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Morgan Stanley No Boost for Yongye as Concerns Taint Bids

Even a buyout bid from Morgan Stanley isn’t enough to boost investor confidence in Yongye International Inc. (YONG), a Chinese fertilizer maker listed in the U.S. that short sellers say manipulated accounting.

Yongye, whose name means “forever business” in Chinese, has trimmed more than half of its 17 percent rally on the Nasdaq Stock Market since a group including Chairman Wu Zishen and Morgan Stanley’s private equity unit proposed a takeover Oct. 15. The stock trades at a 24 percent discount to the offer price, data compiled by Bloomberg show.

The company, whose management short sellers including Absaroka Capital Management LLC said embezzled funds through a fake transaction, joins dozens of Chinese stocks seeking to delist from U.S. exchanges. While lower valuations are luring private equity, U.S. regulators probing potential fraud are intensifying concern over U.S.-listed Chinese companies by accusing the largest auditing firms of withholding documents. Securities and Exchange Commission spokesman John Nestor declined to state which companies are being investigated when contacted by phone yesterday.

“Investors’ sentiment is so poor that the faith in these companies doesn’t exist at all,” said Joe Giamichael, an analyst at Umbrella Research, a research and advisory firm in New York that follows Haidian, China-based Yongye. “That level of distrust and disbelief out there, a lot of it is well earned.”

Photographer: Nelson Ching/Bloomberg

Yongye International Inc. Shengmingsu fertilizer is displayed for sale near Hohhot, Inner Mongolia, China. Close

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Yongye International Inc. Shengmingsu fertilizer is displayed for sale near Hohhot, Inner Mongolia, China.

A gauge of Chinese and Hong Kong shares traded in New York has dropped 61 percent since the end of 2010.

Short Interest

Yongye rallied 17 percent to $5.61 on Oct. 15, when the company said it received a non-binding proposal from the buyout group to purchase the company at $6.60 a share. Yongye said in an Oct. 25 statement that it formed a special committee to study the $295-million offer from the buyers, which also include Hong Kong-based Abax Global Capital Ltd. There can be no assurance that any definitive offer will be finalized or that any agreement will be executed, according to the statement.

The shares fell 2.3 percent to $5.04 in New York today, the lowest level since Nov. 16.

Since Yongye announced the buyout plan, short interest in the company has fallen to about 1.5 percent of total shares outstanding, from 8 percent on Sept. 10, according to data compiled by the U.K. researcher Markit. In short selling, investors borrow shares and sell them later, betting a decline in prices will allow them to buy back at lower costs.

Photographer: Nelson Ching/Bloomberg

Workers package Yongye International Inc. Shengmingsu fertilizer at the company's new plant in Wuchuan county, near Hohhot, Inner Mongolia, China. Close

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Workers package Yongye International Inc. Shengmingsu fertilizer at the company's new plant in Wuchuan county, near Hohhot, Inner Mongolia, China.

Mark Tobin, co-director of research at Roth Capital Partners in Newport Beach, California, said Morgan Stanley (MS)’s investment is a vote of confidence in Yongye, and the takeover deal will probably be concluded.

‘Some Comfort’

“Given the fact that Morgan Stanley had previously made an investment in the company and is now also involved in the privatization, that should provide some comfort that the deal has a good chance of getting done,” he said Dec. 4. A Chinese buyout deal takes about five months to complete, according to Roth.

The investment bank helped Yongye raise capital following its listing in 2009 via a so-called reverse merger, a process where a publicly traded shell company is purchased in order to gain a listing. The SEC has said reverse mergers may be prone to fraud.

Nick Footitt, a spokesman at Morgan Stanley in Hong Kong, declined to comment on the buyout or Yongye’s discount in an e- mail. John Capodanno, an investment relations representative for Yongye, didn’t return two calls and e-mails seeking comment.

Muddy Waters

Investors and regulators have boosted scrutiny of Chinese companies trading on North American stock exchanges over the past two years after short sellers led by Muddy Waters Research LLC. exposed financial irregularities in companies such as Sino- Forest Corp. (SNOFF) and China MediaExpress Holdings Inc. Sino-Forest, a Chinese plantation company listed in Canada, filed for bankruptcy protection in March.

Concern has been mounting since Dec. 3 after the SEC said that Deloitte Touche Tohmatsu CPA Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian CPAs Ltd. refused to cooperate with accounting investigations into nine Chinese companies.

The market value of Yongye has fallen to $260 million, below its net worth, with the shares trading at 0.64 times book value, according to data compiled by Bloomberg.

Since April 2010, 19 of the 49 companies that have announced their intention to go private have concluded the transactions, while four have failed, according to a Nov. 5 report by Roth. Firms such as TPG Capital, Bain Capital LLC. and Carlyle Group LP have been involved in the deals.

Focus Media

Focus Media Holding Ltd. (FMCN), a Shanghai-based advertising company, slipped 2.6 percent to $24.12 today in New York, the biggest one-day decline since Sept. 24, after Dow Jones Newswires reported CDH Investments Fund Management Co. is dropping out of a consortium led by Carlyle Group LP that is bidding to take it private in a $3.5 billion deal.

The report, which cited an unidentified person, said that CDH didn’t see the returns on the investment as sufficient. Beijing-based CDH didn’t reply to an e-mail sent to the address listed on the company’s website after business hours.

Muddy Waters claimed in Nov. 2011 that Focus Media overstated its network. The company said the following day that the allegation was based on “innuendo.”

‘Exceptional Company’

Kevin Barnes, then an analyst at Cheyenne, Wyoming-based hedge fund Absaroka, said in a report in May last year that Yongye falsified a $35 million acquisition in 2010 of lignite coal exploration and production rights from Wuchuan Shuntong Humic Acid Company Ltd. in order to transfer cash out of the company to management. Yongye said in a statement the following day that the purchase was legitimate and intended at reducing its production costs.

Two weeks later, Morgan Stanley Private Equity Asia said it would invest $50 million into Yongye, calling it “an exceptional company” after “extensive due diligence.” Morgan Stanley, the sixth-largest U.S. bank, can get its money back with a premium should Yongye fail to meet specified targets, including at least 20 percent annual profit growth from 2011 to 2014, according to SEC filings.

Barnes, who now works as an analyst at New York-based Kerrisdale Capital Management Co., said in an interview on Nov. 11 that he stands by his report on Yongye.

SEC Query

Yongye’s rising account receivables and negative cash flow are also causing investor concern, according to Nate Weisshaar, a senior analyst at The Motley Fool financial-services company in London.

While Yongye’s sales increased to $130 million in the third quarter, from $18 million in the same period of 2008, cash flow from operations has been negative as the company expands its distribution network.

The company changed its sales recognition methods from the start of the fourth quarter of 2011, after the SEC questioned its accounting practices in July of that year. Net income fell to $16.8 million in the three months through September, from $39 million a year earlier, as the company delayed the revenue recognition. KPMG LLP audited Yongye’s accounts.

KPMG’s Hong Kong-based spokeswoman, Nina Mehra, declined to comment when reached by phone today.

“When you have issues clouding things like growing receivables, it’s become a little harder to take their sales growth at face value,” Weisshaar, who holds Yongye’s shares as a personal investment, said by phone. “To me, that’s not a concern because they have demonstrated they are able to collect throughout the company’s history, but it raises the question what the sales growth looks like going forward.”

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Belinda Cao in New York at lcao4@bloomberg.net

To contact the editor responsible for this story: Emma O’Brien at eobrien6@bloomberg.net

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