The fascinating case of China Media Express Holdings (CCME) sell-off

Citron and Muddy Waters versus Goldman Sachs..
Pump and dump versus short and distort? We have no way of knowing one way or another, but it’s surely fascinating..

China MediaExpress Holdings: Investors Crushed in Rush for the Exit
Robert Weinstein

Without deception you cannot carry out strategy, without strategy you cannot control the opponent.
— Sun Tsu, The Art of War

China Media Express Holdings, Inc. (CCME), the $409M market cap China bus advertising company, lost over 30% of its valuation today. I have been told that there are no coincidences on Wall Street. If that is true, one would ask oneself, why did Muddy Waters Research and Citron Research just happen to issue negative press releases so close to each other? I also might mention it is the Chinese New Year right now (the biggest holiday in China) making it difficult and inconvenient to prove or disprove the reports.

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First to claim fraud was Citron research, which issued a scorching review of CCME a few days ago. As someone who shorts over 90% of my trades, I am always on the lookout for a company that is overvalued and expected to fall. I am currently short Borders (BGP) after news of the expected bankruptcy hit the wire. I went short Manitowoc (MTW) and Unisys (UIS) last night (covered both and then re-shorted MTW into the close today). Therefore, I am very comfortable shorting strong and weak stocks.

I pulled up the chart to look at CCME and realized that I had shorted it just a few days ago. This time was different as it was selling off fast and hard compared to running up fast. I traded CCME today to the long side. While trading and watching the price action, I thought that this big of a move down should cause the volatility to spike in the options. I was correct and the volatility was sky high. Even in the middle of the BP (BP) oil crisis I cannot recall volatility getting as high as CCME did today. The 13 and 11 strike price February puts where topping out at over 200. I closed out the stock position when it reached my target gain and started doing research on the company from a fundamental point of view.

To explain, I wanted to see what appeared to be a cheesecake style option premium. The first thing I came across was the Citron Research report and then the Muddy Waters Research report. I have read Citron’s reports before and I believe you should take what they say with a grain of salt. This time they really went over the top and it was easy to see that it read and felt like the reverse of a stock promoter in a pump and dump (including spelling errors etc..). Using phrases like “Too Good to be True” and “Frauds like Bernie Madoff” caused my BS detector to go off quickly. As someone who has spent a lot of time in China and believes that most Chinese stocks, (including the big ones) are potential shorts, this says a lot. Regardless of what I think or believe, the market believed what was printed and sent the stock to its knees by the end of the day. Here are some of the highlights of the report I found interesting.

  • “In spite of having spent a mere fraction of what competitors have on infrastructure, CCME has purportedly grown profits from $2M to to its recently raised guidance of $85M expected this year, on revenues of $200 million.”
  • “If true, this ROI would be one of the highest in the world, and a complete outlier in the Chinese advertising market, generating even more profit than giant Focus Media (FMCN), and outpacing all of its competition by a landslide, despite their smaller footprint. There is only one problem: No one in China has ever heard of them. It is Citron’s opinion that if this company were operating in the United States, the stock would have buckled long-ago over the lack of transparency in its story.”
Are you kidding me? This is right out of the penny stock promoter playbook. Perhaps active traders in the United States know this company better than the average person in China but it is worth (even after the fall) over $300M. It’s a pretty safe bet that those who do business with them know who they are.
  • “By contrast, advertising on mass transit in China is an extremely well-known and a highly visible business. Therefore, there is no excuse for a lack of proper due diligence on CCME.”
Regardless of visibility I would agree there is never an excuse for lack of proper due diligence. As I did before writing this article, which included reading over SEC documents, EDGAR Online, contacting two former employees in China and reading everything I could find for hours before coming to my conclusion.
  • *Yet, if you Google or Baidu for CCME or CCME’s operating company you will see not one article written on their operating business.”
  • China MediaExpress was named China’s No. 1 small-to-mid sized company with the greatest potential in 2011 by Forbes China. It would appear that someone knows CCME to gain this recognition.
  • “As for Northland Securities, as a professional courtesy, the editor of Citron phoned analyst Darren Aftahi yesterday, to see if they knew something Citron didn’t. After a nice conversation, Darren admitted the possibility that China Media could be a fraud.”
This is one of my favorites because it gives the impression that Northland Securities is saying that they agree with the fraud allegation. But again it is the way that it is worded that lets the reader know there is actually nothing behind the words. Looking at the inverse I believe I could get Mr. Aftahi to say that he believes it is “possible” that CCME could overtake Apple (AAPL) in valuation this year. Being possible and being likely are two very different things. Just another example of how words are twisted and put in place to paint a picture that the author wants the reader to envision rather than to inform.
I find very little difference in the quality of work Citron Research did with CCME and the average penny stock promotion email I get countless times daily. The biggest differences I assume are Citron Research is short CCME and that CCME is traded on NASDAQ.
Looking at the work by Muddy Water Research and I find in my opinion the same level of research performed. Most notably, several times they allege that switow.com does not have a business relationship with AAPL or more importantly a supplier. Again, like Citron Research, a twisting of the words gives the wrong impression. I went to www.switow.com (which is CCME’s website) just like anyone else can, and one of the first things I saw were Apple products being offered for sale. I do not know if they actually have them to sell but it would seem reasonable to assume so.
So any plan to make a trade as a result of the “research” that was made public was destroyed due to lack of credibility. The next question for me was “do I go long and try to catch this falling knife”? Having almost $1k in gains by trading CCME long for the day I could have just left it at that and called it a good day. At the same time if one could correctly calculate the odds of CCME moving higher, lower, or staying the same the options were offering a very big prize in getting the direction correct. I pulled up EDGAR Online to look at the numbers. It did not take long to come to a single strong conclusion. The panic selling today was offering a great buying opportunity, like buying Las Vegas Sands (LVS) for under $2 or GE (GE) for under $6. Panic, may have caused people to dump rationale along with their shares at cheap prices. Here are some of the more notable pieces of data I found in my research.
  • Top institutional holders include Goldman Sachs, Ardsley Advisory Partners, Morgan Stanley and Vanguard Group. The amount that institutions are holding is growing as well. It’s possible that CR and MWR are the smartest guys in the room compared to the institutional CCME stock holders but given the choice I am going to place my bet on Goldman Sachs over Citron every time.
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Who is buying and who is selling? If the company is a fraud and often when it just isn’t doing much, management will be selling every share they get directly or through options. Looking at the insider trades, we find that not only are insiders not selling but have added and bought shares in the last year. Why would insiders who I would have to presume know the company more than anyone else be actively buying shares if they didn’t believe in the company? I don’t know and I bet MWR and CR are unable to provide a good reason either.
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  • Cash of over $4 per share. Yes this profitable growing company appears to have over $4 in cash for every share that is trading. $170M in cash and per share calculation is based on outstanding shares, not just the float.
  • CCME has debt but it is small. This indicates to me that bankers have gone over the books and found the company to be credit worthy. That is not in itself a reason to buy a stock or to believe the numbers are perfect but one more check on the operations that could have turned up fraudulent bookkeeping.

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Saving the best for last we see the mother of all numbers. CCME short interest is a whopping short squeeze nightmare for anyone who is short of 6.44 million shares. With a float of about 10 million shares this means that more than one out of every two shares out there is shorted. Fourth quarter 2010 earnings report is expected to come out next week. If the numbers beat expectations it could kill the shorts as they scramble to get out of the burning inferno that would be cooking them alive. How do you get out of a large short position right before earnings without taking a huge loss? One idea is to issue a “research report” on why you believe the stock is a total fraud. Prices fall and you get out just in the nick of time. There are no coincidences on Wall Street.
Disclosure: I am long CCME.

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