Short-Seller Targets China Stocks 'Where There Is Nothing Worth Saving'

(Bloomberg) -- Even by the standards of the vocal short sellers who have gone after Chinese companies over the past few years, Matthew Wiechert sets high targets -- or low, depending on how you look at it.

“When it comes down to the nitty gritty, I don’t care about 50 percent downsides,” Wiechert said in an interview one week before launching an attack on Chinese manufacturer Hengan International Group Co. “I care about 100 percent downsides.”

With Hengan, Wiechert has had to settle for a more modest reaction, at least so far. The stock has lost about 8 percent since the morning of Dec. 12, when Wiechert’s Bonitas Research LLC accused the personal hygiene products maker of inflating profits. At least 11 analysts reiterated “buy” ratings for Hengan after the Bonitas report, and one even raised her recommendation. The company has denied the allegations and threatened legal action.

Wiechert, who recently hired five staff for his fledgling firm and aims to publish at least one bearish report a month, is pushing his ambitions at a time when Hong Kong’s market seems to have turned against short sellers.

Research by the Securities and Futures Commission shows that the immediate payoffs for shorts, as calculated by first-week returns after bearish reports, have dwindled since 2013. The number of negative reports issued dropped this year through October after advancing for four straight years, the SFC data show.

Short-Seller Targets China Stocks 'Where There Is Nothing Worth Saving'

Wiechert, who operates from Austin, Texas, attributes short sellers’ recent difficulties to Chinese companies getting better at defending themselves. Some are turning to Chinese state banks or local governments for help, getting cheap funding and buying back stock to squeeze out the shorts, said Wiechert -- repeating a common gripe among his peers.

Fullshare Holdings Ltd., a Chinese developer that Wiechert targeted in April 2017 when he was at Glaucus Research, secured a two-year credit line from China Citic Bank Corp. the following month, which helped drive a recovery in the shares. The stock subsequently fell and is down 38 percent since the report was published, compared to a 5.6 percent gain in the Hang Seng Index.

One way Wiechert tries to get around that issue is by going after companies “where there is nothing worth saving,” he said. Highly indebted firms where assets have been siphoned off make for appealing targets because their managers tend to put up less of a fight, he said.

Wiechert’s Guide to Finding Short Targets

Screen for metrics such as huge debt-to-cash ratios and big growth in receivables versus revenue
Look for suspicious trading patterns. Wiechert says he’s found around 40 Hong Kong-traded firms where a six-month strategy of buying an hour before trading ends and then selling at the close noticeably outperformed a buy-and-hold approach. He declined to name them. 
Look for red flags such as excessive reliance on a single supplier or asset disposals to connected parties at very low prices

Hengan’s shares plunged after Wiechert’s report, which accused the company, among other things, of overstating margins and inflating revenues. The next day, the firm fired back with a point-by point rebuttal. One of its key arguments was that its dominant market share in sanitary napkins in China gave it bargaining power against suppliers, helping to sustain industry-beating margins.

Hengan’s chairman and deputy chairman bought a total of almost eight million shares in the company, worth roughly $55 million, in the days after the Bonitas report’s publication.

Short-Seller Targets China Stocks 'Where There Is Nothing Worth Saving'

Wiechert is undaunted. His planned schedule of at least one report a month would make him far more prolific than fellow China-focused activist shorts such as Soren Aandahl (his former colleague at Glaucus Research) and Carson Block of Muddy Waters Capital LLC.

Bonitas will launch public attacks on two more Chinese companies in January, Wiechert said. He declined to name them, though he said one business is listed in Hong Kong. While he has plans to move beyond China, he’s been hiring Mandarin speakers and said he has enough potential targets to stay busy for a long time.

©2018 Bloomberg L.P.