Monday, November 15, 2010

China Media Express: A Wall Street drama

Sorry I have not been blogging for a while.  There are a few reasons.  Firstly I have been travelling to raise money for my funds management business (now in NYC).  Also I have been working on shorts - and whenever I talk shorts I get hate mail and sometimes threats of litigation.  My experience is that the bigger the slime-bag the faster they are to call lawyers... but being on the receiving end of threats from sleazy lawyers makes blogging less fun.

Further - writing about shorts is surprisingly unprofitable.  My experience is that shorts that are widely discussed become riskier (they get crowded) and sometimes go up - whatever - they stop falling in response to bad news.  Universal Travel Group for instance is now trading above when I first blogged about it and the only substantial news has been that their fourth auditor resigned and their fifth auditor accepted the appointment.  They also got a new shareholder - an elderly retired car dealer from California’s Central Valley - who I suppose is also an expert on dot-com travel companies in China.

And so that brings me to the subject of short squeezes and one stock - China Media Express Holdings (CCME).  This is not a stock in which we have a meaningful position but which for a small-cap company seems to get more-than-its-share of attention.  When I wrote the Universal Travel post I got more than ten inquiries about this stock - another China stock listed in New York.  Why this one?  Well it is sort of attractive - indeed outrageously attractive - and unlike all the other US listed China stocks it has a reputable auditor (Deloittes) and a major shareholder with some credibility (Starr International of AIG/Hank Greenberg fame).  

CCME has a simple business model.  It places TV screens on buses in China and bombard captive passengers with adverts.  There are a lot of buses in China because China has the largest internal migration in the world.  Chinese consumers are bombarded with adverts but the really captive bus passengers are a good market.

The company is - at least according to its accounts - frightfully profitable.  In the last quarter the company had $57 million in revenue and only $13 million cost of goods sold.  Selling and administrative expenses were less than $3 million. Head office is obviously tiny.  After tax it is making $31 million per quarter.  This is the fattest margin and fastest growth media company I have ever seen.  It is pretty darn attractive.  And plenty of my smart readers own it despite rumors that it is fraudulent.  One of my smartest correspondents was long.

And a very few of my readers argued to me that it must be a fraud and were short.  Some of them were short six or more percentage points of the funds they manage.  And all wanted my opinion.

Whatever - this was a dangerous stock.  Any stock that normal non-stock-market people have never heard of but which garners this much passion is dangerous.  And at the time it was trading at a low single-digit price earnings ratio - it was either a flat fraud or the stock was going to trade up a very long way.  Indeed it was possible that it was both a fraud and going to trade up a very long way.  I had - as I stated - no opinion.  

But at least a dozen people asked me for one.  So I had a look and was left with the ambivalence which says “don’t touch this stock - long or short”.  There were only two negatives that stood out.  One was that the company once used a stock promoter that has previously been associated with some frauds.  They don’t use them any more.  The second was that the CFO was under 30 years of age, operated from a serviced office in Hong Kong and his only qualifications were a degree from a distinctly second tier Australian university.  [See correction below.  This description does not apply to the CFO but does apply to one external director.  The facts of the serviced office are however correct - the company's registered office is that serviced office in Hong Kong.]

Against this there were real positives.  Many Chinese companies listed in the US have auditors even relatively sophisticated investors have never heard of.  These guys used Deloittes.  And the major shareholder (Starr) supposedly did several weeks due diligence before they invested.  And who am I to question that?  Again I decided to leave it alone.

But the stock went up - and up - and up.  In the last three months the stock has traded between $7.58 and $22.30.  When I looked it was about $8.  

If you were six percent short at $8 - which some were - it was diabolical.  At $20 you were down 9 percent of your fund.  Moreover your position had increased by 2.5 times and your fund had reduced - so now the position would be over 16 percent of your fund.  At that point the position is threatening the existence of your funds management business.  After all it is now possible to lose 20 plus percent of your fund on a single obscure short.   This is a major drama for someone...

The big short has to cover.  At the same time the stock is attracting momentum (mo-mo) investors.  To add fuel to the fire the company throws out yet another series of perfect looking financial results.  This is deeply ugly and you are forced to buy the stock back to save your business.  If you don’t eventually your prime broker will buy it back for you - because they will protect their own.  That buying fuels the upward rise - putting more pressure on shorts and attracting more mo-mo investors.  

If you are a small holder you should - of course - sell some stock into short squeezes.  After all the buying is often artificial (forced covering, mo-mo guys) and when the squeeze ends the buying pressure ends.  The mo-mo investors often become sellers.  We have a guideline at Bronte that we will short 10-15bps of the fund into short squeezes where possible.  You shouldn’t do any more than that because you run the risk of becoming a victim of the squeeze yourself.  And it may not be possible because a borrow is not always possible.  (In the case of CCME borrow is possible but the stock rents for a double-digit percent per year.)  So we are short a little CCME - but way less than half a percent of the fund - and we are hardly committed.  For those that are interested - we are losing money.

Some of my readers however can talk about little else.  It is either the best or the worst stock in their portfolio.  Short squeezes are one of many dramas of Wall Street.  This one - repeated in a few other Chinese stocks like China New Borun - is particularly dramatic for those that are involved - and totally irrelevant for everyone else.

Thinking aloud about CCME’s business

Outdoor advertising is much bigger business in Europe than in America.  Europeans watch much less TV than Americans.  Americans drive home from work (and get bombarded by radio).  Europeans take public transport.  And that is one of the best times to advertise to them.  

Jean-Claude Decaux was the pioneer of street furniture for advertising - and you can guess how the negotiation went.  He goes to a local government (I remember when it was done in Sydney) and tells them that they will install, maintain and clean bus stops and other street furniture and they will pay the local government (or bus authority or whatever) millions of dollars for the privilege.  The cash-strapped local government swoons at the sales pitch.  And JCDecaux gets a few thousand more bus stops to display their adverts at.  

You can imagine this deal was amazingly profitable for Monsieur JCDecaux. It was a naive cash-strapped local government versus sophisticated advertising executives.  And lets face it - TV advertising requires huge numbers of people including some very highly paid creative people.  Street furniture (even if you have to scrub off graffiti) looks like a relatively cheap platform to display adverts on.  Of course it is fat margin.

Fat margins do not last forever.  People - even people that run bus companies - don’t remain stupid forever.  Every time a contract renews the bus company gets a little wiser and the margin goes down.  The long dated contracts are all eventually renew - and they renew at lower spreads for JCDecaux.  And looking at the expiry of the old fat margin contracts you can guess what Mr JCDecaux did.  He listed his company.  

Ok - China Media Express is more profitable than JCDecaux ever was.  The little upstart China Media Express is now as profitable in aggregate as the global leader.  At this rate of growth they will be far more profitable than the global leader.  But what has me really perplexed is that CCME is growing fast at increasing margins.  Last year gross profits for the third quarter were 17 million on 26 million in revenue.  This year they are 44 million on 57 million of revenue.  Margin is exploding...

JC Decaux do street furniture in Chicago (as pictured in their 2002 annual report) - and even in places like Chicago the bus companies and the local governments get smarter over time.  In China they seem to get more stupid or more corrupt.  After all the Chicago local authorities are doing better at extracting the margin from advertisers than Chinese bus operators.  Unusual.

But who am I to question this?  Delloites is the auditor and there is 170 million on the balance sheet (representing past-profits) and that is a pretty easy thing for an auditor to check.  So I am just going to conclude that the people who run Chinese bus companies are stupid.

Really stupid.  Or really corrupt.






John


Post script:  For the avoidance of doubt the fund I know that was heavily short CCME was covering the whole way up.  They are no longer heavily short CCME.  They did however lose meaningful money.  


They would have been only a small part of the volume.  There are probably more than one party caught in this squeeze.  Whether the squeeze is over?  Who knows.


Correction:  Several people have observed that the CFO is not sub 30 and not educated at an Australian university.  I stand corrected.  There is a young director of CCME who is also the financial controller of another listed company that fits that description.  I wrote this from memory and confused my directors.  The registered office of the company however is a serviced office in Hong Kong - the same serviced office as that young director operates out of.

33 comments:

orin said...

Question is whether they can stay corrupt longer than you can stay solvent.

Iceman said...

Hi John,
Two points about the persistence of strong margins:
1. Scale is very important in advertising, both on the supply and demand side. CCME has it, the bus operators don't. None of the operators are large enough to possess significant negotiating leverage unlike other out of home ad markets like public buildings, subway, or airline. On the demand side CCME is the only company with significant scale in the inter city bus segment and obviously that is very important to advertisers.
2. CCME has aggressively gone into the airport shuttle bus market over the past year. This segment has even higher margins than the inter city buses due to more upper class passengers.

justin s said...

what you fail to take into consideration is price, which is a direct function of margin. CCME cpms continue to remain far below the competition and well-well below avg cpms in developed markets. ccme has the potential to continue to grow price, just announcing a 15% increase. the big multinational brands that are buying including the CCMEs Fortune 500 customers, aren't blinking an eye, they want the chinese consumer. what you also fail to take into consideration is the level of contracts driving expansion into new regions and airports, including governmental agreements with the ministry of transportation. what these "stupid" bus operators are doing is literally installing new equipment with CCME and new revenue and content programming into their often long bus ride experiences- 1hr+. i am happy to see such named shorts are so short-sighted, cause i am taking it very easy here.

Anonymous said...

You are both really stupid and really corrupt.

LaVerne said...

Perhaps you missed these.
(mostly Chinese but translated later in the speech)
http://www.youtube.com/watch?v=tli7AI2r9Io

http://www.youtube.com/watch?v=j78H0QL8Q5o&feature=related
(Chinese bus tour for investors)

http://www.youtube.com/watch?v=kvgX477BMR4&feature=related

Timothy Conway said...

John, your article reads more like a warning to shorts than to longs --a refreshing change of tone.

One of the first things to be pointed out about CCME is that they have been thoroughly vetted by not one but several sources:

First, the original SPAC co. TMI, which was looking for a superior company with which to merge.

Then by Starr Int'l, founded by Wall Street legend and pioneering China biz expert Maurice "Hank" Greenberg (NOTE: AIG's irresponsibly toxic derivatives were massively ramped up by the CEO AFTER Greenberg, not during his tenure).

Starr Int'l further engaged THREE outside investigators of CCME in different avenues of research.

CCME was more recently vetted by independent analyst firm Global Hunter --analyst Ping Luo and the firm went on record on Oct. 15 to specially note that they had done wide-ranging extra d.d. to obviate any possibility of fraud with CCME. GH and Luo are putting their reputations on the line with their staunch defense of CCME against fraud charges.

We could add all the d.d. and vetting that has been done by at least 3 major investors (Fernando / "Drexion2004" at InvestorsHub.com and his colleagues) who also attended CCME's Investor Day --and who own between them about 7% of CCME's share-float.

You mention the CFO's background... CCME's CFO Jacky Lam is a former auditor with PWC (Price Waterhouse Coopers). He is very responsive to shareholders, unlike many or even most CFO's you will ever try to contact. You can email him at jackylam (at) mediaexpress.com.hk if you have further Qs.

Now John, though you won't recommend going either long or short, I WILL, having studied CCME for nearly a year and dialogued with major shareholders on CCME's pros and cons. I STRONGLY RECOMMEND CCME as a major "BUY" investment here (and i've backed up my recommendation with a lot of my own money).

CCME's numbers are quite real-- you've got amazing and improving profit margins, an EPS for 2011 that will likely be greater than all its major peers combined (FMCN, AMCN, VISN), and ongoing growth with the expanding # of inter-city buses and much more profitable airport shuttle buses. (Not to mention new and looming revenue streams with tourist buses and likely also high-speed trains, "Skymall" type direct selling to passengers, etc.)

The co. is also overtly talking to shareholders and analysts about instituting a regular, substantial quarterly dividend starting next year.

Finally, it's no small matter that CCME's CEO Zheng Cheng is evidently a devout Buddhist, and the co.'s mission statement (see www.ccme.tv/en/culture.aspx?id=1) is all about hard work, integrity, virtue, service and deep empathy and loving-kindness for fellow workers, clients, contractors and for the public who see the ads run on their set-up. The Buddhist texts that Zheng reads for himself and to his employees speak very often and very clearly about the LAW OF KARMA.

So I'll trust him with my investment money far more than i will trust the CEOs of many American and European companies who have no such understanding of "big picture" karmic dynamics concerning right and wrong.

One very last point: the reason that China's Ministry of Transport has given CCME a virtual monopoly with the high-margin inter-city bus contracts and likely more and more bargaining power with other segments of this overall new media advertising space (airport buses, high speed trains, etc) is that they TRUST China Media Express to only allow wholesome TV programming and advertising and not be culturally "subversive" with unwholesome content. That's a primary factor in CCME's amazing and continuing success story.

John Hempton said...

There was a comment which I accidentally deleted which noted that I was posting a warning to short sellers.

I was. The risk in short selling in any quantity is very high.

Our short position is FAR less than half a percent of the fund. If the stock quadruples it will cause us a bad day - but not in any way threaten us. There is no issue about us staying solvent.

But I was observing that this was a short squeeze par excellence. And they are exicting to watch.

I short trivial amounts of short squeezes. This is a trivial short. I will do this without any strong opinion on the stock. I express no strong opinions here. Someone is corrupt - but it may well be the bus companies not the management on CCME. Do not know enough to express an opinion.

Understand it that way.

Schito said...

John, it's really very easy to figure out why the margins exploded this year for CCME. Just look at their 2 new big business segment. Embedded ads and even more important the new airport shuttle bus business segment.

It's well known that the demographics for the airport buses are much better and therefore the rates are much higher. Also the embedded ads have huge margins and the company explained why.

So it's not that CCME did grow their sales and their margins in their usual business only, they have expanded their business into very profitable additional segments and therefore grew their margins so fast.

It makes perfectly sense. Ping Luo from Global Hunters was in China checking all the bank statements like she acknowledged in her last report and everything was accurate. I'm sure we can safely say she wouldn't lie about such thing openly.

gunnar said...

John, there are a couple of inaccuracies in your article. The CFO is not under 30 years old, he has multiple degrees and has 8 years at Price Waterhouse prior to CCME. Re the 'stock promoter', this never happened. If you are referring to otcjournal.com, they were not compensated for their coverage and purchased their 1k long shares on the market (see the web site's disclosure section).

I fail to understand why you feel someone must be corrupt here. The only corruption I've seen is from endless lies posted on the interweb re this company. Yet no one has ever backed up these anonymous assertions with facts. As you stated - the business model is simple and the company is fully vetted.

Jaap said...

the worst short ever imo has been Volkswagen. at some point, it had the largest marketcap in the world (past Exxon)
in the end it netted us (equity options traders) a small amount, despite huge margins and enormous losses once in a while.
remember, one billionaire killed himself over it.

John Hempton said...

Ah - Volkswagon/Porsche...

That was a strange arb...

The Volksagon borrow never became impossible and the Volkswagon short worked in the end.

IF you were 1 percent in the short - you probably lost money (forced covering). We might have lost a little.

If you were 5 percent in the short (as many were) you had a VERY BAD TIME.

We short MANY stocks in SMALL QUANTITY. This is the reason.

J

Anonymous said...

John, you should check out the Brazilian bank called Banco Panamericano that was caught with fraud last week. The auditor there was also Deloitte and the Brazilian Central Bank found a 2.5B hole in this bank that had 12B in assets..

Anonymous said...

It sounds so much like Antony's speech at Caesar's funeral:

But Brutus says he was ambitious;
And Brutus is an honourable man.

====

Memo Mr Hempton: Don't use anaphora unless you really mean to insinuate shady goings-on.

Jaap said...

well, the Volkswagen short worked in the end because the company was overvalued any dime over 70 euros. the whole market knew, but noone was able to make it happen. ego's at the NRW-government, Porsche and VOW.
the guy who put all his owned in shorts, lost his empire and his life.

another value investor said...

I don't know why WSJ would link to your post as a "worthwhile read of short analysis"... article is weak at best.

Timothy Conway's comment is a worthwhile read though.

Anonymous said...

JCD sign 15 year deals in the UK with local councils for bus shelters and then extend them 5 years into the deal - poor council officers think they are getting a good deal - never know just how profitable the deal!!!!

Steve said...

I find it hard to compare CCME's accounts to any banks accounts. CCME has an incredibly simple business model, income is essentially all cash, minimal debt, minimal accounts receivable, very few physical assets... If there is something amiss and Deloitte is not catching it I would be shocked. A bank on the other hand has an incredibly complex balance sheet.

I guess the conclusive evidence that CCME is indeed legit will be next March when their annual 10-k is filed and Deloitte has announced that the cash flow we are seeing is in fact real. I am on the side betting that Deloitte is not being tricked by the simplest business model of all time and that CCME is just starting its ascent towards a fair valuation.


Side note: it does appear that there is a lot of riff raff that has somehow come to market via these reverse ipos. I find it rather amusing how often fraud! is screamed. On the other hand how can one lump CCME in with these shadier companies. CCME has a legitimate auditor (Deloitte), experienced CFO (Jacky Lam formerly of PWC, and a rather serious amount of cash flow (I think this is one of the keys here that isn't thrown out there often enough, the cash is the key). I think in the next year a variety of fraud will be uncovered in the market but CCME will definitely not be one.

Second Side Note: Any talk of margin compression seems absurd. Right now the cost per minute charged by CCME is incredibly low compared to any other form of media. If the bus operators do decide to increase their rate then CCME should have no problem increasing cpm and maintaining, if not improving!, their current margins.

Potato said...

John, good to see you back at the blogging, after over a month without a post I was starting to worry!

An unrelated question for you: Ontario (Canada) has just announced that it intends to regulate derivatives. Any tips for me to pass along to my MPP on how to make regulations that are actually fair, easy to enforce, and actually effective at preventing future systematic risk? (To my thinking, a central clearinghouse and transparency are just the first step, a needed infrastructure for there to be any hope of enforcement of other regulations).

Anonymous said...

Welcome back John you are truly missed, read and loved by many!

Having had my own expensive time consuming litigious battles I can only hope you are coping better than I did.

Potato,
Hello my fellow Canadian!
Any tips for me to pass along to my MPP on how to make regulations that are actually fair, easy to enforce, and actually effective at preventing future systematic risk?

Here is a tip from Alberta..
We do not even have a national regulator.
Canada has over a dozen and they speak 2 different languages French and English.
Regulating derivatives is impossible as our present structure is flawed to the core.

Davide said...

Hi John, I was gathering information about CCME and the "net" brought me here. I am interested in this company and i am looking for a long position entry point at 14$ or lower.

You said you're short on the stock but your arguments didn't convice me. In sum you wrote:

1- The managment have little experience. (But they are delivering results)

2- Fat margin don't last forever. (Sure, but you can check the margin quarter after quarter and get out of the stock in time)

3- There might be fraud (but you reminded us that the auditor is reputable)

Are there more reason to short the stock?? I'm sure there got to be more reasons for you to short CCME.

I hope you'll forgive my poor english but i am only a young student from Europe.

Best Regards, Davide

Ted K said...

John,
Hope things are going well for you recently. I assume you caught this little piece of news today, which I imagine you took as sweeeeeeeeeeeeeeet!!!
http://www.zerohedge.com/article/rino-signs-own-death-sentence-company-likely-be-halted-forever-chinese-ipo-craze-fizzles

Anonymous said...

Over the past few months, the topic of financial filings with China’s State Administration for Industry and Commerce (SAIC) has made frequent appearances within the U.S.-listed Chinese RTO (“reverse takeover”) sector. I and other critics have advocated that AIC filings are important data points in determining whether certain Chinese RTOs are falsifying their SEC financial statements. In cases where AIC-reported revenue, profit and assets are substantially lower than SEC-reported financial figures, we’ve claimed that this provides material evidence that the companies in question are fabricating their SEC financials.

Our arguments have made sense to many investors, but some remain unconvinced. Misleading responses by certain of the alleged frauds that AIC filings don’t matter have muddled the debate. These companies, such as CMFO, LIWA or CSKI, have claimed that AIC filings are unimportant and are not taken seriously in China, and that investors should not use these filings as data points when analyzing U.S.-listed RTOs. I strongly disagree.

The point of this article is that AIC filings do matter.

Anonymous said...

CCME has a network of 34,000 displays and revenue of US$96 million. This implies a revenue of US$2,800 per screen per year.

VISN has a network of 66,000 displays and revenue of US$106 million. This implies a revenue of US$1,600 per screen per year.

FMCN's has a network of 131,000 displays and revenue of US$229 million (LCD display network only). This implies a revenue of US$1,750 per screen per year.

I just don't see how CCME can command a pricing 50% premium over FMCN and VISN, unless there is something I am missing.

Anonymous said...

1) The official pricing for 15 seconds on 1000 buses per 15 sec is currently at about 200K RMB at a coastal province.

2) CFO quoted utilization rate at 90% in March. VISN and FMCN are far lower. You may wonder if 90% is too high, but the fact that they are migrating to direct sales means that they don't care about the ad agency that much, which they probably won't do if the utilization rate is low.

3) The company pricing, as far as I could see, is at par with VisionChina. The company's claim of lower CPM than Vision and Focus is probably due to means of measure.

Anonymous said...

CCME has 50% of market share with no national competitor, The only regional competitor is a company in Zhejiang province.

blake said...

am sure you have already seen, but in case you haven't, the latest claim is against Chinese education stock CEU by Kerrisdale. Link to the report is here http://kerrisdalecap.com/wp-content/uploads/2010/11/CEU-Report-November-2010.pdf

Anonymous said...

to call The University of Wollongong "distinctly second tier" seems a bit harsh, don't you think? I always considered it to be just outside the top 10 (11-12) - when I think second their I usually think the likes of UWS or Deakin.

and no, I am not, nor ever was, a student at Wollongong.

Anonymous said...

John, As of today's short interest report, short % is at its highest, 48% of float = 4.8mil+ shorts on it. Maybe the same fund got back into the game, looks like there is going to a part 2 of the squeeze soon.

Anonymous said...

Explain this to me: How does Deloitte get fooled by the cash accounts at CME? And why does a company that's supposedly trying to fool their auditors hire - at great expense - a top-notch auditor that will scrutinize the books 10 times more closely than some low-brow auditor that would cost them less money. A giant auditor like Deloitte sends a team into a company's offices and scrutinizes every aspect of the firm's business. They will verify customers, revenues, expenses, cash balance, taxes owed, taxes paid, operating agreements, you name it. And they charge a lot of money to do that, they are the best at what they do and it takes a lot of time and expertise to perform an audit on that level. And if the company is unusually profitable or performing better than other companies in the sector, then a world-class auditor asks questions and finds out why. Basically, hiring Deloitte is the most expensive and most intrusive choice a company can make.

CCME is therefore legitimate.

Anonymous said...

SAIC - here is the reality, minus the spin:

http://www.nyggroup.com/library/NYGG-SAIC.pdf

SAIC is a moot point anyway, this year CCME will submit matching audited numbers to PRC-SAIC and US-SEC (to the extent possible within respective accounting requirements).

Hint: the SAIC numbers will be adjusted to match the SEC numbers, not the other way around.

No one in China has accused CCME of tax evasion. SAIC was not an issue until it was raised by the investment community, and the company is rectifying the situation shortly - the new SAIC is filed in March/April.

Anonymous said...

So, after reading all the blogs about CCME, I am wondering if anyone has a different opinion than before. I noticed that the Directors and 10-18% owners of CCME have been selling significant shares since last August. Doesn't that say something?

Matthew Robertson said...

Coming and reading all these comments after all this time made me squirm and was pretty painful. Poor longs.

http://finance.yahoo.com/q?s=CCME.PK

Steven Solieri said...

John,

In the blog you mentioned that ONE of the negatives that stood out was that "the company once used a stock promoter that was previously associated with some frauds" can you assist me and identify that promoter? I am a Professor who is writing an article about the CCME fraud.

Dr. Steve Solieri, CPA
Queens College, CUNY

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.