China Tracker: New Features

Over the past four weeks we have added several new tools to the Trading China Tracker. The focus is on risks associated with investments in U.S.-listed Chinese stocks. It is absolutely crucial for any China investor to thoroughly assess the risks before making an investment decisions. These tools should work as a starting point for your research.

Safety/Risk Model

We have introduced a two-stage safety/risk model for U.S.-listed Chinese stocks. Stage One is based on publicly available information, Stage Two requires independent research and can not be automatized.

For every stock we are covering on Trading China, you can now find an additional score card for the Safety/Risk Model (Example: CVVT). All the data is compiled into a percentage score that indicates the safety level according to our algorithm. Please keep in mind that this is not meant to be the ultimate truth - it is based on Stage One of the model only - but it will provide a good starting point for your research into the validity of the reported financials, corporate governance issues, and the possibility of fraud.

The following data is compiled on this page and used to determine the safety score for this particular stock:

• Market Segment (Nasdaq, NYSE, Amex, OTC, Pink Sheets)
• Type of Going Public (Reverse Merger, IPO, Direct Offering, SPAC, etc.)
• IPO Lead Underwriter (if applicable)
• Auditor
• Auditor History and Trail (Dismissals, Resignations, Engagements)
• Effectiveness of Internal Controls (Management Assessment)
• Effectiveness of Internal Controls (Auditor Opinion)
• Senior Management Changes (past two years)
• CFO History and Trail (Dismissals, Resignations, Appointments)
• Ownership (Controlling Shareholder)
• Analyst Coverage (Quality of Coverage, Backing)
• Shareholder Dilution (past 12 months)
• Short Interest
• Account Receivables (Balance Sheet)
• Delinquency with periodical SEC Filings
• Reported Corporate Governance Issues (also Trading Halts)
• Recent Short Seller Attacks / Reports
• Detailed Fraud Accusations

The Safety Score is translated into a Safety Label which spans a range from "Extreme Risk" (Score under 30%), over "High Risk" (30% - 50%), "Moderate Risk" (50% - 75%), "Moderate Safety" (75% - 90%), to "High Safety" (Score over 90%). Ideally, all the stocks you want to invest your money in - as in "buy and hold" and contrary to short-term trades - should be labeled with "Moderate Safety" or higher. For all other names you are strongly advised to do your homework before taking any position. Please keep in mind that, with the exception of Account Receivables data, the safety score has nothing to do with reported financials.

From our coverage universe, the companies with the highest safety score are Ctrip.com International (CTRP), E-House (China) Holdings (EJ), and 3SBio Inc. (SSRX). A total of 24 Chinese stocks passed the Safety/Risk Test with a "High Safety" label, and another 20 names scored with "Moderate Safety". Among those 44 companies you will find only two that went public via Reverse Merger, Cogo Group (COGO) and American Oriental Bioengineering (AOB).

A total of 146 stocks failed the test with a "High Risk" or "Extreme Risk" label. The vast majority of them are Reverse Mergers or SPAC deals, but you will find a good number of regular IPOs in that group as well. The overall picture is terrifying. At the time of writing, nine companies do not have an auditor, and trading in 15 Chinese stocks is currently halted by the exchanges (not counting recently delisted CCME and CAGC). 37 companies have not filed their last quarterly or annual reports, some disappeared completely (CGDI, JADA), others filed a "going dark" Form 15 (GHNA, ENHD). I repeat, it is crucially important that you do your own research before taking a position in any of the "High Risk" or "Extreme Risk" stocks. If you don't have the time or means to do that, you should probably avoid this whole group of stocks.

A sortable table with all Safety/Risk scores has been added to the China Tracker.

Auditor Data

We have added tracker pages for all auditors of Chinese companies in the Trading China database. You can find information of all past and current clients of this auditor, if the firm was dismissed or resigned, the exact dates of the engagement/dismissal, and a screen of all related companies with their year-to-date performance. These tracker pages can be accessed from the auditor trails of each individual company within the China Tracker (Example: KPMG).

Another new screen is a chronological list of all auditor changes, starting with the most recent ones. The data is taken from Form 8-K or Form 6-K SEC filings only, not from press releases or other sources. When you click through the pages of this screen you will find that the number of auditor resignations has exploded since the start of 2011.

A similar screen is available for Chief Financial Officers.

Trading China Weekly Summary - July 5-9, 2010

Trading in Orient Paper (ONP) shares has calmed down considerably after the company issued several press releases to defend itself against fraud allegations from Muddy Waters LLC. Orient Paper reaffirmed their 2010 earnings guidance of $0.98 per fully diluted share which gives the stock a P/E ratio of slightly above 7 at current levels. I want to point out that the stock is not exceptionally cheap here when compared to its peers in the U.S.-listed China space, and that neither of the two analysts that are following the company, Hudson Securities and Roth Capital, has issued a note yet to defend the stock after the big turmoil last week. ONP shares lost 4.7% of their value last week.

3SBio Inc. (SSRX) raised their 2010 full year net revenues guidance by about 3% on Monday, due to the strong first quarter sales performance. The stock is up 8.9% for the week.

On Wednesday, China Green Agriculture (CGA) announced the closing of the Beijing Gufeng Chemical Products acquisition and said that this is expected to contribute EPS of $0.39 for FY 2011. While Rodman & Renshaw called the acquisition "attractive both financially and strategically," Brean Murray points out integration risks and expects "all margins to decrease significantly in FY11." All three analysts that follow the stock give it a neutral rating. CGA shares are up 10.1% for the week.

Several Chinese companies stepped up efforts to increase shareholder value by announcing a share buyback program last week. I believe this is exactly the right signal to the market now as most China small caps have lost at least one third of their value in the last three months. China-Biotics (CHBT) announced a $20 million buyback on Wednesday and China Medicine (CHME) a $2 million program on Friday after the close.

Also on Friday, Longwei Petroleum (LPIH) posted strong numbers for April and May and issued a bullish outlook for their 2011 fiscal year that started this month: "The Company expects continued favorable market and industry conditions to boost revenue growth and profitability in the first half of fiscal 2011." The stock gained 11.44% on Friday and is up 17.9% for the week. It is now trading safely above $2 and if LPIH can hold this mark for another four trading days we can expect the stock to trade on Nyse Amex as early as July 19.