Muddy Waters Retreats on Short Selling Chinese Stocks

Muddy Waters LLC Research Director And Founder Carson Block
Muddy Waters LLC Research Director and Founder Carson Block. Photographer: Photographer: David Paul Morris/Bloomberg

Carson Block says it’s become too difficult to short Chinese equities in the U.S. as bets on stock declines drop by 50 percent from a year ago.

Block, known for his allegations that Chinese companies traded in North America engaged in accounting fraud, said in an interview yesterday that he’s lost interest in betting against the stocks because the government helps protect them. Short interest in the 83 biggest Chinese firms listed in New York has dropped to an average 2.61 percent of the total outstanding, from 5.22 percent a year ago, data compiled by Bloomberg and the U.K. researcher Markit show.

Short sellers, who sell securities they don’t own to buy them later at a lower price, are retreating as China limits access to corporate filings and companies such as Focus Media Holding Ltd. try to withdraw from the market through buyouts. The Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. has climbed 1.5 percent this year and Focus Media, which Block’s Muddy Waters LLC targeted last year, has reversed losses to gain 22 percent in 2012.

“Investors will be more comfortable knowing that the threat of short seller attacks is a lot less than it used to be and a lot of companies have stepped up their corporate governance,” Kevin Pollack, a managing director at Paragon Capital in New York, which invests in Chinese stocks, said by phone yesterday. “The fact a guy like Carson Block isn’t aggressively shorting companies hopefully will lead to more investor interest that otherwise would have been scared away.”

Stocks Fall

The Bloomberg China-US index lost 1.4 percent yesterday to 91.43, trimming its gain this year. Pactera Technology International Ltd., a Chinese software-outsourcing provider, slipped 1.8 percent after Chief Executive Officer Tiak Koon Loh said sales will slow in 2013.

The Shanghai Composite Index of domestic stocks closed below 2,000 for the first time since 2009 yesterday, as the value of shares traded slumped to the lowest in four years. It fell 0.7 percent today as of the mid-day trading break.

The iShares FTSE China 25 Index Fund, the biggest Chinese exchange-traded fund in the U.S., slipped 1.3 percent to $36.86 in New York yesterday, as the Standard & Poor’s 500 Index of U.S. equities dropped 0.5 percent.

Block, a 36-year-old lawyer, became the face of the short sellers against overseas-traded Chinese companies last year after his report accusing Sino-Forest Corp. of overstating its plantation assets prompted the shares to slump 74 percent. Sino-Forest, based in Hong Kong and Mississauga, Ontario, filed for bankruptcy protection in March, wiping out more than $3 billion in value.

New Oriental

Since Sino-Forest, Muddy Waters has focused on New Oriental Education & Technology Group Inc. and Focus Media. Their shares have all rebounded after initial slumps when Block questioned their accounting. Both companies have denied any wrongdoing.

New Oriental, an education service provider based in Beijing, has risen 28 percent since July 17, the day before Block said financial statements from the company’s units were fraudulent and that its auditor would resign. Focus Media, a Shanghai-based advertising company, has recouped 93 percent of its losses since Nov. 18, 2011, a day before Block claimed it overstated its ad network. The company has attracted a $3.5 billion takeover offer from a group of private-equity firms including Carlyle Group LP., which would be the largest leverage buyout deal.

Short interest on Focus Media has declined to 4.7 percent of total shares outstanding, from 81 percent a year ago, according to Bloomberg and Markit data. The ratio for New Oriental has fallen to 6.7 percent, from 12.8 percent in July, when Block started questioning the company’s accounting.

‘Conceal Records’

China began limiting access to corporate filings at the State Administration for Industry and Commerce this year after short sellers used them to highlight accounting discrepancies in companies listed abroad, lawyers including Nathan Bush, a Beijing-based partner at the law firm O’Melveny & Myers LLP, said in interviews in June.

“China has gotten harder in the sense that the government has really taken the side of the fraud,” Block said in an interview on with Stephanie Ruhle and Tom Keene on Bloomberg Television’s “Market Makers.” “The government is working with a number of these companies to try to conceal records that are public. When you are up against that sort of strength of the ability to revise history, it becomes difficult. That is one of the reasons we’re not that interested in China anymore.”

Olam International

The State Administration for Industry and Commerce, which compiles corporate records in China, didn’t immediately respond to faxed questions seeking comment today. An official at China’s consulate in New York, who asked not to be identified because it’s against their policy, said that she’s not in a position to respond to Block’s comments.

In a sign that he’s moving on from targeting the Chinese companies, Block is attacking Singapore-listed Olam International Ltd., saying in a 133-page report published yesterday that the commodities trader runs a high risk of failure. Olam, the world’s second-largest rice trader, is the first non-Chinese company Block has said he is betting against.

Olam is suing Muddy Waters and Block for defamation as the stock has slumped more than 10 percent in Singapore since the short seller’s first allegations against the company on Nov. 19.

Block’s allegations over the past two years have increased investor scrutiny of Chinese companies trading on North American stock exchanges, especially so-called reverse mergers, a process that involves buying a publicly traded shell company. The Securities and Exchange Commission has said reverse mergers may be prone to “fraud and other abuses.”

Reverse Mergers

The Bloomberg Chinese Reverse Mergers Index, which tracks the 81 Chinese companies that gained U.S. listings after buying firms that already trade, has tumbled 68 percent since the end of 2009. Companies including China MediaExpress Holdings Inc., an advertising company listed through a reverse merger, have been delisted after Block exposed financial irregularities.

“Carson’s really is a victim of his own success here,” Eric Jackson, managing partner of Naples, Florida-based Ironfire Capital LLC, said by phone. “His greatest successes in shorting Chinese stocks were these very small reverse-listed companies, and, partly because he’s done such a great job of pulling back the curtain, those companies are by and large gone now.”

Delisting Shares

With short sellers pushing down valuations, a growing number of Chinese companies are seeking to exit U.S. exchanges. Since April 2010, 49 companies -- including Focus Media and 7 Days Group Holdings Ltd. -- have announced their intention to go private and delist from U.S. markets, according to a report by Roth Capital Partners issued Nov. 5.

China Development Bank Corp., the state-owned lender, is providing more than $1 billion to assist companies, including meat producer Zhongpin Inc. and Fushi Copperweld Inc., a manufacturer of steel wire, to leave the U.S. market.

“Because of Muddy Waters and other short sellers, there has been a cleansing period and companies have stepped up,” said Paragon’s Pollack. “There are just fewer bad apples that are easily identifiable.”

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