Guangzhou Global Telecom: Mountain of Hype, Small Anthill

Guangzhou Global Telecom has made a big splash in its brief life as a U.S.-traded stock. Shares of the small Chinese retailer started trading here on May 15 with an opening share price of $1.75. In little more than two weeks, Guangzhou soared 51% to close at $2.65 on May 31. Is it the latest hot company from China? Or is its rapid rise just due to hot air? While you decide, we suggest you hold on to your wallet.

Full-page advertisements that appeared in BusinessWeek, Forbes and Fortune make Guangzhou Global Telecom (symbol GZGT, quoted on the OTC Bulletin Board) sound like a major player in the world's most populous country. They say that Guangzhou has partnered with China Mobile, China Unicom and China Telecom, and that its "major carrier partnerships account for nearly $50 billion in revenues." Readers are encouraged to buy Guangzhou's stock because it will "fuel your portfolio for explosive growth."

Expect to see a lot more Guangzhou Global Telecom ads. Its advertising firm says similar ads are scheduled to run in upcoming issues of The Economist, Institutional Investor, Money and SmartMoney magazines, as well as other issues of BusinessWeek, Forbes and Fortune. We rejected the ad in Kiplinger's Personal Finance and on Kiplinger.com because the claims made in the ad could not be substantiated and because our inquiries raised more questions than they answered. In fact, the more we looked at this new stock, the more our eyes burned.

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How to hype a stock: As the promoter, you first order up the advertisements. In the ads, you refer people to a so-called third party to attest to the company's virtues. To be that neutral party, you create an online newsletter. As its editor, you install someone whose existence as an actual person cannot be verified. Then you begin trading the stock, accompanied by almost daily press releases that create a drumbeat of optimism.

Many other penny-stock promoters have trod this path. It's the audacity and intensity of the promotion of Guangzhou Global Telecom that sets it apart. John Pentony, publisher of StockGuru.com, says he has never seen stock promoters advertise in major national business magazines. The promotion also seems unusual to Cromwell Coulson, chief executive of the Pink Sheets, a quotation service that lists thousands of penny stocks. "Business magazine ad selling must be pretty soft if they are taking those ads," he says.

NASD, which runs the OTC Bulletin Board, would not comment on the Guangzhou promotion, but says investors should be wary of stock promotion in general. "Investors have to use exceptional caution when investing in stocks advertised in magazines and fliers because they might not disclose all the material facts that would be important to the decision," says Cameron Funkhouser, NASD's senior vice-president of market regulation.

What we noticed in particular about the advertisement was that it refers readers to a Web site called GrowthStockGuru.com. And it quotes the publisher of Growth Stock Guru, Aharon Bronfman, as saying "Companies like GZGT will be discovered and their valuations will skyrocket." Go to that Web site, however, and you discover that Guangzhou Global Telecom is the only stock it promotes -- one reason being that the site went online only days before the stock began trading. The timing can make you suspicious about Bronfman's claim that three other penny stocks had soared after being discovered by the Web site. (By the way, we searched numerous public and private databases for his name and came up with a blank, meaning that Bronfman has been invisible during the 15 years he claims to have been in the investment business.)

Then we come to learn that the buyer of this small fortune in advertising was not Guangzhou Global Telecom. Richard Yan, a Shanghai consultant who claims to speak for the company, denies it has any involvement in this ad offensive. Rather, the ad agency placing the ads, Mediabids, says the ads were paid for in advance by Growth Stock Guru. In addition to the magazine ads, Growth Stock Guru mailed an expensive glossy eight-page brochure prospecting for Guangzhou investors. Growth Stock Guru, in turn, says it was paid to promote the stock and place the ads by Eminiar VII LLC, which describes itself as a non-controlling shareholder of Guangzhou Global Telecom.

Aggressive promotion aside, is the company worth $2.65 a share? Guangzhou's filings with the Securities and Exchange Commission show a small company that sells cell phones and accessories -- not a national telecom titan as implied by Growth Stock Guru. Guangzhou earned less than half a penny per diluted share last year -- $220,373 on $12.8 million in sales. What about those billions in sales from carrier partners? Well, the company apparently does sell China Mobile, China Unicom and China Telecom cell phones and accessories in its stores, and those companies do have billions in sales. But there are no billion-dollar deals between those big China telecom companies and Guangzhou mentioned in SEC filings or on the company's own Web site.

Guangzhou Global Telecom has eight stores in the city of Guangzhou and 40 employees. Guangzhou plans to grow by expanding to other parts of China and offering more services, such as games and ring tones, Yan says.

Guangzhou Global Telecom stock is wildly expensive, and yet the hype behind this tiny company is creating a tsunami of trading. Of those 53 million shares, all but 13 million were held by insiders at last word. Yet on May 31, more than 9 million shares, or 70% of the "float," changed hands, as the stock advanced 10.4%, to $2.65 a share, putting its price-earnings ratio based on 2006 earnings at more than 500. The company has the chutzpah to forecast its own profits for 2007, 2008 and 2009. Even if you took its 2009 forecast at face value, you're still looking at a P/E of 90 two and a half years from now, based on those fully diluted shares.

We keep bringing up all 53 million shares for a reason. After all, why spend all this money to advertise in business publications? What's in it for the advertiser, Growth Stock Guru, or Eminiar VII LLC? If this promotion plays out in the classic manner, more and more of those 40 million shares that are sitting on the sidelines will be parceled out to naive investors at higher and higher prices. The trading volume on May 31 suggests that this process is well under way. When all shares owned by the promoter have been sold, the stock will have no support, and then it's bye-bye bubble. (See The Truth Behind Penny Stock Spam.)

In sum, this is a small company with a scant financial record, a massive advertising campaign and an expensive stock. For any serious investor, Guangzhou Global Telecom raises more red flags than a Communist Party parade.