Paul Krugman vs Mr Bean

Welcome to the newer readers from Paul Krugman's blog. It is the third time (I think) he has linked me and as per usual he brings a lot of traffic.

My post on margin calls is my second most visited post in the past year.

The most visited post however is Mr Bean declaring the European Debt Crisis over.

Krugman is super-smart, has a platform at the New York Times and at Princeton and has a Nobel prize.

But Rowan Atkinson pulls a bigger crowd and doesn't have to say anything.


John

Who has got the margin call?

Bronte Capital tends - as this blog has said many times - to be long large cap and relatively liquid companies at 10-16 PE ratios.

And we are short the wildest range of frauds, fads and failures you can imagine.

Our shorts are small and relatively illiquid. They are also higher beta - so we tend to be 2-2.5 times as long as we are short and that is only mildly market correlated.

The strategy has been wildly profitable for the last six months and is not bad most the time but we do not like days when the market really pukes.

When the market really pukes it is the biggest, most liquid names that get sold. Why? Because you can sell them.

And they go down hardest.  Which is problematic if you are long that which goes down hardest.

So today is not our strongest day - and whilst we are down far-less than market - I can't say I am enjoying it.

But I am fascinated.

You see the desperate selling of the biggest liquid names is a sign of margin calls.

The market is not puking. Some prime broker is puking the stocks held by one or more very large hedge funds.

So lets play the game: guess who got the margin call!

Guesses by email or in the comments...



John

Are prospective expenditure matching funds in Trina Solar's debt covenants?

Trina Solar buys polysilicon and sometimes wafers and sells finished solar panels. They used to talk about polysilicon processing costs and do their manufacturing at a large and impressive factory.

You can get an idea of the processes involved (but not the scale of the factory) with this YouTube promotional video:



They aim to be the largest maker of solar panels in the world.

This is a high profile company. It sponsors Formula 1 and Indy Car which gives the executives the chance to be filmed in front of fast cars surrounded by pretty young women.

My problem is that the more I look at the accounts the less I understand them.

To this end I wrote a letter to management suggesting that they were in (seemingly unnecessary) breach of their debt covenants and they wrote back assuring me they were not.

This post makes public my letter and their response. Some commentary is provided on their response.

--------

First my letter:


Attention Terry Wang, Chief Financial Officer, Trina Solar 
by email: ***@trinasolar.com


Copied: 


Thomas Young, Senior Director of Investor Relations
by email: ir@trinasolar.com 


***


Puzzling over Trina's debt covenants


Dear Sirs


I am a hedge fund investor based in Australia. I am also the writer of the popular Bronte Capital blog. The blog has been associated with exposing Chinese accounting scandals but the companies discussed on the blog differ substantially from Trina Solar. Substantially they did not exist. Trina Solar clearly exists and Trina Solar panels are distributed widely.


I am increasingly puzzled over Trina Solar's accounts. The issue that puzzles me most is the high cash balance combined with strange debt covenants.


I intend on writing a blog post about this – and I seek your comments because it is almost certain there is a simple and innocent explanation of what I see and I am happy to include your response in my blog post. It is more an education in how a competent hedge fund manager reads accounts. 


Anyway the issue I am raising is how Trina funds its capital expansion.


The last 20F filing contained the following investing cash flow section:

[Click for full detail...]


The columns are for 2008, 2009 and 2010 respectively. Purchase of property plant and equipment was 165, 136 and 144 million dollars for the three years respectively.


The 20F also contains this section about a debt facility to purchase the property, plant and equipment.

In September 2009, Trina China entered into a five-year credit facility of approximately $303.3 million, consisting of RMB1,524.6 million Renminbi denominated loan and $80.0 million U.S. dollar denominated loan, with a syndicate of five PRC banks led by the Agricultural Bank of China and Bank of China. Approximately $269.2 million of the facility are designated solely for the expansion of our production capacity, with the remaining to be used to supplement working capital requirements once the capacity expansion is completed. The facility can be drawn down either in Renminbi or U.S. dollars. As of December 31, 2010, we had drawn down approximately $275.1 million under the facility. The remaining facility to supplement working capital requirements can only be drawn on or after the date of completion of capacity expansion. The weighted average interest rate for borrowings under the facility was 5.53% for the year ended December 31, 2010. Interest is payable quarterly or biannually in arrears for loans denominated in Renminbi and U.S. Dollars, respectively. Interest rate applied for Renminbi-denominated borrowings is the same interest rate stipulated by Chinese central bank plus 10%. U.S.-dollar denominated borrowings are subject to the six-month London Interbank Offered Rate plus 3%. The facility is guaranteed by Trina and Mr. Jifan Gao, our chairman and chief executive officer, and his wife, Ms. Chunyan Wu, and is collateralized by the property, plant and equipment of the project and the related land-use right. Borrowings outstanding as of December 31, 2010 are payable on a biannual basis, commencing on October 27, 2011. For purposes of the expansion, we are required to match draw-downs from the facility with an equal amount of cash from sources other than the facility. The terms of facility also contain financial covenants which, among other things, require us to maintain a debt-asset ratio of no more than 0.60, a net profit ratio of not less than zero percent and an interest coverage ratio of greater than 2. 

At first reading this is very puzzling.  This facility is “designated solely for the expansion of our production capacity, with the remaining to be used to supplement working capital requirements once the capacity expansion is completed.” However we know that Trina's purchases of property, plant and equipment were 144 million in 2010 and 136 million in the WHOLE of 2009. 


They facility is drawn to 275 million.  So it appears Trina has funded their entire 2009 and 2010 capex with this facility.  However the terms state that Trina must  “match draw-downs from the facility with an equal amount of cash from sources other than the facility”. It doesn't look possible that Trina has done that and it appears that Trina has drawn their bank facilities in excess of what the covenants would allow.


I have puzzled further over this – maybe some old property, plant and equipment debt was rolled into this facility.  But according to the latest 20F filing the long-term borrowings outstanding at the end of 2008 were only $14.6 million so the strangely-large draw-down of this facility cannot be the result of long-term debt rollover.


So unless I am mistaken (and I would appreciate you telling me where I am mistaken) Trina has drawn this facility far in excess of what is allowed under the facility terms and is currently in breach of its debt covenants.


This is peculiar because Trina showed free cash in excess of $750 million on their balance sheet as per December 2010. There would appear no reason why Trina would be in breach of the debt covenant. Moreover it is a pretty harsh covenant – it involves a pledge of most the property of Trina and personal guarantees by Mr Jifan Gao and his wife.


Anywhere but China I would consider this as an innocent mistake – one easily fixed by taking cash from the balance sheet and making good on the 50 percent rule. In China you have to question cash balances. I have spotted other companies with fake cash balances. But those were substantially fake companies and Trina is clearly a very large manufacturing concern.


So – I am writing to ask (a) whether my analysis is fundamentally wrong and if it is not (b) why are you in breach of your debt covenants, (c) how much of the cash on-balance-sheet will be used to make good that breach, (d) have you sought a waiver of those covenants and (e) whether that waiver has been made good.


I hope to hear your answer.


I intend on blogging on this in about five days – and I will incorporate your answers in the blog post.


Thanks in advance.






John Hempton


Now their response:

Dear John,

Thank you for opportunity to address debt covenant inquiries centering on the statement:

For purposes of the expansion, we are required to match draw-downs from the facility with an equal amount of cash from sources other than the facility.

First and foremost, and in contrast to your comments received, Trina Solar is not in breach of its facility debt covenants.

Related to this fact, at a high level:

I.  Some capex in 2008 and 2011 are also under (matched) capacity project financing

II. We matched the project financing under agreement through our equity offerings and some contribution from two-year positive operating cash flows.

More specifically,

1. Timing of matching funds:

The Company made significant disbursements for subject expansion project prior to 2009, the year in which the loan facility was finalized. Such payments are common and can be linked to both project infrastructure development (engineering design and construction) as well advanced payments for technology hardware (facility EHS and production line related).  Such ‘early disbursements’ should be included as matching funds.

2. Project completion status:

Though initial phase was commissioned in late 2009, this ultra-large scale facility has yet to be 100% completed in terms of capacity additions. As such, related 2011 expenditures would also qualify as matching funds.

3. Source of our matching funds:

Fund sources include proceeds from our 2008-issued senior convertible notes, our 2009 and 2010 follow-on offerings, and a portion of our operating cashflows.

We trust you find the above helpful and thank you in advance to confirm receipt.

Best Regards,

Thomas W Young
Senior Director, Investor Relations

Commentary:

I showed both the letter and the response to one of my better friends (someone highly familiar with the nuance of debt covenants) and he drolly replied that "prospective expenditures are not exactly matching funds".

The usual notion of "matching funds" is that if you spend $100 on plant and equipment the loan may be drawn to $50 and the other $50 has to come from somewhere else.

According to the company the loan is drawn to $275.1 million as of year end and Mr Young tells me the project is not finished.  $275.1 million is way in excess of half of capital expenditure in 2009 and 2010.

Trina Solar say that some 2008 capital expenditures should also be included. The total investment in property, plant and equipment in three years 2008, 2009 and 2010 was (165 plus 136 plus 144 million equal to) 445 million. If they had only drawn the loan to 50 percent of the last three year's capex they would have only drawn 222.5 million rather than the above-mentioned 275.1 million.

Trina tell us that they can match funds with future expenditures. I find that unusual but as this blog is a fan of Fox News I will answer with the usual rejoinder: I report. You decide.




John

Post script: I think Jeffrey Rothstein's comment below - and my reply to it - are important parts of this story - so I encourage reading of the comments. I am not sure the 20F filing disclosure accurately reflects terms of the loan agreement.

So that makes it alright then...

China Media Express (now defunct and exposed as a fraud) was once the highest conviction and highest stakes short-versus-stock-and-stock-promoter battle on Wall Street.

That mantle has now shifted to Harbin Electric a company which makes (or is that purports to make) large numbers of high-tech electric motors. The Harbin battle has become special for its vitriol and today's 15% plunge and recovery in the stock is just the latest salvo.

Harbin Electric is subject to a proposed management buyout involving the CEO (Mr Tianfu Yang) and Abax Capital (an Asian based private equity fund sometimes associated with Morgan Stanley). The proposed buyout price is $24 and the stock is trading at $17.50 so if the deal goes through holders should make 37% returns. As the deal is meant to close in three months this is an unbelievable 350 percent annualized return. Bulls point to reputable parties involved in this deal including Goldman Sachs and China Development Bank.

Citron's case is that the company is a fraud and the deal is a fraud. The company is worth something close to zero, the deal will not close and the stock will collapse to low single digits. Citron (and other shortsellers) argue the deal is a ruse to suck in unsuspecting arb funds and dumb shareholders and that - absent the deal - Harbin would have collapsed like just about every other Chinese reverse merger.

I am not going to go through the background: all I want to point to is the latest "hit-piece" from Citron Research and Harbin's response.

Harbin alleges criminal behavior by people associated with Citron:

The Company believes that Citron used doctored SAIC reports. The Company has recently reconciled its PRC tax filings on a consolidated basis with its financial statements reported in its SEC filings for fiscal year 2009 and has not found any inconsistency in any material respect. Its SAIC filings are largely in line with its tax filings in the PRC.

Suffice to say that at there is a criminal conspiracy here - either Citron and associates are knowingly peddling lies or Harbin Electric is knowingly peddling lies.  

I don't have access to the original documents and so I don't want to add to that debate. I want to focus on director conflict of interest and Boyd Plowman - the "independent director" charged with assessing the Chairman's take-private bid for the company.

The role of Boyd Plowman

When the management of a company attempt to take it private the role of non-management directors is crucial. After all non-management directors are there to protect against management stealing the company or at least buying it on the cheap.

So typically the board will set up a "special committee" of non-associated directors to assess "the deal". 

Harbin did that.

And the chair of that is Boyd Plowman.

Here is what Citron said about Boyd Plowman's independence:

Mr. Plowman is both head of the audit committee of Harbin, as well as the appointed head of the special committee to take the company private.  This committee is at the center of the requirement that the interests of shareholders be defended.  It is under his watch that we are to trust both Harbin’s financials, and the fairness of the process by which the “takeover” transaction proceeds.  

However, the July 13, 2011 proxy statement filing is the first time investors are informed of the following :

• “Shortly after Abax filed a Schedule 13G with the SEC on December 9, 2010 announcing its greater than 5% ownership of the Company common stock, Mr. Plowman, the Special Committee Chair, brought to the attention of the other members of Special Committee, as well as to Gibson Dunn, the fact that he was then serving as a director of several Abax-controlled entities including Abax Global Opportunities Fund, Abax Arhat Fund, Abax Claremont Ltd., Abax Jade Ltd., Abax Emerald Ltd., Abax Lotus Ltd., Abax Nai Xin A Ltd., and Abax Nai Xin B Ltd. (the “Abax Companies”).”

Citron then made obvious comments about whether this relationship was appropriate or not. 

Harbin replied:

The allegation that Mr. Boyd Plowman is a Director of Abax is simply not correct. Mr. Plowman resigned as a Director of Abax on December 16, 2010, just a few days after Abax acquired 5% of the Company on December 9, 2010. This information has been disclosed in the preliminary proxy statement filed with SEC on July 13, 2011. Mr. Boyd Plowman confirm that he is not a director of Kilometre Growth either as alleged by the Report.

So that makes it alright then?

Seriously though it took from 9 December 2010 to 13 July 2011 to disclose that to the public.

That is 216 days.

But it was disclosed, and I guess within the letter of the law that does make it alright then.

The only problem is that Abax and Harbin have been dealing for some time. For instance the last 10K provides this disclosure:

On July 28, 2010, the Company entered into a Loan Agreement, dated July 28, 2010 (the “Loan Agreement”) with Abax Emerald Ltd., a Cayman Islands limited company (“Abax”), pursuant to which Abax agreed to provide the Company with up to $15,000,000 in loans (“Abax Loan”). The Abax Loan was to be  made pursuant to one or more borrowings (each, an “Advance”) from time to time from the Closing Date (July 28, 2010) to the date falling on the expiration of five (5) months after the Closing Date upon delivering a notice from us to Abax. In lieu of payment of interest in cash on each Advance, the outstanding principal amount thereof  accreted in value for the period commencing on the Borrowing Date (the date on which any Advance is made from us to Abax) for such Advance and ending on the day on which such Advance is repaid, at a rate equal to 10% per annum, computed as described in the Agreement. The Loan Agreement provided that we could  voluntarily prepay any Advance (or portion thereof in an integral multiple of $100,000) at its accreted value at any time upon written notice to Abax. On the Maturity Date (six months after the date of the Agreement), we were obligated to  repay the remaining outstanding loan not theretofore paid, together with all fees and other amounts payable under the Loan. On July 29, 2010, the Company received the $15 million loan from Abax. The Abax Loan was used to pay down certain debt and to support our capital expenditures and working capital.

So the company borrowed at 10% from Abax. Nowhere in the annual filing is this disclosed as a related party transaction. Management were (as we are now told) informed by Plowman that he was a director Abax entities on 9 December 2010 - three months before the 10K was filed.

I guess that would be sort-of-OK if Harbin really needed the money. But Harbin claim to have had almost 100 million of cash sitting on the balance sheet the whole time that they borrowed 15 million from Abax.

This is very perplexing. Harbin borrowed from an undisclosed related party at a high interest rate whilst sitting on lots of cash.

And Harbin disclosed the fact that it was a related party 216 days after management were informed of the conflict.  And they did not disclose it in the 10K.

But it is now disclosed. And we know that that makes it alright then.

John

Wage inflation in Australia (POST NOW WITHDRAWN)

This post is withdrawn - here is an IDENTICAL ADVERTISEMENT in another publication with ONE LESS ZERO.

http://www.seek.com.au/Job/shotfirer/in/rockhampton-capricorn-coast-rockhampton-capricorn-coast/20196165

---

So the typo theory is clearly correct.


John

PS - I am regularly hearing of 300K for skilled mining jobs.  Four times that startled me which is why the post.

------------------------

This is a recent Australian job advert.  Rockhampton region - which means the Southern end of the Great Barrier Reef or a short drive from Airlie Beach where it is warm and the sun shines 300 plus days a year.


7 days on, 7 days off. Must be good with explosives.


Salary: AUD1.2 million plus bonus. That is USD1.32 million.


Anyone think they picked the wrong career?


John

Google Plus thinks I am a social climber...

Google plus has a suggestion process as to who you might add to "circles".

Here - with only minor editing - are five consecutive suggestions made to me:

You see this right. Three of them are Larry Page, Sergey Brin and Mark Zuckerberg in order.

I know none of these people though Zuckerberg shares a single Facebook friend with me and I know someone who was in his computer science classes at Harvard.

Google + is getting users fast - and I find myself looking at Facebook much less - but is the appeal of Google + the asymmetric friending process where I can add people like this to my "circles" and pretend that I am far better connected and far more upwardly mobile than in reality?

For comment.


John

PS. Does anyone else think it is strange that Zuckerberg winds up in my Google + suggested circle so fast?

Apartment shopping in Hong Kong