Merger of U.S., Chinese firms is cautionary tale
SHENZHEN, China -- For U.S. investors hoping to cash in on China's booming economy, Huiheng Medical once seemed like a smart bet.
A presentation for investors called the firm China's leading domestic developer and provider of gamma-ray technology for fighting cancer. Investors were also told about strong customer orders and a joint venture that would supply Western expertise and boost growth.
But four years after first listing its shares in the U.S., Huiheng trades on the over-the-counter market for $1.60 a share, down from a peak above $13. Net income fell to $2.3 million last year, a fall-off from a 2007 high of $9 million. And sales are so slow, the firm hopes to explore preserving food with radiation — but says it lacks cash to fund the research.
Some of Huiheng's first investors obtained a legal settlement in which the firm bought back their stock after they alleged they'd been duped into buying "essentially worthless" shares.
The firm's latest annual report is so filled with caveats that Michael Santoro, a professor of management and global business at Rutgers University Business School, said a U.S. investor would be hard pressed to "make an intelligent judgment about whether to invest in this company."
"The question for Americans is, does it make sense for a company like this to be accessing our capital markets at all?" asked Santoro, author of China 2020.
Huiheng is one of more than 150 firms based in China or nearby that entered North American securities markets since 2006 through what's called a reverse merger. Though they had no U.S. operations, they took over U.S. shell firms or special-purpose acquisition companies already registered for public stock trading. That enabled them to raise millions in capital without the closer scrutiny focused on more costly initial public stock offerings.
A USA TODAY examination of Huiheng, amid concerns about Chinese reverse-mergers, found:
•The financial backers who helped the firm start trading in the U.S. include father-and-son bankers who have tangled with the federal government and have guided other now-struggling Chinese reverse-merger companies.
•Radiosurgery experts question the firm's effectiveness claims for its technology.
•The company is headquartered in a high-tech area of Shenzhen, one of China's wealthiest cities. But a USA TODAY reporter who observed the five-story building housing its offices from just outside saw two floors that appeared to be empty and a third with open boxes strewn about.
Reverse mergers are a legitimate way to raise capital. But USA TODAY's examination of Huiheng highlights the difficulties investors face as they try to verify the reality behind the financial statements and other claims made by some small international firms.
An SEC warning
The examination comes as a Securities and Exchange Commission working group seeks to tighten regulation of foreign-based firms whose stocks trade only in the U.S. That effort includes a review of auditors, underwriters and other gatekeepers who helped Chinese firms execute reverse mergers. The SEC issued an investor alert about reverse mergers in June, and last month approved rules by the three major U.S. listing markets that raised reverse-merger standards.
