Why New Oriental Education's Shares Got Crushed, Again

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Chinese education company New Oriental Education (NYS: EDU) were getting absolutely pummeled by the market today, falling as much as 36% in intraday trading after a similar loss yesterday.

So what: Investors in Chinese companies may remember Muddy Waters from such hits as RINO International, China MediaExpress, and Focus Media Holding. No, we're not talking about the blues-guitar virtuoso; we're talking about the upstart short-seller that went head-to-head with hedge-fund giant John Paulson on Sino Forest -- and won. Now Muddy Waters has dropped the hammer on New Oriental Education.

Muddy Waters released a "strong sell" initiation report on New Oriental today and dropped the dreaded "F" bomb in the report. Not one to mince words, the short-seller alleged that the company, despite saying otherwise, does have franchisees and that "these franchisees are not a hidden bonus for investors. Rather, they are part of a substantial fraud in EDU's accounts."

Now what: Muddy Waters has been very right on some very big calls. However, it's also had a few that appear to be misfires. Does the aggressive short-seller have it right on New Oriental? What we do know from the company's press release yesterday is that it is already under investigation by the U.S. Securities and Exchange Commission. If there is something blatantly wrong, we should hope that the SEC would uncover it. Based on the company's description of the investigation, it didn't sound nearly as bad as what Muddy Waters is alleging, but we could probably expect that the company would want to spin it that way.

It's hard to say what investors should do at this point -- if the SEC investigation is relatively benign and Muddy Waters is blowing smoke, then this could be a darn cheap stock. On the other hand, if Muddy Waters is on target again, there's a whole lot more potential downside.

I've avoided most individual Chinese companies -- particularly small caps -- because of the prevalence of fraud has been so astoundingly high. So potential discount or not, New Oriental holds little interest for me.

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The article Why New Oriental Education's Shares Got Crushed, Again originally appeared on Fool.com.

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