Shares of Hong Kong-listed Chinese diary company Huishan Diary Holdings Co. barely moved after Muddy Waters, a research firm known for betting against publicly listed Chinese companies on grounds of fraud, released a negative report on the company in December 2016.
But suddenly, Huishan stock dropped a spectacular 90% today after rumors spread that the company's key shareholders might have stolen as much as RMB3 billion – an amount double to what Muddy Waters has estimated – and that it faked most of its financials.
In local trading today at around 11:30am, Huishan's share price dropped as much as 90% to HK$0.275 per share, from just under HK$3 a piece yesterday, as investors rushed for exits, wiping out US$4.2 billion of market capitalization. A total of 779 million shares changed hands, a record for the Hong Kong Stock Exchange.
The dramatic turn of events is a vindication for Muddy Waters, but spells disaster for Huishan's shareholders and Ping An Bank, which has taken Huishan shares as collateral to extend a HK$2.14 billion loan to the company. Huishan is a constituent of the MSCI China Index and is also included in the Hong Kong-Shanghai Stock Connect program.
According to Chinese media reports, banks and investment firms conducted due diligence on Huishan after the Muddy Waters report in December. They found that Huishan had faked documents and financials on a massively scale. Company founder Yang Kai and his wife, together with a 73% stake of the company, have stolen RMB3 billion from the company and there is no chance of recouping the money, said the reports.
"We are short China Huishan Dairy Holdings because we believe it is worth close to Zero. We conclude Huishan is a fraud," Muddy Waters wrote in its report.
The research firm said that Huishan had reported fraudulent profits largely based on the lie that it is substantially self-sufficient in producing alfalfa. Huishan has long purchased substantial quantities of alfalfa from third parties, and has engaged in CapEx (capital expenditure) fraud related to its cow farms, the report said.
Muddy Waters estimated that Huishan has overstated the spending on these farms by RMB893 million to RMB 1.6 billion, to support the company’s income statement fraud.
The researcher estimated that chairman Yang Kai appears to have stolen at least RMB150 million of assets from Huishan. The theft relates to the unannounced transfer of a subsidiary that owned at least four cow farms to an undisclosed related party.