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US investment firm Muddy Waters Research has slayed several Chinese firms traded on North American exchanges. But are its methods flagging?
HONG KONG — Like an odd business hex, two little words strike fear in Chinese companies on Wall Street: Muddy Waters.
Named for a Chinese proverb that roughly means “muddy waters make it easy to catch fish,” Muddy Waters is a New York-based research firm that has carved a niche for itself alleging massive fraud among Chinese firms listed in North America.
The model is simple: Muddy Waters issues a research report detailing alleged fraud, publicizes it, and profits by betting that the price will plunge.
The firm does not disclose how much money it makes off of these bets, but it claims a record of forcing four companies to delist from Western stock exchanges over the last three and a half years.
By one estimate, Muddy Waters has single-handedly wiped out over $7 billion in market value from the companies it has targeted.
In 2011, for instance, the firm alleged that Chinese lumber giant Sino-Forest was rotten to its roots. Within a year, Sino-Forest had been felled. Its share price plummeted from about $18.50 until the Ontario Securities Commission suspended it from the Toronto exchange in Canada, citing alleged fraud. It eventually filed for bankruptcy.
The allegations allowed Muddy Waters to borrow shares, sell them when the price was high, then pay back the lenders when the price was low — a sell high, buy low strategy known as shorting.
Since then, Muddy Waters — and its flamboyant, outspoken founder, the American lawyer Carson Block — have become perhaps the most famous scourges of Chinese companies accused of fraud. Over the last three years, they have gone after nine firms with hard-hitting “strong sell” reports that sent share prices cratering.
The pattern goes like this: On some unsuspecting day, Muddy Waters blasts out a report featuring bold, colorful language. (A subtitle of New Oriental Education’s report was “Magna Cum Fraude,” the commodities supplier Olam was dubbed a “black box” with “uncanny” similarities to Enron, NQ Mobile was called, simply enough, “a massive fraud.”) Hours later, the stock price tanks. Shareholders flee. The company scrambles to defend itself. And then…
Well, that’s where the pattern gets a little wobbly.
In some cases, Muddy Waters’ targets have essentially imploded and been delisted. In addition to Sino-Forest, that was the fate of China Media Express, and, most recently, Duoyuan Global Water, which was taken off the New York Stock Exchange in January 2012.
In other cases, the stock price gets battered, but the company hobbles along. That’s what happened to Orient Paper, which has seen its shares limp around $2.75 from a level of $8.50 before the takedown.
And then, in the last two years, more cases have emerged where companies have, bounced back after being subjected to a Muddy Waters assault.
That happened to New Oriental Education, which has seen its shares exceed their level before Muddy Waters’ 2012 report. And it happened to American Tower Corporation, which the firm continues to say should be valued at $44.58 per share, but is currently trading around $78.
So has Muddy Waters started to lose its touch?
That’s the question swirling around its most recent report on NQ Mobile, a Chinese mobile security company based in Beijing and Dallas. On October 25, Block published a report calling NQ a “total fraud,” arguing that 90 percent of its revenue was fake.
The initial selloff was ferocious. The company’s market capitalization shrank by hundreds of millions. The stock price fell 62 percent overnight.
NQ hit back hard at the allegations. In a 90-page report, the company responded to Block’s accusations, showing pictures of one of its major client’s headquarters, which Muddy Waters had said was “an empty shell with no discernible operation.”
NQ announced it was calling in outside auditors to verify the books, and promised to publicly demonstrate it had millions of dollars in liquidity. The company later released screenshots of bank statements showing accounts with a balance in excess of $100 million in cash.
In the two ensuing months, in fits and bursts, the stock price has crawled back upward — though nowhere near its original level. At the beginning of the year, shares of NQ traded around $6. Just before the Muddy Waters report, they hit a high of about $25.