Another short story

More wary of China stocks?

For some of those Chinese companies listed in the United States, 2011 was a torrid year. Short-sellers such as Muddy Waters were turning the spotlight on financial chicanery at previously nondescript firms. The exercise ended up forcing the likes of Sino-Forest Corp and Focus Media to delist from US stock exchanges. Many of their peers took collateral damage in terms of investor interest and stymied valuations as well.

With a group of similar cases exposed lately, starting with Luckin Coffee’s implosion two weeks ago (see WiC490), distrust of Chinese companies is reviving, prompting fears that the Wall Street financing channel is closing up again.

The latest firm in the firing line for suspected fraud is GSX Techedu, an online tutoring service provider accused by Citron Research of “overstating revenue by up to 70%” and projecting unrealistic growth in the future. iQiyi, a video-streaming platform under Baidu, has also been accused of fabricating some of its revenues and customer numbers, according to Wolfpack Research.

These accusations followed an admission from TAL Education, another tutoring company, that an employee may have conspired to inflate sales for its “Light Class” product, which accounts for 3-4% of the company’s estimated revenues.

Currently there are about 250 Chinese companies listed in the US, of which around a third went public in the last three years. Some of these debutants have been a prime focus for short-seller attacks, however. At least a dozen US-traded Chinese firms have been targeted since 2019, including digital content aggregator Qutoutiao, consumer lending marketplace Hexindai, cryptocurrency equipment maker Canaan Creative, classified ad site 58.com, used car dealer Uxin, and the biotech start-up BeiGene.

There would be less interest from the short-sellers if underwriters were under more pressure to turn illegitimate companies away from the US markets, reckons Matthew Wiechert, founder of Bonitas Research.

In an interview with Hong Kong-based newspaper Ming Pao, Wiechert said that the penalties handed out by the US Securities and Exchange Commission are not severe enough to deter brokers and other intermediaries on Wall Street from wrongdoing.

A lack of cooperation between market regulators in the US and China makes enforcement more of a challenge too, adds Nigel Stevenson, an analyst at GMT Research in Hong Kong. In the name of defending national security, Beijing has restricted the US-based Public Company Accounting Oversight Board (PCAOB) from accessing the audits of Chinese firms, a situation cited by those US hawks who believe that Chinese companies should be blocked from selling shares on American exchanges (see WiC470).

And even if Chinese nationals at these companies are charged with committing fraud in the US, there is no extradition treaty to bring them to trial either.

There are signs that Beijing might be willing to take a harder line on some of the US-listed Chinese firms suspected of skulduggery, the Financial Times points out. In an unusual move, the China Securities Regulatory Commission put out a statement on Luckin last week to make the point that it “strongly condemns the company’s fraud”.

But for now, it is Chinese companies trying to float their shares in the US that seem most at risk from renewed investor scepticism over their financials.

“First, the new issuers might struggle to find buyers. Second, even if the shares are wanted, they won’t be priced as desired, but at a huge discount,” Luo Wei, associate professor at Peking University’s Guanghua School of Management, told Securities Times.

“Based on the projects that we’re handling, companies that had begun to prepare for IPOs before the coronavirus outbreak don’t want to suspend the process. But those prospecting for an opportunity have turned more cautious,” expplained a principal at Beijing-based Rail Capital.

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