Shorts Pounce on Harbin Electric With 75% Deal Payout: Real M&A

Short sellers are preying on China’s Harbin Electric Inc. like never before, betting against a Morgan Stanley-backed hedge fund in a buyout that would generate the biggest windfall of any acquisition in the world.

Bearish bets against the U.S.-traded maker of electric motors have almost tripled to a record 28 percent of shares since Chief Executive Officer Tianfu Yang offered to acquire Harbin Electric in a $541 million buyout in October, according to data compiled by Bloomberg and Data Explorers. Short interest increased even as Harbin Electric slumped 34 percent since March through yesterday as concern grew about the accounting practices of some Chinese companies listed in the U.S.

Harbin Electric was forced to refute rumors that Yang had gone missing last month, and its stock dropped to an almost two-year low as Citron Research raised questions about the accuracy of its reported net income. While Abax Global Capital is betting it can profit from Harbin Electric, Chinese companies are facing scrutiny in the U.S. after Rino International Corp. said its financial statements weren’t reliable and China MediaExpress Holdings Inc.’s auditor quit. Traders who bought Harbin Electric yesterday stand to make a 75 percent return if the deal closes.

“I’m very skeptical and have my doubts that Yang can pull this off,” said Yemi Oshodi, managing director of M&A and special situations trading at New York-based WallachBeth Capital LLC. “If it seems too good to be true, it probably is.”

‘Working Efficiently’

Telephone calls to Yang at the company’s headquarters in Harbin, China, went unanswered today.

“The special committee is still evaluating the transaction and everyone is working efficiently,” Christy Shue, Harbin Electric’s spokeswoman, said in a telephone interview today. “We are still waiting for the special committee to make their decision.”

Harbin Electric said on Oct. 11 that it received a non-binding proposal from Yang and Baring Private Equity Asia Group Ltd. to acquire the company for $24 a share, 36 percent higher than its 20-day trading average, data compiled by Bloomberg show. A month later, Baring pulled back from the agreement.

On April 20, Yang and Abax, the manager of $900 million of hedge and private equity funds backed by Morgan Stanley and China Development Bank Corp., submitted an amended agreement to take Harbin Electric private at the same price, according to a filing with the U.S. Securities and Exchange Commission.

Biggest Shareholders

Yang and Abax were Harbin Electric’s two biggest shareholders as of May 1, data compiled by Bloomberg show. Yang owned 40.7 percent, while Abax held a 5.4 percent stake.

Shares of Harbin Electric have declined 31 percent since Yang first disclosed his proposal last year, a sign that traders have become more skeptical the deal will be completed.

Over the same span, the amount of short selling, or the practice of selling borrowed stock on the bet the price will decline, rose to 4.7 million shares on June 2, according to London-based research firm Data Explorers. That represented a record 28 percent of shares available for trading.

Harbin Electric fell 5.9 percent to $13.68 in U.S. composite trading yesterday, leaving the stock $10.32 below Yang’s offer. The 75 percent difference is the widest of any all-cash offer of more than $500 million globally.

Today, Harbin Electric rose 6.5 percent to $14.57.

Harbin Electric’s Shue said on the company’s earnings conference call on May 11 its executives wouldn’t be able to discuss the proposed takeover offer or provide any updates not already contained in publicly available releases.

‘Red Flag’

“The lack of transparency is a big red flag,” said Peter Lobravico, New York-based vice president of merger arbitrage trading and sales at Wall Street Access. “It’s trading where it is because U.S. investors are used to a much higher level of disclosure and trustworthiness of information released by companies. Sometimes radio silence alone can be enough to drive the stock lower.”

The SEC began an investigation last year into the use of reverse takeovers, in which a closely held firm becomes public by purchasing a shell company that already trades.

The Bloomberg Chinese Reverse Mergers Index of U.S.-listed stocks slid 42 percent this year through June 6.

More than 24 Chinese firms have disclosed auditor resignations or accounting problems to the agency since March, SEC Chairman Mary Schapiro wrote in an April 27 letter.

‘Lumped In’

Nine days after short seller Carson Block of Muddy Waters Research said Rino had overstated its sales and claimed contracts that didn’t exist, the maker of water-treatment equipment disclosed that two years’ of financial statements aren’t reliable. The company has lost 95 percent of its value in the past year.

“The whole group of Chinese companies that listed on the U.S. exchanges has been a mine field,” said Wall Street Access’s Lobravico. “Perhaps Harbin is getting lumped in with those. It’s just a trust issue and lack of clarity.”

Shares of Harbin Electric had declined 17 percent since June 1, when short seller Citron Research published a report questioning Harbin Electric’s financials.

Citron said that Harbin’s “four subsidiaries based on subsidiaries’ Chinese filings showed no more than $12 million USD of profits.” That compared with $77 million the company reported in net income last year, Bloomberg data show.

Having a deal “is an easy way to keep your stock up,” said Andrew Left, Los Angeles-based founder and owner of Citron Research, who is shorting shares of Harbin Electric. “There’s no justification of the price. I would put the stock at around $5 a share.”

‘Lost Confidence’

He also wrote a report earlier this year questioning the financials of China MediaExpress, which said in a regulatory filing on March 29 that its auditor, Deloitte Touche Tohmatsu, quit after saying that it “lost confidence in the representations of management.”

Left was disciplined by the National Futures Association for accusations in 1995 that he “cheated, defrauded and deceived commodity futures customers,” according to the association’s website.

“We stand by the company’s public filings and it has provided all of the information required by the SEC,” said Harbin Electric’s Shue. “I don’t have any knowledge of Citron except that it is a short seller and is holding short positions in Chinese companies. We ask that shareholders not look at only one set of opinions, but to look at more than one analyst’s reports and the information provided by the company and use that information wisely and intelligently to assess the company.”

Buy Ratings

Analysts at Maxim Group LLC and Roth Capital Partners LLC, two firms that cover Harbin Electric according to data compiled by Bloomberg, rate the stock a “buy” and estimate the shares will reach $24, equal to the offer price.

Harbin Electric’s financial statements are “most likely” reliable, said Echo He, Maxim’s analyst in New York.

The maker of electric motors used in freight trains, meat slicers, conveyors and automatic car windows said on May 27, the day after the stock tumbled 5 percent, that the company had received calls and emails “from a number of investment professionals” asking about rumors that Yang and Chief Financial Officer Zedong Xu went missing.

Harbin Electric and its management “categorically deny such rumors,” it said in a statement. “The company is happy to report that the entire management team of the company including Mr. Yang and Mr. Xu have been and are at work and are fully performing their respective corporate duties.”

Club Lounge Breakfast

Peter Siris, a managing partner at Guerrilla Capital Management in New York, said he had breakfast with Yang on May 26 at the Club Lounge in the Sofitel Hotel in Harbin, China. Siris held about 400,000 shares of Harbin Electric as of March 31 and has been adding to his position, he said.

“People are willing to make up stuff, make up evidence they claim they have,” said Donald Yang, Hong Kong-based managing director at Abax. “This is almost a wild west, you don’t feel like this is a regulated market.”

It will cost Tianfu Yang about $463.8 million to take Harbin Electric private, according to a May 1 regulatory filing. On April 29, the company received a letter from China Development Bank committing to a $400 million term loan facility to fund the purchase, the filing said. A week earlier Abax said it would contribute financing of up to $63.8 million.

Morgan Stanley became a strategic partner in Abax after making investments in the company “in early 2007,” according to Abax’s website. New York-based Morgan Stanley is also acting as financial adviser to Harbin’s special committee for the deal. China Development Bank, the nation’s state-owned policy bank and its biggest foreign currency lender, was Abax’s anchor investor.

‘One Extreme or Another’

Morgan Stanley’s Hong Kong-based spokesman Nick Footitt declined to comment.

Sachin Shah, a special situations and merger arbitrage strategist at Capstone Global Markets LLC in New York, said he believes the CEO is serious about taking the company private and that the only missing piece is a signed definitive merger agreement from the special committee.

“It doesn’t have to be one extreme or another,” Shah said. “It doesn’t have to be fraud, or a deal gets done at $24. The process the special committee is going through seems somewhat irregular. But just because they’re not offering transparency that doesn’t mean it’s fraud.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE