Into this void, short-seller sites such as Alfredlittle, Citron Research and Muddywaters have seized on alleged irregularities at several firms. They include China Media Express, Deer Consumer Products and Longtop Financial Technologies. The allegations have prompted SEC investigations, delistings (including Longtop) and trading halts involving more than a dozen China-based firms since March.
IBD recently conducted email interviews with the people behind these short-seller sites. An examination of their data and techniques hints that much of what they publish may be true. Yet it’s hard to verify research in China without boots on the ground.
How do short sites gather information in a nation thousands of miles from the U.S., and can you believe what they say?
Alfredlittle.com says it uses local analysts. They are said to comb public documents in Chinese. They also pose as customers and carry out video surveillance. And they compare SEC filings with data on file at China’s equivalent to the SEC. “Very often what is reported to the U.S. exchanges is different to what is reported to local China bureaus,” alfredlittle.com editor Simon Moore said via email. Local probers are said to be paid on a per-project basis based on the work, difficulty or danger involved. They get bonuses if their findings hit home.
Alfredlittle.com doesn’t hide the fact that researchers profit from their data, including short selling the companies probed. “The reports are the product of many people’s labor and they justly deserve to profit,” Moore said.
But short sites also have critics.
“They carpet-bomb the company with allegations all over the place,” said Mitchell Nussbaum, chair of New York law firm Loeb & Loeb’s emerging-markets practice, which represents Chinese firms in the U.S. Nussbaum says if some claims haven’t been disproven it’s because SEC findings or independent probes are pending. Alfred Little, via email, defended his work: “No allegations made on the site have ever been disproven by the companies targeted.”
Little advised against investing in Chinese firms with more than one or two of 12 warning signs in a list published on blogger site seekingalpha.com. They include:
- Reverse mergers with high short interest.
- Unnecessary dilutive share issuances when the company has excess cash or production capacity.
- Amazing revenue and earnings growth relative to peers.
- Weak balance sheets with large receivables vs. sales and unwillingness to disclose customer, distributor or supplier details.
- Weak governance indicated by high CFO and auditor turnover and lack of involvement of truly independent directors.
Muddy Waters founder Carson Block uses investigative techniques similar to Alfredlittle.com.
“Start with an understanding of the movement of the target company’s product or service through the supply chain,” said Block, who appears on CNBC.
Block says shady Chinese companies often create phony suppliers or customers because they know these “counterparties” aren’t going to be audited.
Case in point: Muddy Waters in February alleged that China Media Express, which sells ads in Chinese buses, had less than half the buses it said were in its network. China Media denied it. But its shares tanked, its U.S. auditor quit and Nasdaq delisted it in May.