Chinese groups’ habit of halting trades fails to deter short sellers
Heard about the Hong Kong-listed Chinese company alleged to have smoothed its earnings using a host of connected groups, or the chairman accused of taking millions out of a company? Those are just two of the accusations levelled in recent months by short sellers against companies listed in Hong Kong. The flurry of claims by funds that profit from falling share prices is raising concern over whether this is the beginning of a wave of short attacks on Chinese groups.
The history of short sellers targeting Chinese companies is a relatively long one. A first wave in 2011 made household names of Citron Research and Muddy Waters, among others. Their accusations triggered spectacular share price collapses for two Chinese companies: Longtop, a software provider, and Sino-Forest, a forestry group.
Taking aim at Chinese companies listed in Hong Kong is not new, but the targets are getting bigger.
Huishan Dairy has been the most headline-grabbing. Muddy Waters, a US short seller, in December questioned the group’s reported profits and high debt load. In March, a day after a creditor meeting to discuss missed interest payments, its shares plunged 90 per cent in less than an hour.
The same month that Huishan shares tumbled, Hongqiao Aluminium, the world’s largest producer of the metal, was the subject of a report by Emerson Analytics that claimed Hongqiao had under-reported its costs and over-reported its cash position. The company said the allegations were “untrue and unfounded”. Since then Hongqiao has delayed publishing its accounts, suspended trading in its shares and changed auditor.
The biggest group to face scrutiny is AAC Technologies, an audio specialist worth $13bn that supplies to Apple. Another short seller, Gotham City Research, last week asked how AAC achieved better margins and smoother earnings than its big customer. Yesterday it published a follow-up. AAC, which described the report by Gotham as “inaccurate and misleading,” suspended its shares on the same day after they fell 10 per cent.
Gotham is famous for its attacks on European companies, including exposing fraud at Gowex, the Spanish WiFi provider that subsequently declared bankruptcy. AAC is its first target in Asia, but Gotham’s founder says this is not about China.
“We’re not after China and I want to be clear about that. In fact, I would say that we are inclined to be bullish China and bearish AAC, over the long term. That does not mean that China’s economy will go straight up, nor that AAC’s stock will go straight down,” says founder Daniel Yu, who objects to his research being described as an “attack”.
“I don’t see what we do as attacks, I see what we find companies doing as an attack on the truth of markets.”
Hong Kong has, however, proved tricky territory for short sellers. They must deal with companies’ habit of suspending their shares in the wake of attacks — as all of the above did. Those with short positions then risk being trapped and unable to take profits.
“Hong Kong does seem to be a market that needs attention and that’s what we’re looking for,” says Dan David, cofounder of GeoInvesting. “But it is a difficult market in that it’s a bitter fight for sure.”
A market rally in Hong Kong this year has also lifted most stocks, providing a better level from which to borrow shares and sell short. The city’s blue-chip Hang Seng is up 14 per cent this year, outperforming most major bourses.
The wave of attacks has also come as Hong Kong is debating how best to manage its markets following a series of stocks enjoying stunning rallies and sudden collapses such as Hanergy’s in 2015, where a fivefold rally over one year was followed by a near-halving in half an hour.
The Hong Kong Securities and Futures Commission is reviewing the listings process. Officials, meanwhile, say investors should put the dramas in perspective.
“In a market there are going to be headline cases — frauds and the like. But we shouldn’t get it out of proportion — we’re talking about a very small number of companies and market cap,” said a senior official.
But if the headlines keep coming, that perspective will get harder to maintain.
‘I see what we find companies doing as an attack on the truth of market’