I find this story fascinating because it shows just how a small amount of research and very clever tactics can bring down these scammers and make you rich in the process, while big Wall Street firms are completely unable to come up with any useful information, even after paying their analysts hundreds of thousands of dollars a year.
Did you know there is about $20 billion worth of small- to medium-size Chinese companies listed on U.S. exchanges ? That makes the potential losses for western investors quite high.
Here's the story, with my emphasis.
Sahm Adrangi works with six other people in a small room on Madison Avenue with a view of an adjacent brick building.
He doesn’t speak Chinese. He’s never set foot in China. At 30, he claims no special insight into the sources or durability of the Chinese economic miracle. Yet he has managed to dig up enough information to wreck the fortunes of several Chinese companies — while building up his own.
Two years ago, Adrangi, a 2003 Yale graduate, left an investment banking job and set up a small hedge fund, largely with money from himself and his parents, as well as a few other supporters. Since then, his red-hot fund has increased sixfold, partly a fortuitous accident of market timing but mostly a product of his ability to spot flimsy Chinese companies listed on U.S. markets — which he bets against by short-selling them.
The firm is tiny by hedge fund standards, with $20 million under management. But Adrangi has promoted his bets through newsletters and online postings that savage U.S.-listed Chinese companies he views as “scams.” In doing so and doing well, he has grabbed the attention of eager U.S. investors and fearful Chinese executives — not to mention U.S. regulators who are trying to keep track of about $20 billion worth of small- to medium-size Chinese companies listed on U.S. exchanges.
Here are a few samples of Adrangi’s scathing assessments:
China Education Alliance “is mostly a hoax,” he wrote of a Chinese for-profit education firm, which then had a $150 million market value on the New York Stock Exchange and is now worth less than $25 million.
The company’s Harbin “training center” — which CEA said had “17 modern classrooms” for 1,200 students — had no desks and was all but empty, Adrangi said. It boasted of online revenue, but its Web site didn’t work.
China Biotics claimed to have more than 100 outlets for its nutritional supplements; Adrangi said he hired researchers who checked all the company’s business addresses and found only four outlets. Later, on June 22, the company’s auditors resigned, citing “irregularities” that might “constitute illegal acts” and for which the board had “not taken timely and appropriate remedial actions.” The company is contesting a shareholder suit in Washington that makes the same allegations.
China Marine, a maker of snacks and an algae drink, reported revenue to China’s State Administration of Industry and Commerce that was 85 percent lower than what it reported in U.S. filings, Adrangi said. The company reaffirmed its U.S. reporting, but on Aug. 8 (considered an auspicious day in China), it announced just $1 million in quarterly profits, down 85 percent from a year earlier.
Noting extremely high profit margins claimed by one of China’s battery manufacturers, Adrangi wrote that he believed the firm was “fabricating its SEC financial statements.” He added that the company’s battery plant “is either the world’s most spectacular battery manufacturing facility or the company’s financial statements are fiction. We believe it’s the latter.” The companies have disputed Adrangi’s assessments, insisting that they are not misleading U.S. investors or regulators.
[...] All of their targets are drawn from the more than 300 Chinese companies that since 2004 have taken advantage of a technique known as the reverse merger. It is a sort of backdoor way into the prized U.S. capital markets. It works like this: A Chinese company seeking access to U.S. capital markets swaps its shares with the shares of a U.S.-listed company that has fallen on hard times and has been reduced to nothing more than a shell. Usually the U.S.-listed company takes on a new name, appoints new directors, reports glowing results from its new Chinese operations and raises millions of dollars by issuing stock and luring new investors. And it does this without having to go through the regulatory steps that would be required for a newly listed company, especially one based in China.
[...] Adrangi has taken an accidental route to the China investment field. Born in Iran, his parents moved to California when he was 5 and then to Vancouver. His father, an engineer in Iran, bought a fencing company. Adrangi attended a prestigious boys’ school and then went to Yale. When he arrived, he was an activist.[...] But he wasn’t able to turn those internships into a full-time job. So he moved to New York and went to work for Deutsche Bank. He applied to law schools and deferred three of them. He never went. Instead, he moved to Long acre Management, selling distressed assets of bankrupt companies. Then he went out on his own.
Initially the fund wasn’t focused on Chinese companies. Even today it has invested in about 100 non-Chinese companies, including wireless companies in Africa, a Costco-like retailer in central America and an Internet bank in the United States. But then Adrangi read about Bird and called him for advice. Bird told him that looking at the books of Chinese reverse merger firms was like listening to someone claim they drove 300 mph to arrive on time for dinner. “The sales were outstanding, but it didn’t make sense,” Adrangi said.
Adrangi’s first forays into attack mode were anonymous because he feared retaliation or lawsuits. He created a Web site and posted brief items pointing to companies he believed to be hyped. The SEC forbids hedge funds from soliciting customers on the Web, so Adrangi made no mention of his firm, Kerrisdale Capital, or his fund. Then he read signed reports about Chinese reverse merger companies and he began to do the same. He took aim at China Education Alliance. The company went public in 2004 through a reverse merger. [...] The company said it distributed educational materials online, but Adrangi found through researchers that the Web sites didn’t work, payment mechanisms didn’t function [...] , he sent researchers to the company’s training center. They took photos and video of the virtually empty building, which he posted. CEA said it had more than $12 million of revenue from the center. Since Adrangi first posted his attack on CEA, the company’s stock has plunged from $4.50 a share on Nov. 26, 2010, to 76 cents on Aug. 22 — even though the CEA chairman has bought $1 million in shares to bolster the price, chief financial officer Rogers says.
Adrangi also made money shorting China MediaExpress, a firm that operates television advertising on inter-city express buses. A darling of China investors, the company’s auditors resigned, the stock price collapsed and in time trading in the shares was halted.
And Adrangi profited from the collapse of Rino, a Dalian-based maker of industrial pollution control equipment. The stock, which once traded as high as $35 a share, has since been taken off the exchange.
[...] In 2010, its 81.5 percent return (before fees) crushed the Standard & Poor’s 500-stock index’s 15.1 percent gain. Aside from its bets on a few U.S.-listed Chinese companies, its portfolio “roughly tracked the market,” Adrangi said in a letter to investors, warning that “we do not have a magic formula” for “generating outsized returns.” Three months later, more Chinese reverse merger companies “imploded,” Adrangi told investors, and his firm Kerrisdale Capital rang up more big gains. Its top five investments were all shorts of U.S.-listed Chinese firms. The run continued in the second quarter, when the fund returned 54 percent (before fees) against 0.1 percent for the S&P 500.
[...] Although Adrangi has skewered many Chinese companies listed in the United States, he has little sympathy for investors who lose money on them. “The responsibility belongs with investors who make these investments,” he said. “No one should be relying on the SEC or underwriters to protect them.” He said that if investors “end up holding the bag, that’s just the way capital markets work.” But he conceded it can be hard to see through the stories the companies spin. “Historically, stock scams are promoters promoting stories. The actual numbers will tell a more truthful story,” he said. “If it’s a mining company and there is nothing in ground . . . the numbers don’t lie. The people do. The trick here is that the numbers are made up.”