Chinese reverse mergers (CRM) have a bad reputation with investors. There have been so many fraud allegations over the years that shorting CRMs was practically an investment strategy at one point, and in 2011 the Securities and Exchange Commission warned investors to be wary of reverse mergers (RM) across the board. New research says that this avoidance may be unwarranted because CRMs actually outperform US RMs and non-RM stocks with similar characteristics, though their absolute results don’t have much to recommend them.
CRMs did better than RMs, but neither is impressive
To track relative performance researchers matched up CRMs with control listings (CL) that had the closest market cap among stocks that traded on the same exchange (typically OTCBB or Pink Sheets), were classified in the same industry, and were in business when the reverse merger took place. They also compared CRMs to US RMs as a group, with the CRMs coming out ahead in both cases because they tended to be more mature companies than their counterparts.
“At the beginning of their public life, CRMs have higher market capitalization, lower leverage, higher profitability, and more positive operating cash flows than U.S. RMs. Over the next three years, CRMs continue to fare better than either their U.S. counterparts or a group of exchange-industry-date-size matched firms,” write Stanford University professor of accounting Charles Lee, University of Toronto assistant professor of accounting Kevin Li, Peking University associate professor of accounting Ran Zhang in their paper Shell Games: The Long Term Performance of Chinese Reverse Merger Firms.