Overseas China Stocks on Hold, Waiting for Catalyst

By newsdoug on April 10, 2012

Overseas listed Chinese stocks have entered a sort of holding pattern these last few weeks, with investors neither embracing nor dumping them as the market waits for a catalyst to give some direction. A recent scathing Forbes report on security software maker Qihoo 360 (NYSE: QIHU) has done little to dent that company’s stock, reflecting an ebb in investor skepticism that battered such shares last year. (previous post) But the flop of the first IPO this year by a Chinese firm in the US, Vipshop (NYSE: VIPS), also shows investors are far from willing the embrace these stocks again. The needed new catalyst could lead the market either way, depending on what it is. Famous short seller Muddy Waters is hoping to provide that catalyst to lead the group lower, saying it will issue a new report in the next few weeks on several Hong Kong-listed China stocks. (Chinese article) But a blockbuster IPO in either Hong Kong or the US could lead the market higher if the right company emerges to rekindle investor interest in the China growth story. These last few weeks have been full of mixed signals, both on the plus and minus side for this group of entrepreneurial firms whose shares were hammered last year by a series of accounting scandals that undermined the entire sector’s credibility. Negative sentiment led to a halt in new overseas listings dating back to last summer, when a disastrous IPO for online video sharing site Tudou (Nasdaq: TUDO) sent the market into hibernation. Vipshop, a money-losing online discount retailer, tested the waters to see if sentiment had improved last month by making the first IPO by a Chinese company in the US for more than half a year. Unfortunately, it discovered investors were still highly skeptical, as its shares priced below their previously indicated range and then fell another 15 percent on their trading debut. (previous post) Its shares continued to fall after that, and now trade at about two-thirds of their IPO price. But then weeks later, Forbes issued a scathing report on Qihoo 360 questioning a number of its accounting practices and implying that its auditor, Deloitte, might resign the account later this year. That report followed a similar one late last year by a small research house named Citron, whose motives were more obvious due to its status as a short seller. Despite both reports, however, Qihoo shares have remained remarkably stable in their current range, indicating investors aren’t as willing to believe negative news as they were last year, when new short selling reports were coming out almost weekly. So, what exactly is the market waiting for? In my view, it wants a clear signal one way or the other on the China market’s growth potential and the accounting issue. Muddy Waters founder Carson Block clearly wants his firm to be a catalyst in the negative direction by saying he will soon issue a report on Hong Kong-listed Chinese firms that will presumably show more problems. At the same time, a solid IPO by a good Chinese firm could easily attract investors back to the space if a good candidate comes along. That would mean China would have to find a company that is posting both strong double-digit revenue growth and is also profitable, with the profits being especially important for investors wary of buying into money-losing companies. Such companies do exist, with e-commerce leader Alibaba being the most notable example. Unfortunately, Alibaba has shown no signs of making an IPO anytime soon, and other companies with a similar profile are far from plentiful. The handful of other companies that have filed for US IPOs so far this year, including car rental firm China Auto and online literature firm Shanda Cloudary, are both losing money despite their strong growth potential, meaning neither is likely to provide the right tonic the market needs to rekindle positive sentiment. I would bet the Muddy Waters’ report will do little to further undermine investor confidence, though a resignation by Deloitte or another major auditor from a big Chinese company could send the market back into a tailspin. In the meantime, investors will be waiting for the arrival off a white knight like Alibaba to make an IPO and breathe new excitement into the market — something also unlikely to happen until the second half of the year at earliest.

Bottom line: Shares of overseas listed Chinese stocks are likely to remain in a state of limbo until a major catalyst comes, either in the form of a new accounting scandal or a blockbuster IPO.

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