During the last six months, most Chinese companies that listed on US exchanges through reverse mergers have had the stuffing beaten out of them. Valuations have dropped sharply as a rash of short-seller attacks and fraud investigations launched by the US Securities & Exchange Commission have sent investors running for the hills.
But there are exceptions to this story: AutoChina International, for one. China Economic Review identified AutoChina as a dud last October, when we published a company report highlighting its continued and risky reliance on credit injections (a criticism that remains valid). The company now is facing both allegations of fraud from short-sellers and an investigation by the SEC, which caused a temporary stop in trading on June 30.
Despite these events, AutoChina’s share price remains surprisingly resilient. When it resumed trading the next day, AutoChina shares soon climbed back towards US$25, roughly the same level as one year ago. As of mid-June, short positions comprised only about 1.75% of the company’s outstanding float, compared with ratios of 30-50% for some of the reverse-merger stocks that dive-bombed earlier this year.
With these glaring short-comings, why haven’t short-sellers deflated AutoChina’s share price further? For one, the fairly high proportion of insider ownership is probably dampening movements in the company’s stock price – as of March, eight directors and executive officers held more than 70% of the company’s outstanding shares. Interestingly, a high proportion of insider ownership is one of the factors that Fitch Ratings recently highlighted in a report that counseled investors on minimizing their exposure to companies with corporate governance problems.
On most days, only a handful of trades are made in AutoChina’s stock. That has likely prevented short-sellers from gaining the momentum they need to make money. Some bloggers have suggested that AutoChina shares have been boosted by a “short squeeze” – meaning that the company’s stock price started to trend upward, forcing short-sellers to temporarily cover their losses by abandoning short positions and buying shares. Indeed, this squeeze might have been started by company insiders buying up shares themselves. Short squeezes usually occur in stocks with a small market capitalization and public float, like the company in question.
What is the takeaway here? For those who have criticized short-sellers for bullying the market, the example of AutoChina shows their job is not an easy one. Short-sellers who are moving to target Chinese companies listed in other markets should also take notice. The most successful Chinese frauds appear to be those that fly under the radar: No matter how egregious the facts are, short-sellers cannot make money if no one cares.