Larry Isen’s “Greatest Short Squeeze of All Time”

By Travis Johnson, Stock Gumshoe, March 9, 2011

To be honest with you, I had never heard of Larry Isen before — apparently, he edits a newsletter called Emerging China Stocks, and he has been focused on small cap names in China for at least a year or two, based on his claims of past performance.

The reason he came to my attention today, though, was that a bunch of my readers wrote in asking me who the heck Larry Isen is talking about when he teases the “Greatest Short Squeeze of All Time” and tells us that the Chinese stocks he’s singling out are unfair targets of smear campaigns, with the expectation that they will be the beneficiaries of dramatic “short squeezes” in the weeks ahead.

If you don’t know what a short squeeze is, that’s basically when a large portion of a company’s shares are “sold short” by investors, and the share price then goes up quickly enough that these short sellers are forced (either by brokers or by their own portfolio rules) to cover those short positions and cut their losses.

(More detail: If you don’t know what short selling is, it’s a bet that a company’s shares will go down — you borrow the stock from someone else and sell the shares at the market price today, in hopes that you can “cover” your short by buying them back at a lower price in the future, repaying the loan with those cheaper shares. Holding a short position carries obligations, including the fact that you have to pay any dividends due on those shares, and whatever fees or margin payments are required to hold your short position — and if your broker sees the value of your short position falling, meaning that the stock is going up, there can effectively be a margin call that forces you to buy back the stock).

Short squeezes are real, and there are a fair number of investors who focus on trying to find them — and it is, of course, a fairly risky proposition. If you’re specifically speculating on a short squeeze, that means you’re buying a stock that a large number of investors are convinced is going to collapse. Isen seems to be indicating that the stocks he’s picking are not the targets of the big and institutional short sellers like David Einhorn or Jim Chanos, instead he indicates that they’re the target of small-time amateur shorts who are running internet smear campaigns and trying to drive the shares down.

And though I’d never heard of Isen, he has certainly seen the dramatically improved performance that newsletter teaser-meisters have gotten from using video “presentations” instead of plain ol’ sales letters, so yes, your intrepid Gumshoe has been forced to sit through yet another audiocast for you. Woe, oh woe is me — never doubt, dear readers, that I love you.

So what follows are the notes that I took when listening to his video ad — the quotes might not be exact, but I tried to capture the point of his talk and the specific clues he threw out to entice us about his favorite pick:

Isen tells us that since late last year there’s been a dark cloud of a “cyber smear” campaign about accounting problems and fraud at small Chinese companies, even though, he says, most of those allegations have been proven false. These are campaigns by unsophisticated short sellers, he says — the great short sellers don’t need to manipulate investors to drive the price down, they actually hope to get the price higher so they can sell more shares short.

And when he gets into the clues about his specific pick, he tells us that there is …

“One stock that can break the back of the short sellers sometime between the middle and end of March.”

The other clues? This stock has an earnings release due out in March, and they use Deloitte Touche as their accountant.

And Insiders have been buying — he specifically notes a $1.5 million buy by the CFO at prices that were 10% higher than today’s price, late last year.

Remember how I noted yesterday that Forbes seems to have so many “best” list for companies that it can seem difficult to find a company who’s not in the “best” rankings for something? Well, this stock is apparently atop one of those Forbes lists of best small and medium size companies in China.

The company apparently has a $40 million investment from one well known investor, he doesn’t elaborate on that much.

He tells us that “professionally trained analysts” have refuted the claims of the short sellers.

And that, as of February 15, nearly 50% of the float was sold short.

So … who is Isen telling us will be the “greatest short squeeze of all time?” Toss that into the mighty, mighty Thinkolator and we get our answer:

This mus be China MediaExpress Holdings (CCME)

I don’t think I’ve ever written about this one before, but it’s one of the Chinese advertising companies that focuses on owning networks of TVs in outdoor, public and transportation space and selling ad space on those networks — you may have heard of the giant in this business, Focus Media (FMCN) or of others like Vision China (VISN) or AirMedia (AMCN), each of which claims a different niche. CCME’s niche is running TV ads in inter-city buses, the Chinese equivalent of Peter Pan or Greyhound lines, and they have indeed been the subject of many claims of fraud by investors, and of many negative reports from short-focused analysts.

And yes, they are a match for the clues — the CFO, Jacky Wai Kei Lam, bought 100,000 shares on December 9 at $15, so that adds up to $1.5 million … and the price is roughly 10% below $15 now at just over $13. Insiders control a huge portion of the stock, something like 80%, mostly in the hands of Chairman and CEO Cheng Zheng.

And they have announced that they will be paying a dividend going forward — though I don’t think they’ve announced the amount or have paid one yet (reports I’ve seen are that the dividend will be 5-10% of income). In this case, you’d have to imagine that the dividend is either intended to get the insiders some cash, which is not uncommon for tightly controlled companies where the founder doesn’t want to give up control but does want to pull out some money, or to pressure the short sellers who would have to cover any dividend.

And yes, if the shares do go up considerably one would expect a substantial “short squeeze” — the shares sold short are now more than 50% of the “float” (the roughly 20% of the shares that are not held by insiders), according to Yahoo Finance and about 7.5 million shares are sold short, which Yahoo Finance reports as 56% of the float (though if insiders hold 80% of the 35 million shares outstanding, then 7.5 million shares is more than the float — this is a very fluid situation so I wouldn’t count on any of those numbers, which are from different time periods being precise). Given that, it’s no surprise that CCME is also on the “fail to deliver” list of naked shorted stocks (stocks that were sold short, but for which the investor wasn’t yet able to borrow the stock to sell it yet). Trading is very heavy in CCME as the allegations and reports go back and forth, so it’s also worth noting that the actual short ratio is quite low — there have been many days when the entire float changed hands, so at the recent trading volume it would theoretically only take a day or two for shorts to cover their positions. Note that it probably wouldn’t be as easy as that implies, though, because the short position is so huge and the trading volume lately is probably artificially increased by speculators following the news … if there is some sort of denouement for these shares when things get publicly resolved in a short period of time we shouldn’t assume that there will be “normal” trading for shorts to cover or for longs to sell.

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They are audited by the Chinese affiliate or division of Deloitte and Touche, though what that means in regards to an auditor’s ability to sniff out the kind of fraud that’s being alleged (revenue booked for sales that were never made and bus contracts that don’t exist, things like that) is apparently up for some debate. One would assume that given the scrutiny this stock has gotten from small short-focused research shops, the auditors will be looking extra closely at the numbers, but you know what they say about “assume.” Deloitte is certainly a brand name with a strong reputation, but there have been plenty of brand name accounting firms that have missed scandals before.

And they are on one of those Forbes lists — a China-licensed version of Forbes at least, which put them at the top of an “up and comers” list of small companies. I imagine the person who compiled that list did far less research on the companies than the bulls or bears who are actually buying or shorting the stock, but they are on a list.

Are the short sellers right? I have absolutely no idea. You can read the reports of some of the more prominent short researchers yourself and see how you feel about the stock — the two that I see crop up most often are Muddy Waters Research, whose principal was interviewed by Barron’s over the weekend and which has alleged a bunch of fraudulent or suspicious things about CCME and pegged their fair value at $3.54 (that’s substantially less than the almost $5 cash per share that CCME reports); and Citron Research, which issued a negative report about CCME back in January claiming that the company can’t exist on the scale that they claim and that there are numerous signs of fraud.

The company responded to those two fairly widely-disseminated negative reports with a letter from the CEO that answered those and similar allegations about a month ago, and Herb Greenberg at CNBC speculated about whether Muddy Waters might have been “hoodwinked” (though Greenberg has also been critical of many Chinese reverse-merger companies and said Muddy Waters might still be right).

And some other investors disagree, of course. I don’t know what Larry Isen means by the big well-known investor who has invested more than $40 million in the stock, but the only real substantial institutional investor fits that bill, C. V. Starr, the insurance company, owns roughly that much of the shares. C. V. Starr is run by Hank Greenberg, who built AIG and is certainly famous, though I don’t have any idea whether he plays a role in their investments — or, indeed, whether they still hold the shares (that holding is as of the December 31 report). If you’d like to check out the many folks on SeekingAlpha who are also trying to refute the short sellers, there are a couple reports here and here from just this week, both seem to put a lot of stock in the Deloitte imprimatur. There was also a very bullish report from Global Hunter Securities last month that moved the stock up based on their “boots on the ground” checks, though the report itself was removed from SeekingAlpha (you can see excerpts and comments here, or the report itself is on scribd here).

As for whether “professionally trained analysts” have approved the numbers … well, I don’t know what that means — there are two analysts that I’m aware of following the stock, from Global Hunter and Northland Securities, both tiny, and they think CCME will earn something like $3 a share this year. And I’m sure lots of the folks writing at SeekingAlpha are professionally trained analysts, too, since that term doesn’t really mean anything as far as I know — heck, I’m professionally trained myself, as is pretty much everyone who’s not living in mom and dad’s basement.

The odds seem good, though, that CCME’s stock will probably move a lot when we receive some kind of closure about whether or not there’s really any fraud going on, as the short sellers claim — if the numbers are real, the stock is obviously dirt cheap at 4 or 5X earnings and with ridiculous growth, but if the numbers are made up or their revenue isn’t really there I don’t see how you can come up with any reasonable valuation. And though it’s tempting to put a lot of weight in whether an accountant signs off on a quarterly earnings release, or whatever other company news comes out, it’s certainly possible that this debate between shorts and longs could drag on for quite a while — or that, if there is something big going on, the stock could get a trading halt if the exchange is unhappy with their reporting (meaning, you wouldn’t be able to sell, or buy to cover a short in the stock — this has happened to me before with China Northeast Petroleum, and it’s a pain in the neck, particularly if it goes on for an extended period).

Whether or not you want to get involved with CCME on either the long or short side (though it may be tough to find a borrow to short the stock now) is obviously up to you — it’s your money, of course. I don’t have any interest in CCME in either direction and certainly won’t be trading the stock anytime soon, all I can tell you is that Larry Isen apparently thinks this will be the “greatest short squeeze of all time.”

There’s debate about CCME all over the internet, so you’re welcome to add to it here if you like — if you’ve a position on CCME and the worthiness of their stock, feel free to shout it out with a comment below.

Likewise, if you have any experience subscribing to Larry Isen’s newsletter, please click here to review Isen’s Emerging China Stocks for your fellow investors. Thanks!