Chinese Companies: No Longer Darlings
August 10, 2011 | Business, Entrepreneurship, Government
The following is an interesting article from The Wall Street Journal I would like to share with my readers.
Chinese Companies: No Longer Darlings
10/06/2011 00:18 | NASDAQ OMX Group, Inc.
By Dinny McMahon
BEIJING — China MediaExpress Holdings Inc. once seemed like a small gem among a heap of Chinese companies listing shares in the U.S.
Boasting rapid growth and big profits from selling advertising on video screens in Chinese intercity buses, it drew tens of millions of dollars from marquee investors. It listed its shares on the Nasdaq Stock Market, where its chief executive rang the opening bell last June.
Today, MediaExpress is in chaos, its shares no longer traded on Nasdaq after a turbulent few months marked by investors’ concerns over the size of its business and questions over its accounting.
It is one of dozens of companies from China that have come under fire by investors and regulators for allegedly misleading investors, exposing a loophole that has U.S. regulators concerned.
The company’s auditor, Deloitte Touche Tohmatsu, resigned in March, saying that it had raised concerns over “possible undisclosed bank accounts and bank loans,” and “issues concerning the validity of certain advertising agents/customers and bus operators,” among other issues, according to a MediaExpress regulatory filing verified by Deloitte.
The accounting firm also said it felt it could “no longer . . . rely on the representations of management” and had “lost confidence” in the MediaExpress board’s commitment to “reliable financial reporting.”
MediaExpress said in the filing with the Securities and Exchange Commission that it “believes that it was working to address” the items Deloitte raised.
The same month, Starr International Co., an insurance and investment vehicle run by former American International Group Inc. chief Maurice “Hank” Greenberg, sued MediaExpress in federal court in Delaware. In its suit, Starr claims that it bought $13.5 million of the company’s stock in October on the basis of MediaExpress news releases and SEC filings that Starr alleges repeatedly overstated MediaExpress’s income and the size of its operations. Starr bases its claims largely on analyst reports and the earlier Deloitte statements alleging that MediaExpress had made fraudulent statements throughout 2010.
Starr also said it separately had initiated arbitration in Hong Kong over MediaExpress’s agreements in a separate $30 million Starr investment made in January 2010.
In May, Starr also sued MediaExpress in Delaware state court, alleging that the company failed to turn over certain books and records when Starr asked for them, in violation of Delaware law.
MediaExpress hasn’t filed an answer to the federal lawsuit. But in a response to the Delaware suit, it denied it had an obligation to turn over the books and records, and said Starr’s allegations in the federal suit were based largely “on the claims of anonymous bloggers or short sellers.”
Trading in MediaExpress’s shares was suspended in March after a 50% drop erased almost $400 million in market value. On May 19, MediaExpress said Nasdaq had decided to delist its shares.
The shares now trade over the counter at $1.80, compared with nearly $23 on Jan. 27, valuing Starr’s stake at about $11 million, assuming the conversion of all warrants and preferred stock. MediaExpress has denied its critics’ assertions, blaming short sellers, investors who make money when a stock price declines. It said in May that it had commissioned international law firm DLA Piper to investigate the allegations against it. A spokeswoman for DLA Piper declined to comment.
Underscoring the SEC’s broader concerns, the regulator is examining accounting and disclosure issues regarding Chinese companies that listed in the U.S. through a backdoor process known as a “reverse merger” or “reverse takeover” that requires them to disclose a lot less information to investors than a traditional initial public offering.
“Given the potential risks, investors should be especially careful when considering investing in the stock of reverse-merger companies,” Lori Schock, the SEC’s director of investor education and advocacy, said in a warning on Thursday.
The Wall Street Journal reported last week that the SEC also is investigating some of the Chinese companies’ U.S. auditors, and the inquiry is expected to lead to enforcement cases.
A MediaExpress spokesman said the SEC had contacted its audit committee and lawyers. He wouldn’t say when. He said the company plans to report the results of its internal investigation to the agency. The SEC declined to comment.
A survey by the Public Company Accounting Oversight Board, which monitors auditors, identified 159 Chinese companies from the start of 2007 through March 2010 that listed in the U.S. through reverse takeovers. That is almost three times the number of Chinese companies that launched traditional IPOs in the U.S. over the same period. While most reverse-takeover companies are small, as a group they pack weight: Those covered by the survey had a total market capitalization of $12.8 billion in March 2010.
“While the vast majority of these Chinese companies may be legitimate businesses, a growing number of them are proving to have significant accounting deficiencies or being vessels of outright fraud,” said Luis Aguilar, an SEC commissioner, in April.
Several other Chinese reverse-takeover companies also have been suspended or delisted.
In all, billions of dollars in market value have vaporized in reverse-takeover companies that have come under criticism from investors, auditors and short sellers.
The SEC’s ability to discipline these companies is limited. Reverse takeovers are legal, and the agency’s jurisdiction doesn’t extend into China. With company assets and most senior executives in China, the U.S. has limited scope to enforce any decisions against them.
MediaExpress programs entertainment and sells ad space on video screens installed in buses. The business originally was limited to intercity buses. Its expansion into airport express buses drove it to look into raising capital in the U.S, but the financial crisis scuttled plans to list via an IPO, according to a spokesman for the CEO.
The company listed its shares through a reverse takeover on NYSE Euronext’s American Stock Exchange in October 2009 and raised $46 million.
But short sellers were becoming suspicious because of its stellar results. In its third-quarter results, released in November, MediaExpress’s return on assets far outstripped those of the three major Chinese “out-of-home” advertising companies listed in the U.S.; it was three times higher than the next best performer. And whereas the other firms target a white-collar audience, the long-distance buses in which MediaExpress installs its screens are mainly used by less-affluent students and migrant workers.
In early February, three investors who had shorted the stock, issued negative reports on the company. All three short sellers said they acted independently. A report by one of them, Muddy Waters Research, gained particular attention. It alleged MediaExpress had fewer than half the 27,200 buses than it tells investors are in its network. MediaExpress denied the assertion.
The competing claims by Muddy Waters and MediaExpress are hard to verify, in part because no official information on bus registrations is publicly available.
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Yoli Zhang in Beijing, Ashby Jones and Shira Ovide in New York contributed to this article.
