Where is the next China?

To paraphrase Garrett Morris on the original Saturday Night Live, the People's Republic of China has been very, very good to the reverse merger and SPAC world. In 2007 about one quarter of all reverse mergers involved companies from China going public through a merger with a US shell. According to the Reverse Merger Report, that trend continued through the first quarter of this year. Many SPACs have been focused on deals in China.

The "yuan rush," as I called it in my book (a Google search leads me to believe I may have actually coined this phrase), has led to successful deals for many. Yes a few klunkers along the way, and even a scam artist or two has made it through. But the vast majority of the Chinese deals have been strong, interesting growth companies.

The challenge with any rush is that everybody and their brother wants to join in. The number of players working to develop deals in China has exploded. The competition for deals has become greater. The Chinese government has placed speed bumps in the way of getting deals done because of their concern about too many Chinese companies being controlled by foreigners.

Investors are still snapping up these deals, and the market for Chinese reverse mergers remains strong, with very favorable valuations for these companies as they complete their process of going public in the US. But it is getting a little harder because of the reasons described above.

Thus, a number of key RM players who had set up major operations in China have now begun to hedge their bets a bit and look elsewhere. Some might have thought the other "BRIC" countries of Brazil, Russia and India ("C" of course being China) might be winners. Well, Russia and India are still not seeing much action.

(By the way, according to Wikipedia, "the term BRIC was first prominently used in a thesis of Goldman Sachs. The main point of this 2003 paper was to argue that the economies of the BRICs are rapidly developing and by 2050 will eclipse most of the current richest countries of the world. The Goldman Sachs thesis is not that these countries are a political alliance, like the European Union, or a formal trading association, but they have the potential to form a powerful economic bloc.")

However, it appears the next place to head for RM deals is Latin and South America (yes including BRIC country Brazil). I believe a combination of factors is leading players there. First, these countries are simply closer to home, and those who go to Asia every other month can attest to the wear and tear it takes on them having to leave our hemisphere, not to mention that fabulous 12-hour time difference.

Second, language barriers are fewer as many, if not most, folks speak English. Third, there is generally less political uncertainty in most of these countries than in China. Fourth, in most of these countries, as in China, there is not a well-organized local stock exchange that helps companies go public without leaving the country. Fifth, at least for the moment there are very few players seeking to finance and take public businesses in the region. Sixth, as the Goldman Sachs report attests, there are a number of countries in Latin and South America where economic growth is significant.

What of the concerns often expressed that corruption and fraud are rampant in these areas? As with China, the players will work with experienced partners on the ground in each country to do their best to steer clear of the criminals. What of the juntas, the dictators, the anti-US sentiment in some countries? Again, not every country in the region will be ripe for opportunity, but a number of them will. It has been widely reported that major RM player Tim Keating has chosen Colombia to establish his regional operation.

Personally, I have no particular objection to a major due diligence exercise in Rio de Janiero. Go southern hemisphere!

Our thoughts are with the families of our fallen soldiers on this Memorial Day weekend in the US.

Barron's Article Serves as Good Reminder

An article in this week's Barron's magazine raises a number of concerns about a Chinese company that went public through a reverse merger. The article points primarily to the company's Chinese auditors and a question about their true independence and the extent to which that potential problem was disclosed. As a result, it appears the company's financial statements may not be as reliable as hoped.

The article briefly (and negatively) mentions reverse mergers of Chinese companies, essentially warning investors to adopt a "buyer beware" approach to these transactions.

What is a shame, in talking to friends who are familiar with the Chinese company in question, is that most people who know anything about this company know it to be successful, profitable and growing. It does not appear that the new disclosures change that. But the article seems to imply that, as a result of the questions about the auditors, nothing can be relied upon with regard to this company.

Thankfully, the number of negative articles about reverse mergers has gone down dramatically in the last 3-5 years. The Wall Street Journal declared "reverse mergers move into fashion" back in 2005. US News had a positive article on SPACs this year, referring to "formerly shady reverse mergers." Even the New York Times has come around.

In truth, a number of the few recent negative articles (there was another one not too long ago in Forbes) have centered around problems with Chinese companies. This is sort of unfair given that out of the several hundred Chinese businesses that completed reverse mergers, only a few have faced these kind of difficulties and scrutiny. But unfortunately it's all perception, especially following recent scandals involving dangerous toys and other products being exported from the PRC.

All that said, the article does point out something real and important to pay attention to. That is, placing a high priority on choosing the right auditors in a reverse merger or self-filing, especially when dealing with a foreign enterprise. It is important to check the accountants' references carefully, talk with CEOs of other public companies they have audited, do online research to determine if they have ever faced regulatory scrutiny, and the like.

This goes both ways. If you are an auditing firm, look at yourself in the mirror and make sure you can handle that difficult client who is going to try to get you to help the company "make its numbers" even if that means fudging the information a bit. In the wake of the Sarbanes-Oxley Act and the added burden placed on auditors, one would think that all auditors have learned the importance of taking a relatively conservative approach in such matters. Sadly, as the article points out, this does not appear to be the case 100% of the time.

As with all things Wall Street, the RM world has yet to rid itself of every unsavory character. But there has been a dramatic positive change as the vast majority in our industry have joined the march to the high road to ensure that RM's "shady past" is indeed almost entirely in the past.

Thankfully, more and more articles, TV coverage and conferences highlight these positive developments leading to greater reliability, transparency and legitimacy of the IPO alternatives that help bring so many exciting entrepreneurial ventures to the next level. But as we go three steps forward, as the article indicates, we will occassionally go one step back. We must remain vigilant to ensure that we each do our best to minimize the backwards steps even as the growing popularity of these techniques does draw some players who we would humbly suggest take their marbles elsewhere.

P.S. I have a number of thoughts and comments about the fine print in the final Rule 144 release, including the codification of aspects of the Worm/Wulff letters, but I would like to do a bit more consultation before posting on them. Might be over the holidays or shortly thereafter.

P.P.S. To my faithful blogees (as one put it my "avid readers"), thanks for a wonderful year of sharing our thoughts on this most dynamic and exciting industry. I wish you all a happy and healthy New Year.