Is China Media Express A Fraud? (CCME)

Backstory

Any fundamental analyst who takes a look at the operating metrics and balance sheet of China MediaExpress Holdings (NASDAQ: CCME) would find what appears to be a gem of a company. CCME reported net profit margins for Q3 of 2010 of 54.66% versus 43.48% in the year ago period. Operating margin went from 59.04% in Q3 2009 to 72.42% in Q3 2010. Astounding! But it gets better.

For Q3 2010, CCME reported a return on average assets of 60.97%. Remarkably, this metric (while unbelievably impressive) fell from the 63.15% the company reported in the year ago period. Return on average equity also fell, although it remains unbelievably impressive. In Q3 2009, return on equity was 86.09% versus a staggering 100.84% in the comparable year ago quarter.

Now combine these truly unbelievable operating metrics with a YoY reported revenue growth rate of 118% and you get YoY quarterly earnings growth of 166.90%. What a company! Any rational person would assume that China MediaExpress had found the cure for cancer. What do they actually do? Well, they are engaged in the media business. Kind of hard to believe, no?

But if we are to believe the reported financials of this company, and why shouldn't we, then investors should be throwing money at them, right? This should be one of the highest P/E stocks on the NASDAQ. Margins are unreal, top-line growth and EPS are doubling on an annual basis, and the company operates in an economy that is growing GDP at a rate of about 10% per annum.

The reality, however, is that savvy investors have been betting against this company in droves. The short interest in this name is mind-boggling. This week, when negative reports from Citron Research and Muddy Waters were released, around 6.44 million CCME shares were sold short versus a float of around 10 million shares.

Why? That just does not make sense. These are hedge funds and sophisticated investors. Why would they not buy the shares of what appears to be one of the most successful businesses in human history as oppose to bet against them? After backing out the $170 million in cash that the company claims to have on its balance sheet, CCME's operating business is trading at around 3-4 times earnings estimates for next year. Why?

The reason is because a crime has been committed. Plain and simple. Either Citron Research, Muddy Waters and a cabal of nefarious short-sellers brought this stock down in a coordinated effort (reaping large profits, no doubt) or CCME's management is engaged in fraud. We will be finding out shortly which one of these scenarios is the truth. But, ask yourself, why would a network of sophisticated investors use such a blatant scheme to attempt to destroy this company when they could have just bought the stock?

Why risk it? Have you seen the headlines recently? Sure looks like the SEC and Justice Department may be getting serious about insider trading on Wall Street, doesn't it? Why would you risk the wrath of the regulators to take down a company that, if the financial statements are to be believed, looks like a great long-term bet?

Below is the official description of CCME's business. Please take note of the ownership structure. This is a Chinese reverse merger company that I believe was likely created with the intention of bilking American investors (but I do not know if that is true).

China MediaExpress Holdings, Inc. (CME), through contractual arrangements with Fujian Fenzhong Media Co., Ltd. (Fujian Fenzhong), operates the television advertising network on inter-city express buses in China. The Company and its subsidiaries and a variable interest entity (VIE) are engaged in the operation of mobile television advertising networks on passenger buses travelling on highways in the People's Republic of China. The Company does not conduct any substantive operations of its own, but conducts it primary business operations through Fujian Fenzhong, a VIE of a wholly owned subsidiary, Fujian Across Express Information Technology Co, Ltd. (Across Express). On October 15, 2009, CME acquired all of the issued and outstanding capital stock of Hong Kong Mandefu Holding Limited (the HKMDF), its subsidiary and VIE, and as a result, HKMDF became its direct wholly owned subsidiary.

Citron Research

On January 30th, 2011 Citron Research released a report on CCME titled "The Chinese Reverse Merger stock that is "Too Good to be True." I am not advocating that you take Citron's research at face value. They had a short position in the shares and may be part of a conspiracy by shorts to drive the price down - but I will repeat some of the allegations.

“If it sounds too good to be true, it is…”

"In spite of having spent a mere fraction of what competitors have on infrastructure, CCME has purportedly grown profits from $2M to its recently raised guidance of $85M expected this year, on revenues of $200 million."

"There is only one problem: No One in China Has Ever Heard of Them. It is Citron's opinion that if this company were operating in the United States, the stock would have buckled long-ago over the lack of transparency in its story."

"If you Google or Baidu 中国高速频道 for CCME or 福建分众传媒, CCME's operating company, you will see not one article written on their operating business. There is vacuum of local media coverage of the company."

"It appears to Citron that CCME's entire website is intended solely to reinforce the real business of CCME — which is pushing the stock."

"How can CCME generate three and a half times the revenue per screen of its competitors?"

"Ask yourself this question: How could the fastest growing advertising company in all of China, with industry leading margins and profit, not even get a proper analyst to believe this crazy story?"

This is just a sampling of some of the questions that Citron raised. I urge readers to read the entire report and come to their own conclusions. While the market may not have taken Citron's report at face value, some shareholders became concerned. Between the time that the report was released and February 2nd (the day before Muddy Waters released its report) the stock fell more than 20% and the short interest grew...

What was CCME's response to such serious allegations? The company issued a statement following Citron's January 30th report, stating that the company "strongly disagrees with the views expressed," and urged investors to rely on its Securities and Exchange Commission filed reports. Here is the link.

On February 2nd, a report titled "AutoChina (NASDAQ: AUTC) - The Most Preposterous Chinese Reverse Merger Yet" was published on Seeking Alpha and re-printed at thestreetsweeper.org, a well known fraud busting site. I do not know if AUTC is a scam. But within one day, the company's CEO issued a point by point rebuttal of the claims made in the blog posting. Chinese New Year or not, he was going to defend his company.

Why didn't CCME do this in response to the Citron accusations?

Citron concluded their report with these ominous words..."Stay Tuned For Part Two…Cautious Investing To All."

Muddy Waters

On Thursday, February 3rd, Muddy Waters Research Research released a report titled "CCME: Taking the Short Bus to Profits" and pandemonium ensued in the shares of China MediaExpress Holdings. The stock closed the session down around 33%, and at this point had lost 50% of its market cap in 5 trading sessions.

Again, I do not suggest that you take Muddy Waters' report at face value. Read it. Come to your own conclusion. Muddy Waters had a short position in CCME. Muddy Waters may have been part of a coordinated attack by a group of nefarious short sellers.

This report was more detailed, and damning, than the one published by Citron. According to the authors, CCME shares could be worth $5.28, but likely less. Below are some of the accusations leveled against the company in the report.

"Muddy Waters, LLC believes that China MediaExpress Holdings, Inc. (“CCME” or the “Company”) is engaging in a massive “pump and dump” scheme."

"We estimate that CCME's actual 2009 revenue was no more than $17 million versus reported revenue of $95.9 million, an overstatement of over 464%."

"Our per share valuation is currently $5.28, but is subject to change should we believe that the cash number is incorrect."

"Similar to RINO, we verified that CCME's largest relationship does not exist."

"CCME tells investors that it has over 27,200 buses in its network. However, it tells advertisers that it only has 12,565 buses in its network."

"We caught CCME's management telling a particularly egregious lie. It recently announced it had created an online shopping platform that has an agreement with Apple Inc. (NASDAQ: AAPL – yes, THAT Apple) or one of AAPL's distributors."

"The purpose of this fraud is to generate earn-outs for management, and to increase the market value their stock so they can sell it."

This is a very small sampling of the allegations. I urge investors to read the report and come to their own conclusions as to its veracity. Also, it seems as if the claim made by Muddy Waters with regard to Apple, may not be true.

On Thursday, CCME released a brief statement saying that "it would, as soon as possible, issue a public statement to refute these defamatory remarks and that it expected to be in a position to provide a thorough and detailed response within the next few days, notwithstanding Muddy Water's apparently strategic decision to release its “report” at the outset of the Chinese New Year."

The press release also added that "In a separate but related note, CME today also announced its December 2010 contract with Eading Group, one of Apple Inc.'s official distributors in China to advertise Apple products, specifically iPads, in CME's SWITOW magazine, a new B2C shopping platform for its contracted advertisers." This would suggest that Muddy's AAPL allegations may be false, but raises other questions.

Here is a press release announcing the launch of SWITOW from December 28, 2010. Supposedly the "SWITOW shopping platform includes: a) the SWITOW magazine that will be distributed in CME's network, b) the SWITOW website (www.switow.com) and c) boutiques to be opened in certain major cities."

And in fact if you go to switow.com it does appear as if the site is selling Apple products. It also appears that the company has marketing relationships with Adidas, Nike (NYSE: NKE), and Sony (NYSE: SNE) among others. What I cannot understand, however, is how this B2C website is connected to CCME's core business of operating mobile television advertising networks on passenger buses travelling on highways in the People's Republic of China. According to CCME's financial statements, that core business is absolutely on fire, why are they venturing into something like SWITOW? It just does not pass the smell test.

If the company was trying to scam investors, however, this website would be a great way of promoting that agenda, no?

RINO International (PINK:RINO), Citron Research & Muddy Waters Research

Why did the market freak out on Thursday when Muddy Waters released its report on CCME? Because these firms sent Chinese reverse merger company RINO International to the pink sheets in November. For some reason, long stockholders of China MediaExpress believe that Citron and Muddy are conspiring against CCME (and maybe they are), instead of believing that the two firms have uncovered another RINO.

In May of 2010, RINO shares traded as high as $25 on the NASDAQ. The company through its subsidiaries, operates as an environmental protection and remediation company in the People's Republic of China. It had stellar financials. It had a tremendous growth profile. It had analyst support. Well, RINO turned out to be too good to be true, and was exposed by none other than Muddy Waters.

On November 10, 2010, the firm issued a report titled "Muddy Waters initiating coverage on RINO - Strong Sell". The following day, RINO issued a press release stating "RINO takes its responsibilities to investors very seriously and has launched an internal review of Muddy Waters' allegations. RINO looks forward to providing investors with a timely and detailed response to the allegations upon completion of its internal review."

On November 18, 2010 the company issued a restatement, the stock was halted on NASDAQ, and RINO was subsequently delisted and banished to the pink sheets. New ticker symbol - RINO.PK. I think the same thing could easily happen to CCME. Things are unfolding the exact same way.

Here is the press release detailing the filing of a class action lawsuit against RINO and the restatement which said that "the Company's previously issued audited financial statements for its fiscal years ended December 31, 2008 and 2009, which were included in the Company's Annual Reports on Form 10-K for the fiscal years ended December 31, 2008 and 2009, and its previously issued interim unaudited financial statements which were included in RINO's Quarterly Reports on Form 10-Q for the periods ended March 31, 2008 to September 30, 2009 should no longer be relied on."

Similarly, law firms are currently lining up to sue China MediaExpress for violation of the Securities Exchange Act of 1934. More on that later.

Bronte Capital

According to their website, "Bronte Capital is an Australian and USA licensed global fund manager. We are currently licensed in Australia to invest for non-retail clients in global equity, debt and derivative markets. Our USA license (applicable to USA clients) allows for investment in global equities and debt but not in derivatives (for which we are presently seeking an exemption)."

Bronte Capital has a small short position in CCME and has been blogging about the recent developments in the stock here and here. Read these posts. They are from a hedge fund manager who is offering an objective opinion. His short position accounts for roughly 0.333% of his AUM. He admits that he doesn't know if CCME is a fraud. His summary of the situation, however, is an absolute must read.

Bill Block

I want to preface this section by saying that investors can come to whatever conclusions they want from what Mr. Block had to say. I am just recounting our conversation. I am sure Mr. Block would like to see CCME shares fall. Do your own due diligence. I have no way to verify everything that he told me.

I spoke at length with Bill Block on Friday. Mr. Block is the father of Carson Block, who is the Muddy Waters analyst whose report cratered CCME on Thursday. Mr. Block's LinkedIn profile lists him as President at a firm called W.A.B. Capital. Unfortunately, we did not speak much about his background. But, Mr. Block seemed to be very knowledgeable about CCME, RINO and the situation in China.

Mr. Block told me that Carson Block is a licensed attorney in the State of New York. He said that he has done consulting work for Top 5 AUM mutual funds. He said that Muddy Waters stands by the report, documented every detail in the report, and possesses further damning evidence that was not included. Furthermore, Carson is fluent in Chinese and is acting as an "aggregator."

According to his father, Muddy Waters has a "hell of a network" and is in contact with accounting, manufacturing, marketing, and financial professionals on the ground in China and that "no Caucasian" could get the info he has without substantial Chinese assistance. He further stated that Muddy Waters is wired into a group of hedge funds that short Chinese reverse merger scams like RINO.

Per our conversation, it is my belief that Muddy Waters will issue a rebuttal within days of any response from China MediaExpress Holdings. Bill Block believes that China MediaExpress is defrauding investors and the shares are worth maybe $5. He also confirmed that Muddy Waters does trade in the shares of the company's they cover (something we already knew).

Two very important points were discussed in the course of our conversation that I think will be of some interest to investors. First was the auditor of CCME, which is Deloitte Touche Tohmatsu. According to Mr. Block, it is a completely different ballgame in China, and the "Deloitte audit wouldn't make any difference." I have no idea if that is true, but it would not be the first time that a top auditing firm got egg on its face. Do you remember a little outfit called Arthur Andersen that was the auditor for an obscure company called Enron?

The second point of discussion was about Starr International. One of the points that the supporters of CCME are pounding the table on is the due diligence supposedly done by Starr, which has invested $43.5 million in the company. Starr International is a privately-held global financial services company comprised of insurance entities and investment subsidiaries that is controlled by Hank Greenberg (the former Chairman and CEO of none other than AIG).

You see, the bulls are pointing to this Starr stake as proof that CCME is legit. This stock, despite its unbelievable operating metrics and growth rate, has pretty much no institutional following. If you check out the major holders list, you will see that exactly 9% of CCME shares are held by Institutional & Mutual Fund Owners. But I thought this was such a great company? The institutional holders are all passive investors, most of which hold the shares as part of index funds, etc. Of this, I am almost 100% sure. It is doubtful that any of those firms you see in the major holders section did due diligence.

But there is Starr.

It looks as if Starr got a very sweet deal from CCME. Here is the press release titled CCME)+Convertible+Preferred+Shares+for+$30M/5244250.html">Starr International to Purchase 1M China MediaExpress (CCME) Convertible Preferred Shares for $30M

Here are the terms of the deal, per the press release:

"Under the terms of the agreement, Starr International will purchase, in a $30 million private placement, 1,000,000 newly issued shares of CME Series A Convertible Preferred Stock at $30.00 per share, together with 1,545,455 of CME common stock purchase warrants."

Furthermore: "Each of the 1,000,000 shares of Series A Convertible Preferred Stock will be convertible at any time into three shares of CME common stock. The newly issued warrants will be exercisable at any time into one share of CME common stock at $6.47 for each warrant held."

So according to my math, Starr received 3,000,000 CCME common shares at a price of $10 apiece and 1,545,455 warrants convertible into one common share each at $6.47. Here is the problem: CCME shares were trading at $11.50 when this deal was done. They supposedly had a tremendous business. Why would they give Starr such favorable terms?

Furthermore, as Mr. Block kept saying, why didn't this company just do an IPO in the first place? Why in the world do they have this baffling ownership structure and take the reverse merger route onto the NASDAQ in the first place? Remember, if you look at CCME's growth profile and operating metrics this is one of the best businesses in the world.

Investor Relations - Where Were They?

The investor relations contact for China MediaExpress is a woman named Lena Cati who works for a company called The Equity Group. I attempted to call Ms. Cati on Thursday after the stock had fallen 33% that day and 50% in the previous 5 trading sessions. I was told that she was "unavailable." Apparently Bloomberg and Reuters were also not able to get through to her despite the fact that the company she represents had just lost 33% of its market cap in a couple of hours. Strange, no?

Well I called back on Friday. The secretary seemed interested in putting me into contact with her, but said that she was on the phone. She took my contact information. After an hour or so I called back. This time she said that Ms. Cati was still on the phone and very busy and that I should email her. According to her, they were trying to respond to all emails. I said “ok,” and then asked about Ms. Cati's whereabouts on Thursday. I was told that she was in "meetings" all day.

Plausible, but if she believed in the veracity of CCME's financial statements, I would think she would be trying to calm nervous investors. Needless to say, I did not get an email response. So I called back. I was again brushed aside and told to email.

All the while, shares of CCME kept rising, due to what I believe was heavy short covering. On Friday, the stock closed 25.25% higher at $13.89. That got me thinking...if she really is on the phone, whom is she talking to? Is she talking to other investors telling them everything is fine? Are they, in turn, pushing the shares up?

Clearly that would not be ethical, and likely illegal. Don't we all have the right to the same information? To be clear, I do not have any idea if that is what was going on. The gist of the second email I sent was this: "I am going to write a story on CCME. I believe that a crime has taken place, although I am not sure of the perpetrator (could be CCME management, could be the shorts). I am looking for someone who is willing to defend the company. Do you want to defend the company's reputation? I am trying to get CCME's story out. Give me 5 minutes." No luck.

Who Is Defending China MediaExpress?

Hardly anyone at this point. A firm called Global Hunter Securities did publish a research report on February 1, 2010 reaffirming their Buy rating and $26.00 price target on CCME shares. This report came out post-Citron, but before the Muddy Waters report. I urge investors to read it. If this company is not a fraud, Global Hunters' price target is conservative, in my opinion.

The analysts are supposedly in China doing due diligence. The report details their findings, and it sounds convincing. They claim that they have done "extensive due diligence" during the last seven months. "We interviewed a number of advertising customers, bus operators, and the company's regional managers. We also talked to CTR, the third-party market research firm, visited Starr International's office in Shanghai and talked to the company's independent auditor, Deloitte." Global Hunter is “comfortable” with CCME.

Here is a description of the firm from Bloomberg - "Global Hunter Securities, LLC is a boutique investment banking firm that provides financial advisory services...Global Hunter Securities, LLC was formerly known as Velocity Trading, LLC and changed its name to Global Hunter Securities, LLC in October 2005. The firm is headquartered in New Orleans, Louisiana with additional offices in California and Texas."

The analysts who published the report are Ping Luo and Jody Dai. I emailed them both. Only Ms. Dai responded. Her response piqued my interest. She wrote, "I would be happy to give you my best knowledge of the company, although I would strongly suggest you to contact Ping Luo, who is the senior analyst on the name and conducted the majority of the due diligence." Ms. Luo did not respond. That might mean absolutely nothing, I don't know. I do plan on taking up Ms. Dai on her offer to tell me about CCME, but due to the time difference in the States and China, it will have to be after this article is published.

There are a couple of posters on Seeking Alpha that have come out in support of CCME. They are not institutional level investors, but I do think that readers should peruse their defenses of the company to see if they find them compelling. I don't, but I may be wrong. One is by a poster named Michael Anderson and his piece can be found here. The other is by Robert Weinstein and can be found here. For all I know, these supporters could be correct in their assessment of CCME and, if so, they will likely make a nice chunk of change.

Law Firms Lining Up

Predictably, and justifiably it seems to me, the wires have been active with press releases from law firms lining up to sue China MediaExpress. All of the press releases that have come out thus far are targeting CCME, and none are going after Citron or Muddy Waters - although that could change. Find those below.

Investigating CCME

Levi & Korsinsky, LLP Launches an Investigation into Potential Securities Fraud Claims against China Media Express Holdings, Inc. in Connection with its Issuance of Potentially Materially Inaccurate Financial Statements - (CCME)

Holzer Holzer & Fistel, LLC is Investigating Potential Violations of Federal Securities Laws by China MediaExpress Holdings, Inc.

Robbins Geller Rudman & Dowd LLP Files Class Action Suit against China MediaExpress Holdings, Inc.

Federman & Sherwood has Launched an Investigation of China MediaExpress Holdings, Inc. for Possible Violations of Federal Securities Laws

Law Offices of Howard G. Smith Announces Investigation On Behalf of Investors of China MediaExpress Holdings, Inc.

Summary

I believe that a crime has taken place. I am not sure, however, who the perpetrators are. Either Citron, Muddy Waters and a cabal of short sellers have conspired to take down the share price of CCME for monetary gain, or CCME management has defrauded investors. I believe that the likely outcome is that China MediaExpress will be delisted and forced to restate their financials - but I could be 100% wrong. This is either a $5 stock or a $26+ stock. It is my belief that the onus is now on CCME to exonerate themselves with regard to the fraud accusations that have been brought forward. If they successfully do that, I would be more than happy to take a position in the company at any price below $18.00.

UPDATE: On Monday, Zheng Cheng, the Chairman, CEO and President of China MediaExpress issued a rebuttal to many of the allegations that were brought against his company by Citron Research and Muddy Waters Research. Currently, this is the most substantive information that investors have to go on, so it is an important read. The market was initially heartened by the response as CCME shares rose as much as 15% in early trade on Monday, but gave back all of the gains and then some, closing down 5.39% at $13.14 on very heavy volume.

Disclosure: I have a small bearish position in CCME options

Have More Information? Questions?
Email me at scott.rubin88@gmail.com