Chinese Stocks Hindered by Mistrust

Chinese Stocks Hindered by MistrustWe all know about the trail of fraud initiated by numerous Chinese companies that emerged on U.S. exchanges via the speculative reverse merger process.

The pipeline of new Chinese stocks has essentially dried up in North America, as Chinese companies are now subject to intense scrutiny and detail reporting in order to list. I like the move to clean up the mess from fraudulent companies, albeit many sound Chinese stocks have suffered in the process due to the general mistrust in the market.

It has been a relatively quiet year for new Chinese stocks following the listing of 60 Chinese stocks on U.S. exchanges from 2008 to 2011. In 2012, there has been one Chinese listing along with the delisting of several Chinese stocks that have been going private.

The reality is that I do not sense a return to the recent years. Speculation of several big Chinese e-commerce initial public offerings (IPOs) looking to list in the U.S. this year has not come to fruition. Three Chinese Internet plays that were looking at listing in the U.S. were 360buy.com (an online retailer with an IPO expected at around $4.4 billion), Vancl.com (the largest online clothing retailer in China), and Xiu.com (an online seller of luxury goods). So far, there is no news.

For Chinese companies, it will be a long journey before they can regain investors’ trust. The new strict requirements for listing will help to assure that only sound Chinese stocks list. This is the only way investors can feel comfortable dealing with Chinese stocks.

With the new listing requirements, the pipeline of reverse mergers has dried up from U.S. companies and especially from China, which is stalling. (Read “China Scrambling for Economic Remedies.”)

The weakness of the reverse merger stocks is evident from the poor performance of the Bloomberg Chinese Reverse Mergers Index (CHINARTO Index), which is a market capitalization weighted index that tracks 82 Chinese stocks trading on U.S. exchanges following reverse mergers. As of Wednesday, the index is down over 7.2% year-to-date and 21.3% over the past year.

Another alleged scam concerns Shenzhen, China-based Deer Consumer Products, Inc. (NASDAQ/DEER), which is a small Chinese maker of small home and kitchen electric appliances that is managed by its founders.

Unfortunately, the founders may not be forthcoming in regards to their operating results.

Trading in the stock was halted on the NASDAQ on August 13, and will remain so until the company provides the requested information to the index.

Short seller Jon Carnes (who uses the pseudonym “Alfred Little”) comments online as a blogger on the “Seeking Alpha” stock web site. Carnes has been suspicious towards Shenzhen since March, relating to sales and profit margins. Carnes hired an independent third-party investigator on August 3 to visit two of Deer’s factories in Yangjiang. The result was that there was allegedly no evidence of production or workers. The report even included aerial shots of the facility where there were allegedly no trucks or any sign of activity. Pretty strange given the company’s strong growth in revenues. The fiasco demonstrates the issue with looking at Chinese stocks, as we have to rely on the validity of the financial statements and company newswires.

In too many cases, so far, there have been fraudulent activities that have scammed investors.

I have looked at Deer from an analytical view and found strong metrics, and while I understand the company is real and manufactures products, I question the company’s reporting practices and potential fabrication of results. This you cannot control, which is why so many investors are staying away from the smaller Chinese stocks.