Benzinga Q&A: Matt Wiechert of Glaucus Research
Benzinga Q&A: Matt Wiechert of Glaucus Research
By now, investors are familiar with the controversies swirling around the Chinese small and mid cap universe. In the last 18 months, a significant number publicly-listed Chinese companies have found themselves the subject of scrutiny by investors, auditors, plaintiffs' attorneys and regulators for everything from questionable accounting practices to suspicious related party transactions. Often, short-biased research firms have been instrumental in exposing fraudulent behavior on the part of unscrupulous management teams.
Muddy Waters has to date been the market leader in exposing fraudulent companies. But recently, some analysts have questioned whether Muddy Waters is losing its touch.
Fortunately, there's another sheriff in town. Glaucus Research (www.glaucusresearch.com), a California-based short-selling firm, has presented detailed short reports on Universal Travel Group (NYSE: UTA), Gulf Resources (Nasdaq: GURE), L&L Energy (Nasdaq: LLEN) and China Medical Technologies (PK: CMEDY).
On Thursday, April 12, 2012, Glaucus plans to release its latest report on an undisclosed Hong Kong-listed company in which the firm and its principal have a short position. Glaucus says that its latest report will focus on a multi-billion dollar company with an average daily trading volume north of $10 million, which is followed by a pack of mostly bullish analysts.
As executives of publicly-traded Hong Kong companies nervously watch the newswires, Glaucus' founder and principle Matt Wiechert sat down with Benzinga for a question-and-answer session. Wiechert, who makes no bones about being a short seller, used to work for Roth Capital, a California-based boutique investment bank known primarily for its roster of small-cap clients.
Benzinga: Small cap Chinese companies have certainly grabbed their share of negative press over past 12-18 months. Is this is an epidemic?
Wiechert: “No, it's a pandemic. And it's not limited to small and mid cap Chinese companies. Many investors believe that dodgy accounting practices and corporate malfeasance is limited to Chinese companies that went public via reverse merger, but that is not the case. For example, we recently reported on China Medical Technologies, which went public via a more traditional IPO.:
Benzinga: What's your process for unearthing companies with questionable financials and establishing short positions in those stocks?
Wiechert: "We have a very detailed screening process. First, we run a large universe of companies through a set of criteria designed to narrow the list to a few likely candidates. Then, we start making detailed list of any red flags that we notice in such candidate's public filings. It sounds a bit obvious, but if a company is committing fraud, someone is benefiting. That is why we follow the cash. A management team can lie, but the numbers often do not. That is why a company's balance sheet, cash flow statement and income statement are instrumental in telling us what is really going on at a suspicious looking business."
Benzinga: Can you tell us any specific criteria that you use in finding frauds?
Wiechert: “I cannot give you the keys to the kingdom, but the red flags are almost always in the financial statements. We often look to margins that are suspiciously high, especially if a company operates in an intensely competitive industry. We also scrutinize related party relationships, auditor or senior management turnover, and serial capital raises."
Benzinga: Are there particular sectors where financial fraud is more rampant than in other industry groups?
Wiechert: "There is no question that certain industries attract fraudulent management companies. We find that commodity businesses, such as mining, are rife with fraud because their assets are hard to value, making it harder for auditors, regulators and investors to verify a company's claims."
Benzinga: Is your research limited to China?
Wiechert: "No. Fraudulent companies can flourish anywhere in the world. Take the wave of accounting scandals in the United States: companies such as Enron and Worldcom lost their respective investors billions. So we do not limit our research to China.
"Instead, we look for companies operating in a legal system that incentivizes fraud. The problem is that management teams can do the math: if they lie and exaggerate their performance, they could potentially make hundreds of millions of dollars. If they live in a jurisdiction where regulators and shareholders have no recourse against them, like China, even if they are caught there are no ramifications. How can shareholders navigate an arbitrary judicial system like the one in China to recover value from a fraudulent company? When the rewards for committing fraud are so massive, and the punishment so remote or even non-existent, is it any wonder so many management teams cooked their books?"
Benzinga: Surely you will run out of ideas soon? There cannot be many more frauds left after the short-community has worked so hard to expose corporate malfeasance over the last 18 months.
Wiechert: "As long as there's greed on Wall Street, there are going to be fraudulent companies. Investors are easily seduced by great growth stories, cheap valuations and the potential for enormous returns. Often they are left with nothing.
"We feel like we're doing investors and the markets a service by blowing the whistle on companies that should not be public and that are stealing money from innocent shareholders. Our hope is that such companies are unable to raise more capital, because at the end of the day, that's money investors will not see again."
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