Way to Go, Yongye!

"SPLAT!" That was the sound of a swarm of shorts, who've been bugging Yongye International (Nasdaq: YONG  ) for the past few months, slamming against the windshield of an onrushing Mack Truck.

For weeks, investors in the little Chinese fertilizer maker have gnashed teeth, torn hair, and thrown towels, as a series of "reports" by the likes of Richard X Roe, Ian Bezek, and Absaroka Capital devastated the market value of their company. But this morning, it's the shorts doing the wailing and lamenting. Why? Because in answer to investors' insistent demands that management do something about the stock price, management … did something.

Actually, three somethings:

Step 1: Put your money Wu your mouth is.
First, CEO Zishen Wu announced his intent to set up a 10b5-1 plan to spend $3 million on shares of Yongye on the open market. Yongye's been hinting since April that it had something in the works to support its assertion that the stock was undervalued. Some Fools argued we would see a share buyback. Others argued that if Yongye wants to close the gap with bigger international fertilizer makers like Potash (NYSE: POT  ) and Mosaic (NYSE: MOS  ) , it must deploy all the cash it has to expand production, and will have to find some other way to "fix" the stock price. Now we see the alternative -- Wu using his personal cash stash to demonstrate confidence in his business.

Step 2: Bring a high roller to the table.
Second, Wu managed to secure a big vote of confidence from an international investor, in the form of Morgan Stanley's (NYSE: MS  ) Asian private equity unit. MS is matching Wu's bet -- then doing him 15 times better, taking a $50 million stake in the company. Today's leap in share price suggests a 20% stake in the company -- but if priced at Friday's close ($3.75), MS could own as much as 27% of Yongye.

And it gets better. MS' investment comes in the form of preferred shares, convertible to common at the strike price of … (better sit down for this) … $8.80. That's about 66% more than what the shares fetch today. Also worth noting: when MS gets paid dividends for its investment, these dividends will not be in the form of cash … but in the form of additional preferred shares. Let me say that again: MS is so eager to own Yongye that it's passing up an immediate payback for the prospect of owning even more shares.

Step 3: Hire a watchdog.
Perhaps the best news of all came almost as an afterthought: In defense of its investment, MS is placing the managing director of Morgan Stanley Private Equity Asia on Yongye's board of directors. I'd argue this is the most significant news of the day.

Why? Look at it this way: Anybody can invest money in Yongye. (Why, I've bought a few shares myself.) It doesn't seem to help the stock price much, though. Because no matter how cheap Yongye's financials appear, there's still that nagging worry: What if the numbers aren't real? What if Yongye is lying?

This is why putting a major investor on the board is so crucial. In recent weeks, investors have begun worrying about the integrity of Yongye's managers. Alerted by Absaroka to allegations that the "Big Four" auditors missed frauds at China MediaExpress, China Agritech, Wonder Auto (Nasdaq: WATG  ) , and China Integrated Energy (Nasdaq: CBEH  ) , investors questioned whether KPMG was competent enough to ensure their company is honest. But now they've got a watchdog on the board. At the risk of mixing a metaphor, you know that with $50 million of its own money on the line, Morgan Stanley will be watching this company like a hawk.

Does this dog (hawk?) hunt?
As you can probably tell, I'm pretty pleased with Yongye's triple-pronged response to the short attack. They've done a lot right -- but don't expect everyone to be convinced. To quality-check my read on the situation, I rang up Absaroka Capital this morning for the "short view" of today's news. Here's how it reads, in brief:

  • First, Morgan Stanley is putting money into the company, but in so doing, it dilutes the ownership of existing shareholders.
  • Second, by taking a "preferred" stake in Yongye, MS protects itself if the common stock declines in value. If the stock price falls, MS' stake in Yongye grows.
  • Third, and most importantly, Absaroka argues that MS' putting a director on the board isn't necessarily good news for common stock holders. Says Absaroka, MS' man will protect MS' interests only. These interests may not align with those of common shareholders like you and me.

Foolish takeaway
Make no mistake -- while Absaroka's arguments have a distinct "grasping at straws" feel, there's a grain of truth to each. Morgan Stanley isn't in business to make money for other people, but for itself. It is creating a potential for stock dilution (albeit, only after Yongye hits $8.80). It is negotiating to limit its downside risk. And there may be other risks to the transaction that I haven't yet uncovered.

My advice: If you already own, or plan to buy shares of Yongye, but you haven't yet signed up for Motley Fool Global Gains, now would an excellent time to take a free trial. As we speak, our dedicated team of analysts is poring over the details of Yongye's 8-K filing. If you want clear, unbiased advice on what this deal means to investors, Global Gains is the place to get it. Click here now.

China Green Agriculture and Yongye International are Motley Fool Global Gains recommendations. Motley Fool Options has recommended a synthetic long position on Monsanto. The Fool owns shares of China Green Agriculture and Yongye International. Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Fool contributor Rich Smith owns shares of Yongye. The Motley Fool has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 31, 2011, at 2:36 PM, cattywampus wrote:

    Lately it occurs to me, that as a novice I'm better off watching from the side lines, but what a show to behold. Watching and learning.

  • Report this Comment On May 31, 2011, at 2:49 PM, seasaw6499 wrote:

    How could this news possibly change the fact that the company is a fraud?

  • Report this Comment On May 31, 2011, at 2:51 PM, catoismymotor wrote:

    Time to short on caps?

  • Report this Comment On May 31, 2011, at 2:59 PM, buffalonate wrote:

    I just got 41 points by giving this company the thumbs up after the last attack. I would give it the thumbs down again but I don't think the short attackers have any legs to stand on any more. I am surprised it didn't go up much higher given that it has a p/e rate of 3.5 and a high growth rate.

  • Report this Comment On May 31, 2011, at 3:32 PM, john795806 wrote:

    Rich, if yo think the shorts are hurting, you're dead wrong. The mid-May short attach was timed to drive the price of the stock down right before options expiration date--which they wildly succeeded in doing, then cashed in their positions. Now they're probably riding the stock back up again. This is market manipulation, pure and simple. Bufallonate's post is no purer proof of that.

    I applaud Yongye's actions, but if they really wanted to kill the shorts, they should have done it two weeks ago.

    The lesson to investors is, what you don't know about options CAN hurt you. I rode out the price drop because I knew what it was all about. A lot of Yongye investors panicked, bailed, and got toasted.

  • Report this Comment On May 31, 2011, at 4:04 PM, buffalonate wrote:

    I don't own or short stock in Yongye. I just find it entertaining to watch the short long battle go on. They should have repurchased shares long ago and that would have put an end to the circus long ago. You can put out all the rebuttals and numbers you want but until the company puts its money where its mouth is it won't do any good.

  • Report this Comment On May 31, 2011, at 5:20 PM, coralbayj wrote:

    This is the second time this month that the Motley

    Fool has erroneously claimed WATG was accused of fraud. There has been nothing close to being proven as to fraud, only fear of such due to late filings and poor communication of IR. We share holders do not need MF fanning the flames of fear without solid justification

  • Report this Comment On May 31, 2011, at 7:24 PM, TMFDitty wrote:

    @coralbayj: I sympathize with your concern, but the simple truth is that Absaroka *did* accuse Wonder Auto of fraud -- collateral damage in its report on Yongye.

    You sound like you are not aware of the allegation, however. If you want to contact the analyst to dispute its assertion, you can find the specifics, and Absaroka's contact information, in its report here:

    http://absaroka.com/uploads/YONG.ResearchReport.051811-vFINA...

    TMFDitty

  • Report this Comment On May 31, 2011, at 7:45 PM, FoolioD wrote:

    Its ridiculous that Absaroka is stating that MS is only looking after MS, therefore that is not a reason to trust MS's investment.

    How about Absaroka is only looking after Absaroka?

    Their rebuttal is as full of innuendo and no concrete facts as their research report on YONG

  • Report this Comment On May 31, 2011, at 10:38 PM, rookie2010 wrote:

    Best opening line for an article ever! ...AND an excellent article! Way to Go, Rich Smith (and Yongye)!

  • Report this Comment On May 31, 2011, at 10:52 PM, jekoslosky wrote:

    Funny that I just blogged about why I bailed on Yongye over nagging concerns that the shorts might be right just yesterday at stocksnovice.blogspot.com.

    I'm glad for those who hung on. That comes as a nice reprieve.

    Still not feeling good enough to dips my toes back in China just yet, though.

  • Report this Comment On May 31, 2011, at 11:25 PM, Darnedifino wrote:

    Tried to log into Global Gains, as suggested in the last para. but am unable to using my Stock Advisor log in, but it doesn't work.

  • Report this Comment On June 01, 2011, at 1:18 AM, TMFDitty wrote:

    Darnedifino: Global Gains is not part of Stock Advisor; it is a separate newsletter. What you'll want to do is sign up for the GG free trial at this page:

    https://www.fool.com/shop/secure/order-01.aspx?dc=3b2cb776-b...

    TMFDitty

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