Market Overview

The Curious Case of Harbin Electric

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It has been a wild month for shares of Harbin Electric (NASDAQ: HRBN). The company, which designs, manufactures, supplies, and services electric motors in the People's Republic of China, has been the target of much scrutiny, as allegations of fraud have run rampant, wreaking havoc on share prices and whipsawing investors over the past 30 days.

The allegations were first published by Citron Research and can be found here.

In a nutshell, Citron alleges that the proposed buyout of outstanding Harbin shares by the company CEO, Tainfu Yang, for $24 per share is a sham – nothing more than a ploy to keep the stock price artificially inflated while the business underperforms.

The report was published on Thursday, June 16th in the midst of the Chinese stock assault, and had devastating results on the company's share price. Harbin's stock plunged 59.8% from $14.50 to $5.82 in roughly four hours.

The dip was short lived, however, as the company responded to Citron's research report the next day, vehemently denying the allegations. The response sent shares flying, trading as high as $20.70 in premarket trading on Monday, June 20th.

Since the report was published by Citron, there have been quite a few developments, which have seemingly poked numerous holes in the allegations made by the research firm, sending shares back to “pre allegation” levels.

1) Harbin filed all necessary 8-K documents with the U.S. Securities and Exchange Commission (SEC).

2) China Development Bank verified that it has agreed to loan $400 million for the purchase of all outstanding Harbin shares.

More examples can be found here.

So that brings us to today. Shares of Harbin are currently trading at $17.50, closing in on their two month intraday high of $18.31. The stock has seemingly shaken off Citron's report, but is still trading well below the proposed $24 buyout offer made by Tianfu Yang's company (Tech Full Electric Company).

There are a few ways to trade this stock. Most of them are extremely risky, but potentially extremely profitable.

Only time will tell how this one plays out.

ACTION ITEMS:

Bullish:
The buyout is scheduled to conclude in the fourth quarter of this year. Investors who believe that the buyout of Harbin will go through might want to consider the following trades:

  • It is pretty straightforward, buy in now. If shares get taken out at $24 per share as scheduled, current buyers will be rewarded handsomely with a 37% gain in no more than six months – not too shabby.
  • If straight buying is too risky for you, write puts. December 17.50 strike puts are going for $6.30. If you write these contracts, you can collect a nice premium, while significantly limiting downside risk.

Bearish:
Investors who believe that Harbin is, as Citron alleges, a fraudulent company and will be relegated to the Chinese stock trash pile in the near future, may consider an alternate positions:

  • Start building your short position in small increments. Short covering, along with legitimate buying has pushed shares up to current levels, but the fact that the stock's price is nowhere near $24 tells you that there is significant doubt in the market regarding the validity of the buyout proposal. Assume your maximum loss is the offer price of $24, while the maximum gain is in the low single digits – say $5. That is a potential risk of a $6.50 per share loss versus a potential gain of $12.50 – not a bad risk/reward ratio.
  • Start buying puts. If the proposed buyout does not happen, then the share price will undoubtedly be mauled, as the allegations of fraud will have been confirmed. Such an event would make the single digit puts extremely lucrative. December 6.00 strike puts are currently trading at $1.23. December 7.50 puts are trading at $1.55.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

 

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