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Why New Oriental Education's Shares Got Crushed, Again

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Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Chinese education company New Oriental Education (NYSE: EDU  ) were getting absolutely pummeled by the market today, falling as much as 36% in intraday trading after a similar loss yesterday.

So what: Investors in Chinese companies may remember Muddy Waters from such hits as RINO International, China MediaExpress, and Focus Media Holding. No, we're not talking about the blues-guitar virtuoso; we're talking about the upstart short-seller that went head-to-head with hedge-fund giant John Paulson on Sino Forest -- and won. Now Muddy Waters has dropped the hammer on New Oriental Education.

Muddy Waters released a "strong sell" initiation report on New Oriental today and dropped the dreaded "F" bomb in the report. Not one to mince words, the short-seller alleged that the company, despite saying otherwise, does have franchisees and that "these franchisees are not a hidden bonus for investors. Rather, they are part of a substantial fraud in EDU's accounts."

Now what: Muddy Waters has been very right on some very big calls. However, it's also had a few that appear to be misfires. Does the aggressive short-seller have it right on New Oriental? What we do know from the company's press release yesterday is that it is already under investigation by the U.S. Securities and Exchange Commission. If there is something blatantly wrong, we should hope that the SEC would uncover it. Based on the company's description of the investigation, it didn't sound nearly as bad as what Muddy Waters is alleging, but we could probably expect that the company would want to spin it that way.

It's hard to say what investors should do at this point -- if the SEC investigation is relatively benign and Muddy Waters is blowing smoke, then this could be a darn cheap stock. On the other hand, if Muddy Waters is on target again, there's a whole lot more potential downside.

I've avoided most individual Chinese companies -- particularly small caps -- because of the prevalence of fraud has been so astoundingly high. So potential discount or not, New Oriental holds little interest for me.

Want to keep up to date on New Oriental Education? Add it to your Watchlist.

Motley Fool newsletter services have recommended buying shares of New Oriental Education. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Fool contributor Matt Koppenheffer has no financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter, @KoppTheFool, or on Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (3) | Recommend This Article (3)

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 July 18, 2012, at 6:38 PM, TraderatWork wrote:

    Welcome to China. The land of the fraudsters.

  • Report this Comment On July 18, 2012, at 9:40 PM, dhollinger wrote:

    EDU is the dominate private education company in China, with branch in every major city and range from small child to adult on variety of language and technical training, even branch in oversea. it is one of the most competitive company fund by PKU graduate. EDU is one of the most credible of all Chinese companies.

  • Report this Comment On July 18, 2012, at 9:44 PM, dhollinger wrote:

    EDU is one of the first private company in China, with gigantic chain of schools in every corner and dominate education agency in China.

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