Eliminating the Chinese Reverse Mergers

by The Graham Investor on May 13, 2013

Several people have asked me about the proliferation of Chinese Reverse Mergers (or Reverse Takeovers) appearing on the NCAV screens. For those not in the know, these are Chinese companies that have found their way onto the US Markets – mainly the OTC, but sometimes the Nasdaq – somewhat surreptitiously, by performing a reverse merger into a US “shell corporation“. That is, a US company with few or no real assets.

The process is well-documented; the clearest explanation of this practice is provided in a NY Times Article entitled “China To Wall Street – The Side Door Shuffle

With bankers’ help, the Chinese companies executed what are known as reverse mergers. They bought American companies that were merely shells and assumed those companies’ stock tickers — sort of the Wall Street equivalent of “Invasion of the Body Snatchers.” The strategy let them avoid reviews with state and federal regulators that are normally required for initial public stock offerings.

In recent months, GrahamInvestor’s screen, NCAV Stocks (Shares Out) – New Version has become inundated with these Chinese stocks – ZST Digital Networks, China Botanic Pharmaceutical, China Auto Logistics, Cogo Group, and so on (to name but a few). The challenge was to reproduce this screen but without the Chinese stocks. In the end, it all boiled down to:

  1. Locating the address of the company’s HQ (if China or Hong Kong, zap it…although a select few have US-based HQ’s)
  2. Parsing the company’s name (if  ”China” or “Sino, zap it)

I could have made a list of all such stocks and deleted them from my database, but they might re-appear or new ones could be created in the future. Besides, certain investors visiting this site may actually want to see them (read on).

The resulting screen is: NCAV Stocks (Shares Out) New Version – Without Chinese RTOs and is listed in the navigation menu at the top of the site. Why didn’t I just remove the Chinese stocks from the existing screen rather than creating a new one? Well, some people might still want to invest in them. After all, the NCAV Stock Screen is essentially a cigar butt screen where you buy a large number of stocks, and a cigar butt is a cigar butt, whether Chinese or otherwise. It might be all right to buy a couple of these within a typical large Graham-style portfolio of 30-40 NCAV stocks, but – caveat emptor – these Chinese stocks frequently fail to file financial reports, a practice which can get their stock suspended. When this happens, it can be difficult, if not impossible, to exit a position.

{ 10 comments… read them below or add one }

1 Ralf Becker May 17, 2013 at 3:47 am

Hi,
nice site, one of the bests. I want make a few comments to chinese Stocks. There are stocks that are chinese and it is obvious that they are targets of shortsellers. Example CGA, 25 days daily volume to cover short interest. It is not difficult to find out if this company is fraud or not. They make business in an area were chinese governement pays a lot of attention. How to feed so many people? This is critical in China, which must feed 22 per cent of the world’s population with only 7 per cent of global
arable land. Here are a few words of the Ceo:
http://www.cgagri.com/IR/cgagri/Letter_to_Shareholders_final_on_website.pdf
Simple accusing every chinese RTO as fraud is to simple. Keep your mind open. Not all chinese are criminals. It is a big advantage for a chinese company to be listed at NYSE if they want to grow and be an international player they will do everything to maintain their status.

2 The Graham Investor May 17, 2013 at 6:54 am

Thanks, Ralf! You are absolutely correct – not all of these RTOs are perpetuating a fraud and may in fact turn out to be good investments longer-term. That’s why I left them in the original screen – some visitors might want to invest in them.

3 Ralf Becker May 21, 2013 at 9:46 am

Hi,

i have read an investigation about chinese versus US reverse mergers. My interpretition of this analysis is that US reverse mergers are far more dangerous. Please read:
http://leeds-faculty.colorado.edu/zeyun/workshop12-13_files/LLZ%20(02-19-13).pdf

regards

Ralf

4 The Graham Investor May 21, 2013 at 12:52 pm

Great paper. Thanks for sharing, Ralf. Key comments from Abstract: “Chinese RMs, however, are
generally healthier and fare better than either their U.S. RM counterparts, or a group of
industry-size-date matched firms from the same exchange. Despite negative publicity (some
from short sellers), we find little evidence that the integrity of U.S. capital markets is harmed
by Chinese firms entering via RMs.”

5 Mike June 27, 2013 at 3:25 pm

Great website – just curious why PennyMac is screened out when you run the NCAV list ex-CROs.

Thanks -

6 The Graham Investor July 17, 2013 at 8:27 am

Not sure, will check that out.

7 RALF beCKER August 7, 2013 at 5:00 am

Hi Graham Investor,

can you check why CGA is greyed out ?

regards

Ralf

8 bob crawford October 15, 2013 at 2:34 pm

Beware of some of those chinese companies. Many of them are a fraud. I found some articles about them on http://www.zerohedge.com here http://www.zerohedge.com/article/china-integrated-energy-cbeh-latest-alleged-chinese-fraud-true-value-076share

The article alledges that China Integrated Energy (CBEH) was a fraud.
I’d run a web search on any chinese company if I were you, even if their financial statements are downright beautiful and make them look like they are very well run companies. This just goes to show the importance of ‘due diligence’.
sincerely
bob crawford
p.s. great site by the way. XD

9 Ralf Becker December 3, 2013 at 8:55 am

Hi Bob,

i am always careful when i deal with chinese stocks. But you should also be careful if you read “fraud” warnings of hedge fonds or muddy waters. I beleave that a lot of chinese stocks went dark because of the negative unfair press against them. Most of them were startups and in need of more money.

I am fully convinced that AGRIA and CGA are serious and i am buying sometimes and try to sell shortly before the resets after earning results came out. For CGA i suggest it is good idea to buy in the mid of december, the rising UREA prices since November will help to beat their estimates.

CGA today 4,0$ for 15 February my bet is 6$. Good Luck

10 Ralf Becker December 3, 2013 at 8:57 am

@bob,

your warning on CBEH was a typical example for short selling fraud:

http://finance.yahoo.com/echarts?s=CBEH+Interactive#symbol=CBEH;range=1y

CBEH has doubled !

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