Great points.
The explanation you've described, in which these companies come to us at terrible prices because they need capital to execute time-sensitive business plans, is the explanation that *they* feed us. Of course. I no longer believe it to be true. Chinese people who know what they are talking about tell me that it is *not* true. The chinese private equity markets are overflowing with investment capital seeking a destination. Worthy companies can get that capital. Unworthy companies can't. Simple as that.
And that should be expected. In a world where everyone wants Chinese growth, why would these wonderful companies *not* be able to generate any interest domestically? It's the same thing as when someone wants to sell you a used car for $1000. They can't find buyers at a higher price? Something must be wrong, there are no free lunches.
These canned explanations that we hear from Rodman or Roth are whoever are totally unreliable IMO. It's like the explanation wrt SAIC filings. They don't matter. Yeah... bull shit they don't matter. When you dig, you find out that they actually do matter, especially to FIE's--a substantial fraction of our space. They match for the tier one names, and they match for names abroad. But not our names. Is that a coincidence? Uh, no.
I refuse to believe these canned lines anymore. I really feel that these RTO pumpers--including the stock promotion outfits that call themselves banks--are either clueless themselves or completely untrustworthy.
"Now here comes the decisive test! Remember we assume here that ABCD is a legit company, Mr. ABCD has only the best intentions for his company. Will Mr. ABCD bend the truth in an attempt to gain an advantage for his company, to get a better deal for his capital raise, maybe even in the delusional mindset of doing the right thing for his company?"
Absolutely. Why wouldn't he?
As your example illustrates, even if the "we need capital now" excuse is the primary reason that the company goes public at 5 times earnings despite 30% growth, the fraud risk remains quite elevated. The entrepreneur has absolutely no reason *not* to lie--especially if the best you will give him is 5 times earnings. Maybe he turns that into 20 times earnings, something more fair. It's not hard to do. If he just fails to report some of the costs in the earnings equation, or overstates his selling prices, or whatever, and finds a bogus project with an exaggerated price tag (Inner Mongolia black holes and $9MM renovations with LTUS, the ridiculous CGA land purchases, all the CAGC nonsense, ZSTN's multi-million dollar office expansions) to explain the fact that the company hasn't generated any net cash, he's there. He's done. The auditor will not be able to catch him very easily--and probably won't want to.
One key reason to believe this has to do with the margins. The average operating margin for a US listed RTO small cap is 18%. The average operating margin for a Chinese listed small cap is 11%. That's a humongous discrepancy, and it cannot be reasonably explained without the fraud hypothesis.
I absolutely refuse to believe that China's best and brightest businesses, with the highest gross and operating margins, are the ones that cross the pond to come here for the good deals with Rodman or Redchip at P/E 5. No way. Hence my large fraud estimates. The fraud rate has to be very large--there is no other way to explain the anomalies in financial numbers.
Returning to your example, the only thing stopping him from lying, twisting the truth, exaggerating things in material ways, and so on, is the emotional discomfort associated with lying. Pardon my stereotype, but that discomfort does not seem to be as strong in Chinese culture as it is in the cultures of the US or Germany.
Lying is *very* common in China, much more common than in West. Essentially everybody I know who is from China and who has lived there says that.
I remember introducing a Chinese friend of mine to these stocks back in the Summer. He was like, "Are you crazy?" He literally lauged at the idea of investing in a small chinese company listed here in the US. He said that fraud in China is abnormally common *even* in the Chinese stock markets. How much worse it must be with small chinese companies listed in the US!
I didn't take him seriously at the time, as I clung to my portfolio of worthless paper: ZSTN, CGPI, CNAM, LLEN, yuck. But now I do.
I don't know much about China. We don't know much about China. Rodman doesn't know much about China. The people that do know something about China and that are not financially impacted by this space seem to share the same negative view. The space is extremely dangerous--enough, at least in my opinion, to make the upside not worth the risk or the hassle.
As I said before, the only thing I'm willing to own right now is CCME, and by Monday or Tuesday, I'll know if even that is a viable position to have. I fully acknowledge the criticism that CCME sold shares at 5 P/E on more than one occasion (the SPAC, Starr) despite having no need for the cash (a telltale sign of fraud). That's the main source of my own discomfort personally, but I just can't accept the claim that Deloitte colluded in this or missed this during a Starr-funded audit. Maybe the world is flat, I'm just not going to believe it until I see a smoking gun.
At the same time, if CCME isn't investable, then I'm categorically done with the space. New requirement: to be worthy of investment, you have to have been backed by a major investment bank (GS, MS, Credit Suisse, Citi, JPM) and your IPO has to have been conducted at 20 times trailing earnings or more. Not a single stock in our space satisfies that criteria, therefore I cannot invest. I can play XIN, I can play CNTF, I can play GU, and so on--but everything else, the stuff we really liked in the past, is off limits as far as I'm concerned.
Seriously, I see no reason to be involved with these stocks. I would estimate that at least 50% of them are trading at prices that are many multiples higher than fair value. And let's be honest, we don't even own the companies. These are family businesses, and as shareholders, we are just means to an end.
My take. Bearish, but that's the way I now see things.
On a side note: I just took another look at ZSTN's balance sheet, read the 10-K again, listened to the various CC's. Geez, what was I smoking to fall for that? Just looking at their situation now--$34MM in cash, no debt, totally obscure business, and now they want to do another offering, SURPRISE. It's like they know we think (probably correctly) that they are a fraud, and they are still going to stare us directly in the face and do another offering at a firesale multiple.
Dude, I think this space is going to *implode* come audit season in a few months. Absolutely *implode* with blowups and failed audits and FUQIs and TXICs and on and on. It's scary to even think about.
AI
