New Oriental Clears Muddy Waters

 | Oct 15, 2012 | 11:51 AM EDT
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After an incredible run of shorting several Chinese reverse-merger stocks such as Rino, China Media Express and Sino-Forest, Muddy Waters has hit a rough patch.

The firm's last three shorts -- Spreadtrum Communications (SPRD), Focus Media (FMCN), and New Oriental Education & Technology (EDU) -- have all effectively rebutted Muddy Waters' claims against them.

Those three trades could have still been very profitable for Muddy Waters.  We'll never know where the firm got in and whether it covered. But that's really beside the point.

The real issue for Muddy Waters is its reputation going forward. People will likely pay far less attention to the next Muddy Waters report when it comes out because of these last three reports.

The latest setback for Muddy Waters came on Friday night when New Oriental filed its 20-F annual report with the SEC and it was accepted. New Oriental was up more than 12% earlier on Monday morning. It's still above $18.

That's still way below the $27 at which it traded last June before hints of the Muddy Waters' allegations began to tank the stock, but it's certainly well above the $9 it dropped to in July. Deutsche Bank came out this morning resuming its coverage and reinstating its $24 price target.

Muddy Waters' recent problems stem from a few problems:

  • Founder Carson Block no longer travels to mainland China to conduct first-hand due diligence of Chinese companies.
  • The reverse-mergers that Block made a fortune shorting are now virtually all gone. The easy money has been made.
  • The recent Chinese targets Block has gone after are larger, which makes them a more complex story to unravel and prove that there is fraud going on.
  • These larger Chinese companies are better connected to other powerful players in China and the government. Former head of Google (GOOG) China, Kai-Fu Lee, went after Muddy Waters and Citron Research recently to try and discredit them.

In a mid-September interview with Chinese business magazine Caixin, Carson Block said that Muddy Waters would no longer target Chinese companies and, instead, go after American, Japanese and Indian ones. To me, that doesn't sound like a recipe for success. It's in geographies where Block has no prior direct experience, so it will be tougher for him to stand out. Plus, the reputation he built up with his Sino-Forest successes has now lessened, so his calls will have to stand on their own merit, which will be tougher.

If past is history, Muddy Waters will probably move on following the New Oriental 20-F filing. The firm stopped its attack on Focus Media before, and it will probably go after an American company next.

That means New Oriental probably has more upside ahead of it.

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