Those China Smallcaps once more

More mist, fog, obfuscation and an inability to decide which party is closer to the truth. We’ve often said that financial markets tend to suffer from information asymmetries. Look no further than this space for conformation of that. In the meantime, those sidelines indeed look comfortable..

Long Strange Trip: Chinese Small Caps
By Matt Koppenheffer

I’ve been fascinated with the brouhaha that’s been going on with Chinese small-cap stocks. Of course, when I say “fascinated,” I mean fascinated like when everyone on the highway slows down to stare at a multi-car wreck.

Unless you’ve got money invested, it’s tough to figure out who to root for in the whole mess. On one side, you’ve got these apparently fast-growing Chinese companies that came into the public markets through reverse mergers — which is sort of like visiting a friend’s house by sneaking in through an open window. Most of these companies appear to be showing gangbuster growth, but at the very least their management teams have had a heck of a time clearly communicating with investors.

On the other side of the tussle, we’ve got self-styled crusaders out to crush the supposedly fraudulent companies. Many (most?) among this guerilla band short the stocks that they attack, hoping to profit as the stocks’ prices fall. While there has been some really good work done by some of the sleuths, as more and more blood enters the water it seems that anyone who can come up with a noble-looking logo is ready to take potshots at Chinese small caps that they’re shorting.

Like I said, it’s tough to wave a flag for either side.

Getting down with diligence
I was struck again by how nutty it’s gotten after covering three separate Chinese stocks yesterday that were reeling after bearish reports. Yongye International (Nasdaq: YONG  ) , Gulf Resources (Nasdaq: GFRE  ) , and China-Biotics (Nasdaq: CHBT  ) all lost more than 10% of their value after online reports surfaced questioning the veracity of the respective companies’ businesses and financials.

Of the three, it was China-Biotics’ tumble that stood out the most to me. It appeared that the stock’s decline was driven by a blog post on Seeking Alpha from an amateur investor named Gisli Eyland, who posts under the name “Sportgamma” and sums his approach as “Sports business meets value investing.”

There was really nothing wrong with Eyland’s post on China-Biotics. He notes that he’s had some concerns about the company and then details some simple diligence he tried to do to allay those concerns. Eyland apparently scoured publicly available documents for China-Biotics and then sent out a series of emails to the company and third parties to try and verify or question what he’d read. All but one of his emails — which included attempting to contact large companies like Wal-Mart and Unilever — went unanswered.

As a result, Eyland was left with the same questions he started with and a queasy feeling in his gut. He said, “I’m inconclusive whether China Biotics is indeed a fraud or a rose bud among cabbages, but what I do know is that I have a huge information disadvantage.” So he shared his decision to sell his China-Biotics shares.

Somebody’s getting greedy
Interestingly, in the midst of the sell-off there didn’t seem to be much notice that investor Richard Azar continues building a large stake in the company. Yesterday, the company filed a “Form 4” showing that Azar increased his stake by 178,500 shares on May 17. That follows a filing the day prior reporting a holding increase of nearly 400,000 shares. Based on his holding as of Tuesday, Azar’s stake at yesterday’s price is worth nearly $32 million.

Now who exactly is Richard Azar? Good question and one that I didn’t initially have an answer for. Interestingly, there is little information readily available about him. Based on a Facebook profile, he’s a snappy dresser and a fan of Boccelli, Shakespeare, and Charlie Rose. More importantly, it appears that he is a big-time Trinidadian investor who is a big fan of Warren Buffett. His name is even mentioned a couple of times in Roger Lowenstein’s Buffett: The Making of an American Capitalist.

Even smart investors do stupid things, and perhaps Azar is throwing good money at a bad company. However, it boggles my mind that investors in the China small-cap space are so scared out of their minds that they’d allow a stock to be knocked down more than 10% based on the musings of an amateur investor while a big fish is throwing real money at the shares.

Not that I’m all that surprised by this — to some extent it echoes the crazy sell-off in China Shen Zhou Mining (NYSE: SHZ  ) last month. In that case, it appeared that investors completely misunderstood the meaning of a statement by the company’s accountants.

If ever there were an environment of “shoot many times in the face first and maybe, possibly ask questions later,” it exists right now with Chinese small caps.

Boy, the sidelines are comfortable
I started out by saying that I’m fascinated by what’s unfolding here, and I’d bet my left arm that I’ll continue to be wowed by new developments. While I’ve considered the possibility of entering the fracas by investing in a basket of these shunned stocks — and thereby hoping that some big gainers would offset any proven-out frauds — I’m still currently enjoying the view from the sidelines, particularly since I’ve been finding good opportunities in stocks that are much easier to get my arms around.

Now I know you have something to say about the Chinese small-cap showdown, so head down to the comments section and sound off!

Yongye Shares Plunged: What You Need to Know
By Matt Koppenheffer

Although we don’t believe in timing the market or panicking over market movements, we do like to keep an eye on big changes — just in case they’re material to our investing thesis.

What: Shares of Chinese fertilizer manufacturer Yongye International (Nasdaq: YONG  ) were taking it on the chin today, falling as much as 30% in intraday trading on heavy volume.

So what: For that keep tabs on Yongye, today’s “news” sounds very familiar. Yet another report has surfaced that takes the company to task, citing numerous supposed red flags including the acquisition of the Wuchuan Lignite Coal Project, relationships with suppliers, efficacy of the company’s product, and management compensation issues.

Now what: The report was released by Absaroka Capital Management, and if you’re wondering who they are then that makes two of us. However, the note was given wide distribution by being highlighted by the well-followed Zero Hedge blog. Though the world of Chinese small caps has been plagued by companies apparently doing some very sketchy things, many of the accusations against Yongye are largely insinuation and conjecture. Without a smoking gun, this leaves Yongye investors wondering whether these allegations hold water or their stock is getting cheaper for no good reason.

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Latest Alleged Chinese Fraud: PUDA Coal (NYSE: PUDA) – $2.66 Price Target, 70% Downside, By Alfred Little

Submitted by Tyler Durden on 04/08/2011 10:05 -0400

Notorious contrarian Alfred Little, who recently made a splash in the alleged Chinese fraud basket, by issuing a scathing report against Deer Consumer Products (Nasdaq: DEER) which has since cut the price of the stock in half, yet gotten the author in hot trouble with the company which decided to sue both him and Seeking Alpha which hosted the report (even as shareholders of DEER should be thanking him for issuing the report when the stock was still at $11) is out with his latest report, taking on the next in a seemingly endless sequence of potential frauds (check the Nasdaq halt list and find the most recurring word): Puda Coal, Inc (NYSE: PUDA). Cutting to the chase: “Considering the 2009 and 2010 audited financials can no longer be relied upon, and  more importantly the complete lack of internal control that allowed Chairman Zhao to first steal the company, then sell half the company (pocketing the proceeds) and then pledge the other half of the company to a Chinese PE fund while piling on $530.3 million of 14.5% debt, I strongly believe $2.66 is the most this stock is worth today.” Those buying puts are cautioned that the stock may halt and never reopen. Place your bets appropriately. Puda Coal Final Report
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In this mist it’s hard to see what’s what. The good suffer from the bad, valuations have been slashed, and opportunist take advantage to talk good companies down or buy them up. An example of the latter is China Fire & Securities Group (CFSG), one we were actually following here and have been in and out of. It’s bought by Bain group for $9 a share, quite a bargain.