk to a short position in ORS shares due to a possibility that the company will increase “positive” news flow in the coming weeks. We will continue to delve into the ORS story.
In a recent development, Muddy Waters Research posted an Open Letter to SPRD that elicited a response by a Seeking Alpha blogger who claimed the China Hybrid sector had turned the corner. Regardless of our view of SPRD (we are not close to this story), we had to chime in on account of this blogger’s broad opinion of the sector since we vehemently disagree with his perceptions:
“Really? Turning point? Carson [from Muddy Waters] is not an idiot. Law 101: Never ask a question to which you do not know the answer (especially when you are short)!!!!!!!!! He wants SPRD to engage. I doubt he is going to risk damage to his reputation by performing mediocre research, nor will he risk being accused of market manipulation.
You need to start digging into the operations of many more firms before you claim that this space has turned the corner. We may have little bounces based on sentiment since the short game may be viewed as a little “tired.” But the deception still being orchestrated by our beloved ChinaHybrids, here and abroad, is alive and kicking. Stay tuned.”
Please view this link (Password is ‘GEOTEAM’, make sure to use all caps) to see why the GeoTeam has established short positions in certain ChinaHybrid names. Keep your eyes and ears open for breaking news regarding companies we suspect are engaged in foul play in the ChinaHybrid space.
Our portfolios’ long positions are largely comprised of U.S. equities, which has led to a frustrating experience over the last two months. The majority of our GeoBargains and GeoSpecial have seen precipitous drops in share prices. The declines in price have been exacerbated in the micro-cap arena which has historically powered the crux of our trading strategy. While the Greek debt crisis may have found a short term resolution, markets could remain tepid as we await a resolution on the budget talks taking place in the White House. Whatever the case, we will continue to attempt to identify fresh and timely companies to include in our portfolios. We feel that most of the damage has already been done on many names in the micro cap space. Remember that pull backs are healthy and create opportunity.
We recently shed some of our portfolio positions in selected names in order to make room for fresh ideas like BZC, ESIC and SEM. One of our newest GeoSpecials, NATR, has bucked market trends and more than doubled from our original mention on May 6, 2011. We are removing the stock from the GeoSpecial list and our portfolios due to valuation, but will monitor the story closely and still trade on the stock’s volatility. Other stocks we removed from GeoBargain and GeoSpecial lists include:
ASYS – see note
MCZ – see note
NANO – see note
ABL – see note
See notes on one of our newest GeoSpecials ESIC
We added to our FRD GeoSpecial position after the company reported strong Quarterly financial results this morning. See alerts
Notes on GeoSpecials BZC and SEM to come soon.
Disclosure: Short ORS, SGOC, SPRD, YUII, CHBT; Long ESIC, SEM, NATR, ABL, BZC, ESIC