Thinking about the Abacus sign

The widely distributed - nay viral - picture of a young woman carrying a sign referring to Abacus - the much litigated Goldman Sachs/Paulson/IKB deal got me thinking.

Here is the sign for the small number of you that have not seen the picture:

It says that "It's wrong to create a mortgage-backed security filled with loans that you know are going to fail so that you can sell it to a client who isn't aware that you sabotaged it by intentionally picking the misleadingly rated loans most likely to be defaulted on".

I can't help but agree except this is not what happened in the Abacus case. The Abacus security was an entirely synthetic security. It was not filled with loans that were intentionally picked, it was loaded with derivatives that someone thought were most likely to be defaulted on.

That is an important distinction. If Goldman had created a security filled with bad loans and sold them there is no way that the client would be able to work out that someone was betting against the loans.

But that is not what happened. It was filled with derivatives where it was obvious that a financially sophisticated counter-party was taking the other side. Indeed what the security was was the reverse side of a bundle of bets against mortgage securities bound up by Goldman Sachs and the simplest understanding of it revealed that fact. Sure the buyer did not know it was Paulson taking the other side of the bet. (Indeed, given Paulson's latest run the fact that was Paulson neither adds nor subtracts from the case for buying or not buying the Abacus bundle.)

I think Goldman Sachs was done here unfairly (although it is hard to imagine it happening to more deserving people). Anyone who was financially sophisticated (and IKB certainly portrayed themselves as sophisticated) should have realized there was an opposite side to that bet and that someone had deliberately taken the opposite side with respect to every derivative in the bundle.

Now contrast this with what happens when I make a short sale. I borrow a security from a broker which is identical to any other security with the same cusip number. I sell it in the market. The person on the other side purchased a security and they have no idea whether they purchased it from a long or a short.

People who buy securities from me in the regular securities market are at a disadvantage to IKB. IKB knew there was someone making the opposite bet. When we make money short selling (and we have made plenty) the people who lose have no way of knowing that Bronte/John Hempton was on the other side of the bet.

I am (in part) a short-seller. I regularly try to stuff the market with securities that are "intentionally picked" as "most likely to be defaulted on".

Where is my sign?


John

Huabao: derivative transactions and disclosure

Huabao - a fragrances and flavors company and the subject of attention on this blog - has suffered a rapid stock-price decline lately.

The company put out a press release related to the unusual activity in the stock.

To quote:

UNUSUAL PRICE AND TRADING VOLUME MOVEMENTS 

We have noted the recent decreases in the price of the shares and the significant trading volume involved of Huabao International Holdings Limited (the “Company”). Save as disclosed below, we are not aware of any reasons for such incidence. 

We have been recently notified by Ms. CHU Lam Yiu, the controlling shareholder of the Company,  of her entering into a derivative transaction on 14 October 2011 relating to a long position of a monetary value equivalent to 94,736,842 shares of the Company with a contract period starting from 14 October 2011 to 13 January 2013...

I have a simple question: what is the "derivative transaction" that Ms. CHU Lam Yiu entered into regarding over 94 million of her shares?

In my world all derivatives can be bifurcated into a series of forwards, put options and call options. (The bifurcation is alas not unique...)

Unless I am mistaken then she has either

(a) sold her shares using forwards in which case it is effectively a forward sale (she has just cashed out and used fancy language and derivatives to obscure this fact),

(b) sold the upside of her shares by selling call options or

(c) protected the downside of her shares by buying put options or

(d) some combination of the above.

All of those are bets against her shares in some form or other. Of course I can be mistaken, but it seems the CEO is betting against her own shares using derivatives.

I am also betting against her shares - so I have something in common with her.

But not much.

You see I am just a guy who reads public filings. She is the controller of the company and the world's youngest self-made female billionaire. She is a smart cookie too: took her company public via reverse takeover, sold a chunk of shares in 2008, and again in 2009 and again recently. She is, on some lists, the eighth richest woman in the world.

And she still seems to be betting against her shares. Mostly she sells at lower prices.

But whatever: I think we are entitled to know precisely the nature of the bet that the CEO has taken against her shares.

I am happy to disclose my bet: I am short. Ms. CHU Lam Yiu, it is your turn to disclose.




John

Huabao and the Queen of Cashout

The Shanghai Daily (subscription required) has taken to calling Zhu Linyao as the "Queen of Cashout". She is otherwise known as the controller of Huabao - an interesting company I have previously written about.

She is the second biggest insider-seller of any Chinese stock according to this list - having cashed out about half a billion US dollars this year.

I have now emailed with many people who have an interest in Huabao. Some visited the (recently purchased) reconstituted tobacco leaf plants - and they were moderately impressed. Some visited the flavors plant (the legacy business) and they found a few blue drums and a vat full of strange liquid but nothing redolent of a business then worth over USD3 billion. They ran a mile from the stock.

The most impressive website any of the people I communicate with has found is for their Peacock brand. They sell 572 products (far less than most retail shops) including "tomato sauce" and "cheese powder". Press "new products" and you get a one word answer: "no". A similar response is given for "food flavor". Isn't this meant to be a flavors company?

This compares as I noted in my previous blog post with maybe 100 thousand pages of text on the website of the major company in this industry (Givaudan).

It is unlikely you make 60 plus percent margins reselling flavored yogurt on an obscure Chinese website. I am not joking - see this link.

The only way that the margins - almost five fold the margins of Western competitors - are possible is by selling at an inflated price to the Chinese state owned tobacco companies. And indeed that is what the bull story is as many of my readers have pointed out.

I can neither confirm nor deny the existence of those sales. My only correspondents who have visited the factories responsible for those sales found a few blue drums. But there might be a large and complex factory behind that or there may be other sites so their word should not be taken as complete.

Moreover Price Waterhouse Coopers audited the accounts and they tell me the sales are real so I presume they are. Whatever: if real it is likely that one day the State Owned Enterprises will try to renegotiate the deal which seems unreasonably favorable to Huabao...

Maybe that is why Zhu Linyao is the "Queen of Cashout".



John

Bronte Capital enters strategic partnership with Diageo - maker of Guinness beer. Oh and a comment on Trina Solar

Bronte Capital have entered into a strategic partnership with Diageo - the maker of Guineess. But we haven't really. We are in a pub in London knocking back a pint of the black liquid. Guinness tastes better in the old country. [It is the old country to an Australian...]

We now have a commercial arrangement with Diageo - albeit a temporary (though tasty) one. But that has not stopped us writing a press-release trumpeting this "strategic partnership". I may send a copy to the news wires to see if they will run it.

In all seriousness they probably would. They ran this:

CHANGZHOU, China, Aug. 17, 2011 /PRNewswire via COMTEX/ --
Trina Solar Limited (TSL) ("Trina Solar" or the "Company"), a leading integrated manufacturer of solar photovoltaic (PV) products from ingots to modules, today announced that through its subsidiary, Trina Solar Australia Pty Ltd, it has signed a strategic partnership with Origin Energy Australia ("Origin"), the leading Australian integrated energy company.
Under the terms of the agreement, Trina Solar is expected to supply Origin with approximately 22 MW of PV modules over the next twelve months starting from the third quarter of 2011. 

"We are delighted to initiate our relationship with Origin, Australia's leading energy retailer and the country's largest green energy retailer with significant investments in renewable energy technologies," said John Susa, Trina Solar's Country Manager of Australia and New Zealand. "We are confident that this long-term partnership with Origin will bolster our ability to expand and strengthen our market position in the residential segment."

Being a cynical sort of guy - and knowing that Origin Energy are reputable I checked this release. Here is what Origin said.

Hi John, 

Origin has not put out a release as it is simply part of our ongoing supply arrangements and not material in its own right.  Trina is one of a number of suppliers we use. 

Cheers,

Angus

Angus Guthrie
Group Manager, Investor Relations

I blogged this response here.

I almost did not need to check. When a party announces a "strategic partnership" and the press release offers contacts from only one side of the deal then you should be skeptical. Indeed it can hardly be strategic if only one side comments.

There are other strategic partnerships announced by Trina. In all cases there is no contact given for the "strategic partner", for they once announced a strategic partnership in Italy.

I am going to be blunt. The Origin press release has as much substance as Bronte's "strategic partnership" with Guinness. I have no idea about the other strategic arrangements but Trina says some strange things about Italy. For instance in the last conference call the chief operating officer said:

I have been waiting for Italy since I got here. So, we are actually seeing some good activity finally. And we have some pickup in activity. We see it. Obviously, our historic Italian account is at the utilities. We also see Spanish accounts that a lot of them actually served projects there. So, after much waiting and unclarity, we are seeing some pickup in demand. There is – we still have a mix of utility projects in commercial rooftop there. And so what we are seeing moved quicker was the stuff that was utility that was finishing off and now it’s blending into commercial rooftop.

It is possible that Italy was taking off just as he said this - but it seemed unlikely to us. After all the banks in Southern Europe were under sharply increasing financial stress at precisely the time of this conference call and funding for long term projects (like solar) was drying up. I did not believe the statement. Maybe it was true - but there is a problem with statements about insignificant "strategic partnerships". Those statements predispose you to not believe further statements.

So here is what I believe. I believe Trina is burning cash increasingly fast. So fast that it is in deep trouble.

Trina, through operating cash burn and capital expenditure chewed through $136 million last quarter. I blogged the calculation here. Chinese banks funded this.


The average selling price during the quarter was $1.46 per watt (reference given here).

The prices per watt have fallen to $1.10 or below when priced wholesale.

So revenue per watt is running 36c lower than during the quarter.

The costs per watt have dropped too. Polysilicon has dropped from say $48 to $38 per kilogram - but exact numbers are hard to find.  At 6 grams per watt the costs per watt thus dropped 6c. Efficiency gains add another 2c reduction in costs per watt.

Nonetheless margin per watt will be 28c per watt lower than last quarter.

Production is going to be (at least) 450 million watts - so aggregate margin is going to be $112 million lower than last quarter.

There won't be any tax paid - or anything like that - but the company looks like it will burn through $136 million plus $112 million in cash - more if stuff keeps accumulating in warehouses - less if the hard-selling they are doing actually works.

$248 million per quarter - or roughly a billion dollars a year is a little bit much for Trina to bear.

Unless there is something dramatically wrong with my calculation Trina is doomed. Not even a Chinese bank comes at a billion a year funding requirement just to stay in business.


Now of course all of this is my estimates. I can only go on public information and my own inquiry and my own analysis. I wish I could just use Trina's statements but - and it might just be the PR people who have done this - Trina has devalued its statements with overblown puff pieces about "strategic partnerships".

But I have trouble trusting Trina. And you should have trouble trusting me. I am effectively short the stock. Besides, I have just entered into a very enjoyable "strategic partnership" with Diageo.

And I might just have another Guinness.


John

Going one up on Jeff Matthews with Chaoda Modern Agriculture

Jeff Matthews (he of the fabulous blog and excellent book on Warren Buffett) tweets every day his least helpful broker call. His twitter stream is here.

His latest tweet:

JeffreyMatthews Jeffrey Matthews Least Helpful Call, So Far: JPM cuts price target for TRMB (gps for construction) from $51.50 to...wait for it...$47.50. Last trade, $37.49.

Jeff however does not follow Hong Kong listed frauds.

Today I received a copy of Felix Fok's latest piece on Chaoda Modern Agriculture. This is from JiAsia - in other words from Societe Generale. To quote:

Ji Asia is terminating coverage of Chaoda Modern Agriculture (Holdings) (682 HK, HK$1.10, Ji BUY, Target HK$10.50).

The price on my screen is 55c but it is not trading any more.

The reason stated by Felix Fok is "following a realignment of resources within the team".

Chaoda is suspended for a reason: it is almost certainly a grotesque fraud.

The buy was a bad call. The dropping coverage: that was clearly the most useless call of the day.



John

Disclosure: Proudly short Chaoda Modern Agriculture.

Anarchists for good government

Today was my one afternoon of being a tourist in New York. After the return trip to the Natural History Museum I went downtown to see the "Occupy Wall Street" protest in Liberty Square. I had no clue about their agenda and the general description was that they did not stand for anything. If they stood for something like bringing back Glass Steagell maybe we would understand it and maybe they would achieve something - but it seemed far more unfocused than that.

My goal was to work out what they wanted and for that I was going to use a simple research tool. I was going to ask them.

On the periphery I found gold-bugs and anti-fed activists - not really part of the main group. They were a lonely looking lot. This photo of one, standing alone, describes them accurately:

Somewhere between the lone-ranger gold-bugs and the protest were the police. They were numerous and one of their horses startled and scared me. One protester was walking by with a placard protesting the extent of police presence and the seeming cost of that.

I thought he had a point. To an Australian the police seemed far more scary than the protesters though when I asked a protester about them he thought the police were "well behaved".

The first detailed conversation I had was with a middle-aged guy who was there "largely to exercise his first amendment rights" and the "rights embedded in the constitution". He did not really know what he was saying except that he had the right to say it and that it somehow involved good government. He did not like the libertarians (who he thought were rather silly) but he kind of liked the anarchy of the whole scene. And he gave me the quote of the day. The protesters were "anarchists for good government".

Anarchists for good government sounded silly but it was accurate. Whilst there were people carrying placards that said "fight for socialism" that was not why any of the people I asked said they were there. They were there because the system was broken. They thought that income distribution was screwy in America and whilst they thought the Wall Street bailouts might have been necessary they found big bonuses in bailed out banks deeply offensive. And I can't say I blame them.

They almost universally thought that government was owned by "corporations" and uber-rich individuals who have purchased the politicians. A middle aged woman was carrying a placard wanting "no more congressional whores". Almost universally they thought the system did not work for them but it did work for some shadowy elite.

But if you asked them what to do about it they did not know. Some had specific ideas (one argued that the Citizens United Judgement should be overturned). Most however had no specific agenda at all - just a general feeling of malaise about the economy.

A pretty young black woman I spoke to was about the most lucid person I found. She thought the American dream had been narrowed to a very small elite and that class distinction was rampant. She was at the protest because she thought that Wall Street was the most obvious bastion of elitism in America.

I asked her what she wanted to do in life and she said she wanted to work in the fashion industry in New York. I looked at her puzzled and she sheepishly admitted that was another bastion of elitism. Then she told me she wanted to start her own company. I wished her luck. She was charming in her hypocrisy.

This placard best summarized the crowd:

Our economy could be "more fair" is a reasonable statement of desire or even fact - but it contains no prescription at all. The United States has had times of high income inequality (the Guilded Age, now) and times of lower income inequality. And I do not want to say it was the New Deal or anything else that caused changing income distribution. Income distribution in Australia was flattest at the end of a very extended period (23 years) of Conservative government. The economy could be more fair. Then again it could be less fair.

Somehow we have developed a winner-takes-a-great-deal economy. I regret not asking these people if they begrudged Steve Jobs dying with 7 billion dollars personal wealth. I somehow doubt it. iPhones were ubiquitous and they clearly believe that Jobs created something that they wanted.

But they would have universally thought it unreasonable that Wall Street CEOs were so rich when their banks were bailed out.

In other words they had a view that the economy could be more fair and that their definition of fairness actually accords with a lot of other Americans. Plenty of people would agree with them.

The Tea Party protesters in America are also animated by a feeling that the system could be more fair - as are the people who protested the Federal Reserve bank. For that matter the (very small) minority at this protest wanting "socialism" probably feel that way too. The feeling is unifying. The prescriptions as to what to do about it are not.

And the puzzling part of this protest was that there was no consistent prescription and nobody arguing for one - so they were unified by their common feeling and not divided by their hostility to each other's prescriptions.

In other words like most Americans they do not have a practical clue on how to get the sort of economy they want and the sort of politics they want. And so they had no agenda at all.

But most Americans don't go to protests. These people go to this strangely unfocused protest. This man - clearly middle-class and better dressed said it quite well. He was at this protest and he just wanted to tell you that. He had no agenda.

I found the lack of an agenda puzzling as did one life-time protester I talked to (someone who thought that growth-led capitalism would eventually fail because of environmental problems). He thought it was the most anarchic protest he had ever been to (no leader, no agenda). But then he thought the food was better than at any protest he had been to. I repeated the anarchists for good government line to him and he agreed. Then he said, pointing at dinner just being wheeled out, that the food was great. It was also he said anarchists with good government.



John

Happenings in Little Italy: nurses and litigation risk

This evening I was in a restaurant in Little Italy New York. Fine place too.

The maître d’ asks loudly if there is a doctor in the restaurant. Nobody responds. He asks again. Nobody responds.

I have a surf-lifesaving first aid certificate and volunteer at Bronte Beach. (I have previously blogged about that.) In the absence of anyone else I volunteer.

The victim has fallen over (his wife later tells me he was drunk) and he has hit his head - but for all I can tell he had a seizure. Whatever: he was barely conscious and was not answering his name or details.

Still he has landed in a recovery type position or moved to a recovery type position. His mouth is pointing down. 

I checked that he was breathing - and he was - his chest was moving up and down.

I checked what was coming out of his airway - and it was weak - and there was some blood coming out of his mouth - maybe consistent with biting his tongue really hard or maybe consistent with something really nasty. There was quite a lot of blood coming from his head but there was nothing I could do about that without moving him (and I was not prepared to move him). I checked his pulse and it was weak. (I did not expect otherwise - he was breathing...)

I asked him a few questions and I got no answer but he said he hated this and then said nothing sensible again. I did not get a name.

I did not see any upside in moving or treating him so I just chatted to him (without response), monitored his breathing and waited for the ambulance.

In the midst of this I worked out that two women sitting at a nearby table were nurses. I can't tell you how inappropriate it was that I was doing this and the nurses were sitting there. They are well trained - I did a 40 hours course 5 years ago. If it were me lying there unconscious and bleeding I would want the nurses looking after me... 

But they would not - even with pleading - take over. They were scared of litigation risk and they said they could not touch him. I did not move him and ultimately he was neither better nor worse off for the fact I was there. (Moving him when he was still breathing is beyond my pay grade. But I would still have preferred not be involved...)

I am an Australian who loves America. Many things are better than Australia. Many things however are worse.

Litigation risk that means a nurse would rather sit there watching an unconscious person bleeding rather than help them - that is something that is worse about America.

John

Post Script:

I do not doubt there are Good Samaritan laws that apply. There are specific ones in NSW for volunteer surf lifesavers. However it was commented later that if the request had been for a lawyer in the restaurant the hands would have all gone up. And the nurses were genuinely scared of litigation...

J

Elegant ladies in high heels, water at $1000 per liter and Huabao, an interesting stock on the Hong Kong Stock Exchange

A couple of years ago my wife and my business partner's wife turned up at our office in Bondi Junction and then went shopping in the mega-mall below.

This is the sort of thing that gives a tight-wad like me nightmares.

A couple of hours later they returned with their bags. My wife was wearing a new perfume which I kind of liked.

I would have told her I liked it even if I was completely indifferent (she is my beloved wife) but I could say it honestly. It was Chanel Gardenia.

This was about a month before our tenth wedding anniversary so I had solved the gift problem – or so I thought. Later I popped down to DJs (think Nordstrom for Australia) and Myer (the also-ran department store) looking for Gardenia. No chance. Eventually a customer took pity on me and told me you could only find this at the Chanel shop.

I could see the bill going up.

I found the Chanel shop in a part of the mall I never visit and the shopkeeper (an elegant woman in high-heels who looked straight through me) eventually showed me the perfume which came only in sizable and expensive bottles. Three minutes later and $230 lighter I had my gift.

Mission accomplished.

Australian labeling laws require that Chanel specify some of the ingredients. Here is the label (now somewhat decayed):

It is a pretentious label. They call water “Aqua”. Guess they can't bring themselves to admit they sell water at almost $1000 per litre. Alcohol is the main ingredient – probably a good proportion of the total. Most the rest I had never heard of.

Being an inquisitive type I looked them up – I even looked on Alibaba for the cost (per tonne) of these chemicals so I could get some idea of how much I was being ripped off by the fancy box and the elegant lady in high-heels. It spoiled the romance but was educational. According to Wikipedia, Citral is a 3,7-dimethyl-2,6-octadienal or lemonal, is either of, or a mixture of, a pair of terpenoids. The E-isomer is known as geraniol (also an ingredient of the perfume). It is pheremonal in insects (and in the hope – probably vain - of the perfume manufacturer pheremonal in humans too). There are lots of suppliers on Alibaba – mostly by the barrel. Most of these are distributors for Givaudan – a Swiss flavors and fragrances business.

Linalool is a major fragrance chemical used – according to Wikipedia – in 60-80 percent of “perfumed hygene products” and also by pest-professionals as an insecticide. (Note what this perfume does – drives insects wild with pheremones and kills them. Think what it can do for you!) Again most the distributors on Alibaba are distributors for Givaudan. You can buy it here for $5 a kilogram and they will sell you 1000 tonnes per month. It is kosher (and Halal) too!

From there I went looking at Givaudan – the company that probably manufactured this fragrant “Aqua”. It is an interesting company with an enormous website containing technical specifications (instructions, FDA approvals etc) for the thousands of flavors and fragrances it manufactures. When you see apple-pie and cheesecake flavored yogurt what you are seeing is their fine Swiss technology. There are - if you do a Google count - about 11 thousand pages on this website. This is a sophisticated and wide-reaching business.

Givaudan is an interesting stock (we think about it as a long) and it is currently trading fairly low relative to sales vis its history. It is the technological leader in flavors and fragrances.

Here is its P&L in Swiss Francs for the past two years...

This company does CHF336 million (almost 400 million dollars) a year in research and development. That is what your cheesecake flavored yogurt and Britany perfume cost to develop. This R&D is a pretty solid barrier to entry. After quite considerable distribution costs (you have to interest the food manufacturer in the bizarre terpanoid you have developed) and considerable R&D Givaudan winds up with operating income of 13.1 percent of sales.

There is another flavors and fragrances company – International Flavors and Fragrances – that used to be the leader and is still the leader in tobacco flavoring (a declining business I would guess). IFF is well known to people who have read the investment classic “Common Stocks and Uncommon Profits”. IFF had a tech leadership for generations and was a fantastic stock - it is still not a bad one. Somehow (I don't know how as I do not have the history) it ceded much of that leadership to Givaudan.

All very interesting and grist for the memory bank.

Recently I came by Huabao – a Chinese flavors and fragrances company listed on the Hong Kong stock exchange. Market cap is about 20 billion Hong Kong dollars - about 2.5 billion USD.

The web site clearly is not as sophisticated as Givaudan. Counted pages on the site in Google total 49.

Huabao has a market cap of a bit over a third of Givaudan, and is a strange beast. Like IFF it claims to be primarily a tobacco flavorant. Here is the P&L.

Huabao it seems is a truly miraculous business. Gross profit is over 70 percent. Marketing and distribution expense is 80 million Hong Kong dollars – roughly a twentieth of Givaudan. Research and development expenses are 73 million HKD – a little over 10 million or about a fortieth of Givaudan's expense.

Profit before tax is 1871 million Hong Kong dollars on total sales of 2852 million HK dollars. That is 65 percent of sales and it compares (very) favorably with 13 percent at Givaudan of sales.

Huabao gets superior margins – nay vastly superior margins – whilst doing much less R&D and having much less selling expense. Truly miraculous. Givaudan – the putative technical leader – should watch out.

I wanted to work out what Huabao actually sold – what R&D they had – what technology they had that justified their superior returns. Alas this was difficult. You see HBGlobal.com is not a very informative website.

Here – in pictures – is the page (yes one page) that describes their product set.

Compare this page to the very detailed  specification at Givaudan. HBGlobal does not even allow its product specifications to be indexed on Google. (Go on – look at the page – it is pictures of text, not text, and hence not indexed.)

I went looking for all the chemicals in my wife's perfume on Alibaba. I could not find Huabao as a supplier. Nor could I find HBGlobal.

I googled “+Huabao. +citral” and the core reference I found was to Jishui Huabao Natural Medicated Oil Factory being a buyer of citral. Similar results were obtained for other chemicals.

I did this with lots of combinations of chemicals and the brand names they operated under (at least the brand names they operated under according to the HBGlobal website).

The website states that Kongque is a long established food additives brand in China. Kongque turns up in one index as one of literally 40 pages of suppliers for food flavor additives. Here is their entry which tells you nothing about them but gives a limited range of products (Lecithin, Foodstuff Essence, Flavor, Collagen Protein, Stuff Additives, Trichloromethyl Sucrose, Crystalline Fruit Sugar, Phosphate, Water-retaining). I have no idea what "stuff additives" are - and Trichloromethyl Sucrose is also a strange product - according to some links a sweetener 8000 times as sweet as sugar - but I can't find any non-Chinese references to it. Moreover this claim is likely false: saccharine is usually thought to 300-500 times as sweet as sugar and that is sweeter than most of the other standard sugar substitutes.

This tiny list of lightly specified products does not compare favorably to the sophisticated list at Givaudan.

For the life of me I can't work out what Huabao does that makes it so profitable – I can't work out what chemicals it makes, what  products it sells and why it manages to do so with much less research and development than Givaudan (or International Flavors and Fragrances).

Still Huabao must be real. You see it is audited by Price Waterhouse Coopers, it is not a reverse merger and it is listed on the Hong Kong Stock exchange – and we know that the HKSE is far more honest than the reverse mergers in the US. Mr Charles Li, the CEO of the HKSE told us.

So – if any of my readers know more about the flavors and fragrances business than you can get from reading Wikipedia and a perfume label and looking at Alibaba will you let me know.

Please.

Meanwhile – on the basis I can't understand any of this I am short on behalf of my clients. Super-fat margins in a chemical company almost devoid of research and development does not sound very sustainable to me.

My readers are a clever lot – so if you can help me, or talk me out of this position I would be thrilled.

Thanks in advance.



John

Post scripts: Some commentators have suggested that this company is a reverse merger - going public via the back door in 2006. I have not checked.

Also some commentators have suggested that Trichloromethyl Sucrose is the sweetener known in the US under the brand name "splenda". The 8000 times as sweet as sugar statistic sort of matches - and splenda has three chlorine atoms in the structure so cold be "trichloro" as per the name. But I am not sure where the methyls (ie CH3s) come in. There is a structure illustrated here.

Missing Bronte

Travelling, away from my family. And away from Bronte. And missing home.

This cheered me up - a winter swell coming in.

Enjoy.



PURE BRONTE from Marcus O'Brien on Vimeo.

For the avoidance of doubt these waves are much bigger than anything I would dare surf in.


J

Time for Discover

Financial stocks in the US have been very weak.

The consensus is that the situation is bad on credit. I suspect the situation is more likely to be bad on revenue - but either way the consensus is bad for financials.

I am going to give you an anti-consensus set of charts. This is credit data on Discover Financial Services (NYSE:DFS) from their master-trust for their credit card products. The information is from indispensable Portales Partners. They do not like people redistributing their stuff - but I hope they are happy with an advert: if you run a serious amount of money in North American Financials you should subscribe to them. They are likely to make you think.*

Here is the last ten years of DFS delinquency data:

Note that delinquency is near a ten year low.

And here is the charge-off data:

The spike and the collapse in the numbers in the middle of the sequence is the change in personal bankruptcy laws which gave people an incentive to bring forward bankruptcy filings. This meant a spike and subsequent drop.

Net of the spike which was caused by a policy change the charge-offs are about the lowest in a decade.

Delinquency leads charge-offs so given the delinquency is low you would expect the charge-off to drop.

Some of the low charge-offs are caused by high recovery of past written-off debts (recoveries count as negative charge-offs).

Recoveries have come back to a high level.

Observation

DFS are reporting among their best credit numbers in a decade - and they are reporting it in a very sour economy. If the delinquencies really are a leading indicator these numbers will be the best in a decade shortly.

So what is happening?

I can see three broad possibilities:

(a) The numbers are not real - DFS is faking it.

(b). The numbers are real but they are DFS specific and they relate to changes in DFS policy such as a dramatic tightening of credit standards, or

(c) The numbers are real and middle American unsecured credit has improved dramatically despite the recession because consumers have retrenched and really are paying back their loans.

I will leave it to my commentators - you are a smart and well connected lot - to work out which.

But if it is (a) then DFS is a strong sell, and if it is (b) DFS is a strong buy. If it is (c) then there are a wide range of financial stocks you should buy.




John

*Seriously - this advert is warranted. Portales really are one of the better specialist firms out there.

Post Script

I know I am cheating with this list of choices - there are other possibilities like

(d) It is all going to get worse ... so don't buy financials when this data is at its peak (in other words do not buy).

(e) DFS earnings are artificially inflated with recoveries and hence earnings will fall when recoveries normalize (in other words do not buy).

(f) The revenue line for all American financials is toast as per the Japanese experience. So far one of the biggest problems for American financials has been falling revenue but that is not widely commented on outside specialist bank analysts. (In other words sell.)

I left it vague because I wanted to encourage comment. I learn a lot from the comment - but I got many emails that thought I was being unfair and simplistic. So I needed to clarify.

Let me tell a story though.

When I first went to visit BofA in Charlotte (and this dates me) I wanted to ask them about credit. They told me they had 36 billion in revenue and 18 billion in costs and 2 billion in credit costs and that I should watch where the revenue and cost lines were going because they drove it.

That turned out to be wrong of course.

But it may not be wrong in the future.

Post Script 2

I think I should say this is not Discover specific. Consumer credit looks about as good (ie safe) an asset as it has ever been. (It can get worse..) It can also be spurious (extend and pretend for instance).

The best comment yet received by email suggests that I should measure the delinquency against availability of cheap rollover credit cards. Why default - or so the argument goes - when someone will give you a balance transfer and extended credit at 2 percent?