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China Stock Battles Destroy Value

NEW YORK ( TheStreet) -- A fierce public debate over the legitimacy of China-based small cap companies is wreaking havoc on share prices and costing unaware investors billions of dollars.

On one side are professional investors who take short positions in stocks. They make money if share prices go down, so, of course, their analysis is almost purely negative, striving to point out what's amiss at the companies they've shorted. On the other side are pros with long positions, who often overflow with optimism in defense of their investments. Frequently there is no neutral arbiter, no balanced and objective view.

Orient Paper (ONP - Get Report) is a good example. Either the company is a fraud, working with obsolete equipment, or it's a nascent industrial giant, destined to grow rapidly as the Chinese economy develops an appetite for paper products; the answer depends on whom you believe, longs or shorts. There are no known regulatory problems or formal charges of fraud against the company; the argument is all opinion on the Internet. The company has roundly rejected the charges of the shorts, and has mounted an energetic defense. Still, controversy has triggered some huge moves in the stock.

In June, before the shorts attacked, Orient Paper stock traded as high as $9.12. In the weeks that followed the first attack, the stock slid steadily, finally bottoming at $4.08 on August 31. As the company's defense has taken hold, the stock has recovered to a degree, holding above $6.00 in recent weeks.

A good many other Chinese reverse-merger companies have been whipsawed by the back-and-forth claims and counterclaims of the shorts and longs in much the same way.

Take China Sky One Medical (CSKI). When it became the subject of controversy in the spring of 2009, shares of this maker of traditional Chinese medicines fell 35%, to less than $11. The stock rocketed up at at the end of last year, to more than $25, but has been in steady decline ever since. It trades today at about $7.

Universal Travel (UTA), an online travel agency, was attacked by the Australian fund manager John Hempton in September. The company called the charges "unfounded." Its stock lost more 40% of its value between August and October, before recovering later in the fall. It now trades about at $6.50, a long way from its all-time high near $17, touched in August 2009.

China Marine Food (CMFO), a seafood processor, was publicly criticized by short-side bloggers this past summer. Its shares slid by more than 40% to a low of $3.07 before rallying a bit this fall. Trading recently just above $5, the stock remains well below its all-time peak of $8.44 in January 2010.

The Shanghai Numbers

"Most people who own these stocks don't go to China, they don't know these companies, they don't speak the language. And so they can be suckered in both long and short," says Peter Siris, a principal at Guerilla Capital, which has invested early in many Chinese companies. Siris has often written bullishly about his holdings in a column in the New York Daily News.

Where opposing camps of investment pros are issuing reports on a stock that are totally inconsistent -- and both sides have positions in the stock -- investors are apt to wonder whether one side or the other might be trying to manipulate the stock. Until now, individual investors have gotten little help from regulators. Language barriers, legal barriers in China, and the sheer volume of small cap deals have impeded effective regulation.

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