June 6, 2011 / 9:24 PM / 8 years ago

Analysis: Muddy Waters is 5-for-5 on China short calls

NEW YORK (Reuters) - Perfect records are hard to come by, especially among stock pickers, but so far it looks like one team has been able to pull it off.

Muddy Waters Research, a firm specializing in finding Chinese companies it believes are frauds, shorts the firms’ shares and publicizes the charges on its website.

So far it has made money on its first five bets.

Many would envy the firm’s record as even the most experienced short sellers have a number of misses before they hit the jackpot. And even when stock watchers are correct about a company being overvalued, it can sometimes take the market several years to catch up to the prediction.

Muddy Waters’ track record is based on a Reuters analysis of the published research that is available on the firm’s website. It is not clear whether Muddy Waters or its director of research Carson Block have made other research calls or taken other positions.

The latest target for Muddy Waters is Sino-Forest Corp TRE.TO, a forestry plantation company whose shares fell 65 percent after the firm, led by Block, accused the company of theft and fraud.

Sino-Forest fought back on Monday, accusing Muddy Waters of defamation and saying it was mulling its legal options. The response helped shares rise more than 50 percent to C$8.01, though they remains well below its last close before the report at C$18.21.

Of the five companies Muddy Waters is known to have advised investors to sell, with all asserting some level of accounting irregularities, two have been delisted from the Nasdaq and one has not traded since April.

Of the two that continue to trade, neither has come anywhere close to approaching the levels they changed hands at before the reports.

But a portfolio comprised of these five companies would be up an estimated 66.9 percent if the investor had shorted the shares and bought in the day before each report was issued. If the trader had leveraged their bets using options, the returns could be even larger.

“If you’re going to make accusations of fraud the way Muddy Waters does, you’re going to have to be correct” to be effective, said Michael Shaoul, chairman of Marketfield Asset Management in New York. “You need a greater standard of care.”

Block agrees, saying short-sellers have to be accurate in their reports because false claims would diminish their credibility and limit their influence on shares, a major revenue source. The firm discloses that it shorts the stocks it covers but does not disclose the amount it has in assets under management.


Muddy Waters first gained prominence last June with a scathing report against Orient Paper Inc ONP.A, which it called a “fraud” that had overstated its 2009 revenue by about 40 times. The company disputed the allegations, but the stock, which closed at $8.41 the day before the report, now trades at $3.71, down 56.5 percent.

All of the relatively small firm’s subsequent reports had similarly outsized impacts — a source of controversy to critics.

The Muddy Waters reports “were brilliantly reported and laid out, but you can never get past the fact that they’re doing this for money,” Roddy Boyd, the editor of thefinancialinvestigator.com in Wilmington, North Carolina told Reuters last month.

“If something doesn’t work out ... these guys could have a situation where they went after a company and made money but couldn’t substantiate their claims,” said Boyd, who has also written critical reports, but does not hold positions in the companies he writes about.

Others are not as glowing.

Drew Bernstein, the chairman of Orient Paper’s audit committee and co-managing partner of Marcum Bernstein & Pinchuk in New York, last month said the Muddy Waters report was full of “enormous allegations” that were untrue and that a lawsuit against the firm was probably justified.

But so far Muddy Waters’ influence has only grown with each subsequent report. Duoyuan Global Water Inc DGW.N slumped 29.3 percent from its close before the April 4 report until April 19, when its shares were halted. They have not traded since.

RINO International (RINO.PK) plummeted 96.5 percent, from $15.52 before the report to 55 cents currently, while China MediaExpress Holdings CCME.PK is down 91.8 percent to $1.28. Both stocks were delisted by the Nasdaq following the charges and currently trade on the pink sheets.

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