Murky past of China’s Focus Media provides lesson
By — Pedro Matos, Emir Hrnjic and Lianting Tu
July 17, 2015
The big idea: The extreme volatility in the Chinese stock market is challenging foreign investors. China has emerged as the world’s second-largest economy, but does this momentum translate into investment opportunities?
The scenario: One such opportunity might be the Chinese media market, which has a potential audience of more than 1.3 billion people. But government restrictions on direct foreign ownership and on content mean that investors must invest in Chinese-based companies. In 2005, Focus Media Holding was the leading digital media network in China. When it went public that year, it was the largest initial public offering of a Chinese company on the Nasdaq composite index. The number of China-based firms on U.S. stock exchanges peaked in 2010; at that time, Chinese firms represented more than 25 percent of all IPOs.
In 2011, Muddy Waters, a U.S. short-seller fund and equity research firm, accused Focus Media of overstating the size of its business and deliberately overpaying for acquisitions. Muddy Waters had been involved in uncovering some of the most high-profile cases of fraud allegations in China. Four of the first five firms it targeted had to delist. Muddy Waters was named after the Chinese proverb “muddy waters make it easy to catch fish,” which suggests that nontransparent markets allow for opportunistic behaviors.
The resolution: Focus Media’s stock price fell sharply at first but rebounded as the company countered Muddy Water’s attacks. In 2012, the SEC launched an investigation and pressured Focus Media to amend some of its filings. Focus Media was taken private in a deal valued at more than $3.7 billion — China’s largest-ever buyout. In the following months, several Chinese companies followed suit and delisted from the Nasdaq.
As of 2015, private-equity investors in Focus Media are looking to exit from the deal. Going public in Hong Kong appears to be the preferred option, but the situation remains murky.
The lesson: Cases such as Focus Media, and the challenges and opportunities surrounding Alibaba’s high-profile IPO in 2014, illustrate how attention to corporate governance and an understanding of regulatory differences will continue to be a priority for investors in the Chinese market.
Investors should keep several ideas in mind:
●Don’t make the assumption that financial statements and filings can’t be changed; in some cases, fraudulent practices, in any country, do not become obvious for some time.
●Be careful about basing an investment decision purely on the favorable-looking economic or GDP-based growth characteristics of a country or region.
●Understand governmental and regulatory restrictions on ownership as part of your research and be sure to understand exactly what you’re investing in.
In other words, make sure the water is clear.
— Pedro Matos, Emir Hrnjic and Lianting Tu
Matos is an associate professor at the University of Virginia Darden School of Business. Emir Hrnjic and Lianting Tu are with National University of Singapore.