Tuesday, April 5, 2011

China Media Express and a comment on the efficient market hypothesis

China Media Express has announced that it will appeal its suspension from the Nasdaq.

I guess they are going to say that - apart from this amazing 8K they were completely kosher.

[Deloittes] has informed the Company in its resignation letter that it was no longer able to rely on the representations of management and that it had lost confidence in the commitment of the Board and the Audit Committee to good governance and reliable financial reporting. Prior to its resignation, DTT raised the following issues (some of which may be considered to be disagreements) encountered during the audit, including: issues related to the authenticity of bank statements; a loss of confidence in bank confirmation procedures carried out under circumstances which DTT believed to be suspicious; issues concerning the validity of certain advertising agents/ customers and bus operators (including with respect to certain of the Company's top ten customers); concerns over possible undisclosed bank accounts and bank loans; information on file with the State Administration of Industry and Commerce as to certain subsidiaries appearing to be inconsistent with comparable financial information provided to DTT; the verification of the validity of a sampling of tax invoices issued in connection with certain large transactions; the verification of certain subsidiary tax payments with the local office of the State Administration of Taxation; the verification of salary payments made in cash directly to employee bank accounts; the verification of the production process for advertising programs; and the potential double counting of a certain number of buses. As a result, DTT had requested that the bank confirmation process be re-done at the banks' head office and that the issues described above be addressed by an independent forensic investigation. 
You see Deloitte had lost confidence in the management and the board and the audit committee. The board is going to the Nasdaq to protect their listing.  The board is substantially unchanged.

They thought there was problems with the authenticity of bank statements. [Translation: they can't be sure the money was there.]

They lost confidence in bank confirmation procedures carried out under circumstances they thought were suspicious. [Translation: the local bank was in on the scam...]

They thought there was a problem with validity of certain advertising agents/customers and bus operators (including with respect to certain of the Company's top ten customers). [Translation: the customers and bus operators were faked.]

They thought there were concerns over possible undisclosed bank accounts. [Translation: the money raised largely from Starr but also others was transferred to undisclosed bank accounts and is no longer there - presumably stolen.]

They also thought there were undisclosed loans. [Translation: Chinese banks lend money to fictional customers - which will cause awful problems when the Chinese boom ends. This is a bell-ringing observation on China generally.]

Deloitte requested that the bank confirmation process be done again at head office. Management refused. [Translation: head office of the bank was not in on the scam.]

I could go on.

Potemkin Villages and gullible Western investors

This is a company that claimed to advertise on buses.

They showed Western investors buses with media content and adverts. If you asked to be connected to someone from an advertising agency they would take you there. It all looked real. But it was all a Potemkin Village (a good enough one that Delotte signed the previous year accounts).

If you actually went to spy on them unannounced you discovered it was all fiction.

Unfortunately few investors actually stand outside head office or a factory or a bus yard or did any genuine third party check.

That is not what most investors do. [Bronte has a process for doing some third party checks - and even with them we have worked out ways of losing money!]

Instead what most investors do is go on investor relations tours, stay in good hotels, go to nice dinners.

They turn up to a Potemkin village and believe it. Completely believe it. Some people strangely still believe in Potemkin villages even after the scam is exposed.

Gullibility and the efficient market hypothesis

We know - for sure - that there are people who still believe Chinese scams after they have blown up because they have been taken to Potemkin villages and refuse to disbelieve their own eyes. They are truly gullible.

Its a sad statement on the funds management profession that people entrusted with so much money are so easy to deceive. These people are born to lose money. Rich fools. Kids (often money managers under 35) who get recruited because they look good in a suit and can convince people that they are a safe place for a billion dollars in retail money. Or kids who inherit their position.

Critics of the efficient market hypothesis (EMH) have looked at people with better than average results and argued that those results were because they were so smart. I think the EHM critics have got it backward: they should be researching dumb people. The easiest way to argue the EMH is to demonstrate that it is possible to do better than the market because some people are so dumb.

You only need to identify the dummies.

Look at the institutional investors left holding the bag on this stock or on other Chinese shorts and I reckon you have found your candidates.



Anonymous said...

Could not have expressed it better, and I tried!


Anonymous said...


except for PE firm CV Starr, there wasn't any insti sponsorship of CCME.

Besides, CCME has a single-digit PE up till its suspension. Only the silly value investors were banging the table on the supposedly valuation cheapness.

The fool and his money are soon parted,

Anonymous said...

Is this firm delusional?

Looks like those CAGC guys put on quite a how if you tell them ahead of time that you're coming.

John you might want to respond to the Glickenhouse report since it mentions you. Funny thing is the kid is proving your case and doesn't know it.


DanielC said...

Isn't this the time to say, "the shorts are worried"? ;-)

(Great work on this John, it has been really nice to follow along)

Anonymous said...

I don't follow China RTO stocks, but I'm assuming that most of them have been dragged down to some extent by the frauds. Would now be a good time to sift through the rest to identify those that are not frauds and find some long opportunities?

Anonymous said...

@Anonymous 6:10am

There are no, repeat no, reverse merger stocks in the US markets that are not a scam in some way. Companies only go the reverse merger route (in the US) because they are crooks or stupid.

Companies choose that route because they knowingly do not want to go the legit route. Sure, they may try to fool you and say it is "quicker" or "cheaper" but RTOs are simply playthings for crooks. Management teams that do them are either crooks themselves or suckers too.

Why would anyone want to invest with crooks or with morons? Either way you lose.

Anonymous said...

What if 80-90% of the RTOs are frauds? We are dealing with a terrible adverse selection problem

britt said...

Really have enjoyed following your coverage of frauds in China! Do you think we keep uncovering these until we see an overall bust in the market there, potentially led by the looming property bubble?
I would love to know your macro thoughts on the region...

britt said...

I am not sure how that Glickenhouse kid thinks he has disproved the short-case on CAGC if he is showing up announced.
Plus it didn't look like those trucks would be traveling too far with bags packed the way they were about ready to fall off the truck at any turn. A few other red flags in the video he fails to consider....

persistentone said...

How can we believe in any Chinese reverse merger when the corruption in China is systemic? The government is corrupt. The banks are corrupt. The businesses are corrupt. And, largely, citizens there act on these examples.

One of the reasons the Chinese frauds went undetected so long is that no auditor would have believed that banks throughout China actively participate in the fraud. But for the right fee, your bank balance can be anything you need it to be.

So if the business owners are corrupt, and the banks are also corrupt, cannot we at least appeal to the leaders of the country to address this situation? Here too Westerners simply cannot be made to understand that the leaders in China are also part of the corruption. What do you do when the son of a Communist Party official calls you and tells you to deposit $20M in an unnamed account in order to give him an interest free loan for a year. If you do the right thing, you are put out of business. If you do the wrong thing and give him the money, now you have to use your "Guanxi" to find someone even more powerful to get the money back.

You don't believe that happens? Consider the amazing releases recently from FUQI where they reveal their CEO was asked by the "bank" to transfer about $86M out of his accounts to three unidentified customers. We should all clearly understand that the bank is just a conduit for the Communist party, and FUQI was simply doing what someone in the party told them to do. FUQI got the money back eventually, which should make no one feel any better.

Western investors incorrectly impose their own legal system and frame of reference onto the Chinese culture, but that doesn't work. There is no rule of law in China. There is only power in China, and you have it or you do not. And if you have it, anything goes, and "to be rich is glorious."

NVI said...

I think you are dead on about the under 35 year old fund managers-- many of them are big swinging d#$ks who know next to nothing about proper due diligence and far too much about how to match a suit and tie.

Great article. Keep up the good work!

The New Value Investor

Anonymous said...

I think that your allegation re: investment managers under 35 is probably accurate, but I think it misses a very important nuance. The people who manage money by age 35 are probably very excellent at talking the talk, as a result of having spent too much time honing this ability, rather than sitting down and figuring out how exactly to walk the walk.

I do believe that there are a number of very sophisticated young men/women in there 20s/early 30s who are capable of running money, but have spent their time honing an understanding of security valuation the value of thorough due diligence, and economic/financial trends, rather than working an interview and/or clients. Think Warren Buffett.

The question is, how do we get those people into the proper place?

Anonymous said...

So I see the auditor was Deloitte? I thought Deloitte walked on water, unlike your favorite whipping boy Mantyla McReynolds.

On the second point about efficient markets, some of your readership proves you right in a very ironic way.

Hester said...

At this point, I'm almost thinking that just shorting all the Chinese RTO's that are public in the US (that are also borrowable obviously) as an equal weighted, very diversified basket would be the best thing to do.

Even in the very unlikely scenario that 10% of the RTO's are real and become 5 baggers (which would take the average one from a 3-4 p/e to a 15-20)), and the rest are fake and only lose 80%, the trade will still make over 30%.

I think there is a good chance that almost all, if not all, are a fraud in some way. I'm inclined just to short them all and not worry about company specific analysis. Why bother? Plus it shields one from the specific volatility of each security.

Or maybe one could just short a diversified basket of RTO's that share common fraud characteristics, like SAIC and SEC filing mismatches, or dilutive stock offerings despite supposed large cash balances, etc...

Any thoughts?

ben said...

Great post John. I am always amazed at the lack of due diligence most managers of other peoples' money actually do.

Out of curiosity, who is their primary banker (of the accounts we know about!).

G said...

The short all Chinese RTOs idea seems like it would work out.

I got a list of all Ping Luo stocks from a post at Zero Hedge, looked for those that could be shorted at a reasonable cost, and came up with CNYD, which I wrote about on seeking alpha:


The zero hedge list is here:


Anonymous said...

Your good work is getting noticed where it really matters...


JK said...

Hi John,
I am curious on how you do this "[Bronte has a process for doing some third party checks - and even with them we have worked out ways of losing money!]". what sort of process you did to verify it?


Unsympathetic said...

When I need a laugh, John, I go back to the first thread you posted regarding CCME and read the bizarre assertions and threats of physical violence from the CCME staff. Excuse me, "anonymous internet posts."

Is the Chinese economy built entirely on fraud?

Sure, there's money changing hands, but without enforced regulations, reliable audits, prosecution of IP theft, etc -- why would anyone trust anything from China?

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