Focus Media: some follow up to the post about the loan from Jiang Weiqiang to the company

In the the second to last post I raised a disclosure about Focus Media needing a $2.5 million loan from the CEO's father to "relieve a temporary shortage of Renminbi":

In March 2006, Weiqiang Jiang, the father of Jason Nanchun Jiang (the CEO/controller of Focus Media), provided a short-term loan to the Group of approximately $2.5 million to relieve a temporary shortage of Renminbi the Group experienced at that time. The loan is unsecured and was provided to us at no interest. The loan will become due and payable in full on June 30, 2006.

I wondered whether the Jiang Weiqiang was the civil servant who worked for the State Council Information Office. Despite gossip from usually well informed sources in China I doubt the link. The reason (links after this post) is that the man who is presumably the father-of-the-groom in Jason Jiang's wedding photos does not resemble the government official.

That said, I am far more interested in content of the disclosure than the personage of the dad.

The company reveals that in March 2006 it was facing a "Renminbi shortage".

This is a super-profitable company generating great gobs of cash in China (presumably great gobs of Renminbi). It is surprising they had a "Renminbi shortage" however I went looking for 2006 accounts to see if I could piece it together.

The March 2006 accounts

Here is the balance sheet from the March 2006 results which show a healthy cash balance both at December 2005 and in March 2006 with no obvious expenditure that would cause a Renminbi shortage in that period.

                         Focus Media Holding Limited
               UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

                         (U.S. Dollars in thousands)

                                                       2006-3-31   2005-12-31
                                                          US$          US$
                                                      (unaudited)  (unaudited)
     ASSETS
     Current assets
     Cash and cash equivalents                          $41,863      $36,653
     Investment in available-for-sale securities         34,792       34,836
     Accounts receivables, net                           37,275       22,235
     Inventories                                            605          480
     Prepaid expenses and other current assets            7,786       45,364
     Amount due from related parties                      2,982        2,073
     Total current assets                              $125,303     $141,641
     Rental Deposits                                     13,245       11,819
     Equipment, net                                      70,993       43,695
     Acquired intangible assets, net                     30,881        1,158
     Goodwill                                           406,791       13,298
     Long term investments                                1,118           -
     Other long term assets                                 221           -
     Deferred tax assets                                    193          743
     Total assets                                      $648,745     $212,354

     LIABILITIES AND SHAREHOLDERS' EQUITY
     Current liabilities
     Short term bank loans                               $1,247         $991
     Short term other loans                               6,778           -
     Accounts payable                                     8,280        5,848
     Accrued expenses & other current liabilities        71,414       11,747
     Amount due to related parties                        2,496           -
     Income taxes payable                                 2,188        2,108
     Total current liabilities                          $92,403      $20,694

     Minority interest                                      460          246

     Shareholders' equity
     Ordinary shares                                         25           19
     Additional paid in capital                         530,088      177,420
     Deferred compensation charge                            -          (247)
     Retained earnings                                   22,430       12,997
     Accumulated other comprehensive income               3,339        1,225
     Total shareholders' equity                        $555,882     $191,414
     Total liabilities and shareholders' equity        $648,745     $212,354

Cash has gone from $36 million to $41 million over the quarter. There was an acquisition in the quarter (Target Media) but they paid for that partly in stock and partly by doing a capital raise. (The observant will notice shareholder equity going from $191 million to $556 million.)

Bluntly, the acquisition Target Media could not cause a cash shortage - it was USD44 million in cash and the rest in stock. USD44 million was less than the cash raised.

In other words there is nothing in the accounts that quarter that suggests a pressing Renminbi shortage in March 2006.

I thought that there might be a Renminbi shortage because all of the above cash was held in USD. That would be unusual - but it was at least theoretically possible, however the prospectus issued in January 2006 disabused me of that notion. That prospectus raised US Dollars but the company in the prospectus said that the accounts were pretty well entirely in Renminbi (including the cash). To quote:

Foreign Exchange 

We maintain our accounts in Renminbi and substantially all of our revenues and expenses are denominated in Renminbi, while we report our financial results in U.S. dollars. Fluctuations in exchange rates, primarily those involving the U.S. dollar against the Renminbi, may affect our reported operating results in U.S. dollar terms...

It goes on - but we are informed this cash was all in Renminbi.

So I am left puzzled as how there could possibly be a Renminbi shortage which required the CEO to touch up his dad for a loan? I have no plausible explanation.

Two theories - both ugly - though only one very ugly

I have two theories to explain this sudden loan to cover "Renminbi shortage" when there was no Renminbi shortage in the accounts.

The first theory is that dad never lent $2.5 million to Focus Media however dad (or somebody else) was repaid $2.5 million from Focus Media - and the "loan" was just a mechanism for disguised looting. However in this case the dad might not actually be the beneficiary - it could be anyone associated with a large management team - just dad's name was put in as a place-holder.

The second theory is that Focus Media never had sufficient Renminbi cash because all the Renminbi cash generation and cash holdings are fake. In this case the company had US dollar cash from selling to US shareholders (also known as suckers) and had a "for-show" business in China which does not actually generate cash, but does generate plausibility to gain more suckers (and hence raise more US cash). In that case they needed Renminbi cash to keep the whole charade going.

I can't see any other plausible explanation but I am open to suggestions.

The first theory is ugly - it is the theory that Focus Media is being continuously looted. If that theory is correct then it bad for shareholders - but not awful. That theory is that Focus Media is hugely cash generative, only it is being looted by management. In that case the deal can close because once they own it the PE buyers can grab control of all that cash flow and put existing management on a very tight leash.

The second theory however is devastating for shareholders. It is the theory that there is no cash generation here at all - just pretend cash generation. If they really did want for a few million Renminbi the whole business can't be worth very much at all. Probably less than 100 million Renminbi based on demonstrated lack of cash generation. This theory is awful for shareholders because if that is true this stock settles BELOW ONE DOLLAR when the big goes away.

Note to the arb funds

There are a lot of arb funds who hold this stock. Don't think for a moment your downside risk is the stock goes back to $20.

If this is just a looting story (and that really a possibility) this stock goes to $27 and the deal closes.

But if the $2.5 million loan from Dad was necessary because this company actually generates no cash then the stock should settle somewhere between zero and one dollar.

I don't know the answer. Truly. But this is a company with very strange accounts - and there is a high risk the stock is a true debacle.

Arb this at your own risk. I for one will stay on the other side of your trade.





John

One reader sent me a link to some wedding photos for Jason Jiang and his very pretty bride. The Father-of-the-Groom (presumably the man on the far right) does not resemble the man in photos of the senior Chinese officials. So I withdraw the suggestion made to me by several well connected Chinese sources that there is a family link to officialdom.