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.

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