For any investor who has put a toe in the Chinese market over the past few years, it's been a wild ride. Unfortunately for those same investors, that ride has mainly been in the direction headed south.
Today, one stock that's well off highs set back in 2009 is bouncing back. Let's take a look why Yongye (NASDAQ: YONG) is up 17% today, and what its jump says about foreign-listed Chinese stocks.
A brief history in Chinese stocks
After briefly cresting past 6,000 in late 2007, the Shanghai Stock Exchange Index Composite (SSE) has come back down to its current level around 2,300. The declines in Chinese equities is even worse for most stocks listed abroad. Using reverse mergers into shell companies, a host of Chinese companies seized upon euphoria over Chinese growth in 2009 and 2010 to list on American exchanges.
While these companies posted eye-popping growth for a time, the unfortunate reality for many was that their reported financials ended up being -- and this is a kind way of saying this -- less than reputable. A slew of companies such as Rino, Sino-Forrest, and China Agritech fell as short-sellers issued reports that exposed that their reported financials and reality had a wide gap between them. Thanks to the wide use of variable interest entities (VIEs), foreign investors had little legal recourse against fraudulent companies.
The continued cases of fraud cratered most small-cap Chinese stocks listed abroad. Simply put, small-cap Chinese companies executing reverse mergers were guilty until proven innocent. Considering the amount of high-profile examples of fraud, that's a reaction that's not surprising. No one wanted to be the next big-name investor getting caught holding a large position in a Chinese company that was proven to be a fraud and made near worthless overnight.
An exit for investors, or a mirage?
However, one interesting facet of the story is that after the sell-offs, certain Chinese companies are now looking to go private. Focus Media (FMCN), a company that has long been a favorite of short-seller research reports, is the poster child of the shift in Chinese companies moving back to being private companies. In August, the company announced a deal between its CEO and several investment firms to take the company private at $27 per share.
Yongye, a company that has seen its own share of research into the veracity of its financial reporting, is following in Focus Media's footsteps. The company is attempting to go private at $6.60 per share in a deal led by its chairman and CEO along with several investment firms. Such a move would end Yongye's time as a public company.
There was never a problem with growth surrounding Yongye, as the company grew from a reported $48 million in revenue in 2008 to $427 million in the past 12 months. Yet at the same time, the company's accounts receivable swelled from $2.7 million to $188.4 million. The continuing rise in accounts receivable led to questions whether the company could actually collect on its reported earnings. Then further "research reports" -- often from nebulous sources -- questioned such basic questions of whether the company lied about the benefits of its core product, which helped the growth of crops.
As Yongye continued receiving negative attention along wtih other foreign-listed Chinese stocks, its share price kept sinking. That is, until today, when the going-private offer sent the company soaring to 52-week highs.
The market's not fully buying it yet
Yongye closed today at $5.61, well below the $6.60 per share that's being offered for the company to go private. The difference between the offers and where Yongye's trading shows some of the continuing skepticism that the company will be able to close out its deal to leave the public markets. Likewise, Focus Media has seen some recent selling and now sits about 11% below its own "go private" offer.
Battles still rage over companies like Focus Media even as they prepare to go private. The interesting question becomes, what sort of information do private-equity firms like Carlyle -- which is part of the group taking Focus Media private -- learn while conducting their own due diligence? What do these companies know that keeps them involved in the deal while the rest of the financial world avoids buying their shares?
It's an interesting story-line. In the end, expect far more news and heated debate ahead before this round of Chinese companies successfully goes private. There are simply too many questions still unanswered.