Wednesday, May 9, 2012

A stock called Comedy: the joke is on someone or other

China Medical Technologies – a Chinese diagnostic, medical testing and genetic tools company which I am short – is possibly the strangest story in our portfolio. Here is the official “business description”:

China Medical Technologies, Inc., a medical device company, develops, manufactures, and markets immunodiagnostic and molecular diagnostic products. It uses molecular diagnostic technologies, including fluorescent in situ hybridization (FISH) and surface plasmon resonance (SPR), and enhanced chemiluminescence immunoassay (ECLIA), an immunodiagnostic technology in the development, manufacturing, and distribution of diagnostic products for the detection of various cancers, diseases, and disorders, as well as companion diagnostic tests for targeted cancer drugs. The company offers immunodiagnostic products, such as ECLIA analyzers and reagent kits for various clinical applications, including anemia, cardiac diseases, food safety, growth disorders, hepatitis, HIV, infertility, liver fibrosis, metabolic function, reproductive endocrinology, SARS, thyroid disorders, and tumors tests. It also provides FISH probes, a molecular diagnostic IVD reagent for the prenatal diagnosis of various genetic diseases; detection and prognosis of various cancers; and identification of cancer patients. In addition, the company offers HPV(human papillomavirus)-DNA chips, a molecular diagnostic biosensor chip, and SPR analyzers for the diagnosis of HPV infection and genotyping of HPV. It sells FISH probes and SPR chips to large hospitals through its direct sales force; and ECLIA reagent kits to small and mid-size hospitals through distributors. The company was founded in 1999 and is based in Beijing, the People's Republic of China.

The old ticker for the company was CMED but the company has been delisted, trades on the pink-sheets and has gone completely silent. They issue no SEC filings, pay coupons on none of their debt and do not answer questions from investors or regulators. The ticker is now CMEDY.PK.

According to their last published accounts they had roughly 100 million US dollars in cash, 20 million US dollars (118 million RMB) in quarterly pre-tax profits and were under absolutely no financial stress. They did however have $396 million US dollars in convertibles outstanding. At a high stock price those converts would convert. At a low price they would pay in cash so if the stock price was low enough the company might have had to refinance. However with 20 million per quarter in profitability it was hardly going to a problem.

Well it looked like it was not going to be a problem.

Some shortsellers thought that the company was using its cash to purchase assets from undisclosed related parties. More florid allegations went around but I have verified none of them.

Still the stock went down.

It went below the conversion price for the convertible which meant the above-mentioned covert would be due in cash. And then – strangely – the company put out a press release stating they intended to restructure this debt. Here is the key release:

BEIJING, Dec. 13, 2011 /PRNewswire-Asia-FirstCall/ -- China Medical Technologies, Inc. (the "Company") (Nasdaq: CMED), a leading China-based advanced in-vitro diagnostic ("IVD") company, today announced that the Company intends to implement a debt restructuring plan to improve its balance sheet. The plan may include, without limitation, a debt-for-debt exchange with existing holders of the Company's convertible notes maturing in August 2013 and December 2016, which may potentially involve holders receiving new debts with different interest rates, maturities and principal amounts compared to the existing debts or other alternatives to be agreed. Holders of the Company's convertible notes are requested to contact the Company's Cayman legal representative, Thorp Alberga at, which will collect contact information from such holders to facilitate their communication with each other to form a noteholders' committee to liaise with the Company. 

This was truly remarkable. The company – at least on the stated balance sheet – had enough money to pay the debt (at least for a while). It certainly did not need to default on trivial coupons – but it defaulted.

Worse – it did not even tell anyone it defaulted. The bond trustee notified holders and that is all. And since then the company has been completely silent. It does not answer any questions from investors or regulators. It has just disappeared.

So what happened?

There are two hypotheses: (a) this really is a fraud or (b) this is a real company and the management are playing “silly buggers” to restructure the balance sheet to their liking (or even to steal the company).

A lot of people believe the second thesis. In this a solvent company simply stopped paying its debts and are hoping the convertibles covert (at $10 a share) and sell the stock in market (at $2 a share) to recover what money they can. And the insiders (who are talking to nobody) are buying the stock at $2 a share (perhaps with cash from the company) and in the end they will really own it.

There are other theses – including that the company is being taken private surreptitiously through a shadowy arrangement with a small American mutual fund group. This furthered the spike in the stock.

Read the Yahoo! chat board and you can have another twenty theses some implying honest management and lying short-sellers and some implying awful things about the management. There is very little way of telling them apart. Management answer no questions so all speculation is in a knowledge vacuum.

We were short but we were worried that this might be the good Chinese company thrown out by a fraud allegation - we are always wary of being wrong. And the stock was going up which is never comfortable for a short seller.

So whilst the stock hung in the air much the same way bricks don't we hired someone with genuine expertise in diagnostic tests to look at the technical specifications of the medical tests they had on their website. (Our expert can read Chinese.)

Here was their response:

They have three product lines: ECLIA, FISH, and SPR. I am a bit busy doing other stuff, so I will do this in three parts, one product line per part. Here is the first part on ECLIA: 
ECLIA instrument and assays are proprietaryECLIA Product brochures have no product specification Sensitivity of instrument is stated as 10^-19, but no units givenCan’t find any patents that belonged to the company 
ECLIA is what they call Enhanced chemiluminescence immunoassay. The company said it is a closed system, i.e. proprietary instruments and diagnostic assays. The assays cannot be used in 3rd party instruments, and the instruments cannot be used for 3rd party assays. This is very strange because cost is important in diagnostics based on chemiluminescense technology. A closed system means higher cost, smaller volume, but you hope to make up for it on price, i.e., differentiate products based on quality. Indeed, they claim that their instrument is very sensitive, 10^-19. But 10^-19 of what? They don’t specify the unit. Regardless, whether it’s molar or ng/ml, 10^-19 sounds very impressive. However, I am used to nano or pico scale, and 10^-19 is one million times more sensitive than pico scale. This seems impossible. Not only impossible technically, but also business wise –  what diagnostic applications would need this kinds of sensitivity? I can’t think of any. Also, I don’t think sensitivity matters for the type of assays they sell. 
Chemiluminescence immunoassay is the technology found in pregnancy tests sold in drug stores. This is an old and cheap technology. In general, you use this technology to get yes or no answers quickly and cheaply. The sensitivity of  chemiluminescence immunoassay is usually below 0.5ng/ml, i.e., already very sensitive. Regardless, for in vitro diagnostics, most of the technology should be in the assays, not in the instruments. And here is where I found strange - the company does not have product specification for its assays on the web. On the other hand, lots of Chinese instrumentation and diagnostic assays products sold on Alibaba show no product specification at all.  The only immunoassay technology that is known for its sensitivity is radioimmunoassay, but it is a niche product specific for detecting allergen for allergy diagnostic. If CMEDY’s technology is real, then it's ECLIA products have a very small niche and it probably has no sales - the company has only one test for allergy – total IgE.
We remain short this stock. CMEDY is a good ticker – add an 0 (which is where I think the stock will wind up) and you get COMEDY. That is good for a laugh.



Jon S said...

It seems in these situations there is a positive feedback going on, with two drivers, (1) more short investment through re-balancing or just more people shorting, and (2) more shares available as the risk-averse dump their shares.

I would expect effect (2) to peter out with a nonzero fraction of the float still unavailable. And if (1) continues for too long as the short capital and the market cap move closer together, it becomes a squeeze target (short interest balloons).

What's your rule of thumb for when to cap/reduce/cover?

Anonymous said...

When will the other 2 parts be analyzed?

Anonymous said...

New thoughts here? AER and Deutsches continue to buy stock aggressively and squeeze down the float. Bidding stock up to get converts to play ball? Bizarre situation indeed and another example of Chinese way of doing business.

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