Focus Media - focus on movie screens

I am obsessed as to what the due-diligence on Focus Media done by the private equity firms might look like and what it might find.

Lets start with the easy stuff.

Probably the easiest place to do due-diligence on Focus Media is the theatre screen business. Focus Media claims to display advertising on roughly a quarter of the cinema screens in China - but this is still a relatively small number of cinema complexes (316 at last annual report).

It is almost impossible to audit more than 100 thousand LCD screens - at least without a small army and a sampling method. But checking out whether the numbers make sense in 316 theatres is relatively simple. A sample could include a large proportion of the total without being prohibitively expensive. Those 316 theatres probably have only 30-40 owners (most owners own chains). That will make the testing easier still.

And I think the private equity bidders probably will test this (as part of their due-diligence) because the theatre business raises red-flags which animate the bears in this stock. The central issue seems to be the number of theatres and the size of the multiplexes - however I think Focus have largely cleared up that story.

But I should run you through it anyway.

The controversy around the number of cinema screens Focus places adverts on

You would think that counting cinema screens and number of theatres is easy. They are big things. They don't run away. If I said I was opening a film on 270 screens you would know what I mean. These statistics have well defined meanings - and those meanings don't seem to change much.

Except in the case of Focus Media.

Here is a disclosure that mentions number of theatres focus runs adverts in (from a 20F for the year ended 2009.)

Net advertising service cost-movie theatre and traditional outdoor billboards. We incurred advertising service cost of $56.9 million in 2008, a 99.6% increase from $28.5 million in 2007. The increase is primarily due to (1) our acquisition of Huaguang, the subsidiary operating the traditional billboard business in 2007. We consolidated Huaguang’s results of operation only after the acquisition was consummated, while in 2008 we consolidated their full year costs of revenues; (2) the increase in the number of billboards leased from 492 in 2007 to 542 in 2008 in response to greater customer demand; and (3) increased leasing costs associated with time we rent on movie theatre screens as a result of an increase in the number of theaters we leased in our network from 10,930 in 2007 to 27,164 in 2008.

The bold section is pretty clear... a result in the increase in the number of theatres we leased in our network ... to 27,164 in 2008.

This number and similarly large numbers are laced throughout Focus Media's filings. It is not a one-off number.

There is a problem with this number.

A big problem.

There are not that many theatres or screens in China!

In March 2011 the LA Times did a story on the cinema building binge in China. At that point there were 6,200 screens in all of China up very sharply since 2008. According to Government statistics there were only 1545 screens in all of China at the end of 2008. 

Focus media says they had 27,164 screens. The government says there were only 1,545 screens in the country.

Unsurprisingly Focus has amended its numbers. Here is what they say in the latest annual filings:

Movie theater advertising network

We operate our movie theater advertising network by selling leased screen time as time slots to advertisers. We have the right to screen time prior to the screening of each movie shown in the theater. As of December 31, 2011, we had rights to lease advertising time on screens in 316 movie theaters (consisting 2,190 screens) in cities across China.

How did they reconcile these numbers?

Well they said that they counted as a "theatre" a "screen in which an advertiser had agreed to buy space". That means if 10 advertisers had chosen to show advertisements in a theatre with one physical screen they counted it as 10 theatres.

As of December 31, 2010, we had rights to lease advertising time on screens in 260 movie theaters (consisting 1,553 screens) in cities across China and Hong Kong SAR. Prior to 2009, we calculated the size of its movie theater network by calculating the number of screens on which each of its advertisers had purchased advertising and then summing the screen count for each advertiser to produce an aggregate number of screens. With a change in management in late 2008, we changed the method for calculating this operating metric beginning in 2009, basing it instead on the number of movie theaters for which we had rights to lease advertising time as of the relevant period, regardless of the number of screens in such theaters or the number of advertisers that had purchased advertising on each such screen. The large decrease in screen count for the movie theater network over this period was a reflection of this change in calculation methodology.

That is a mess. At minimum it is a definition of theatres that I was previously unfamiliar with. But Focus now tell us what they say are the true numbers on standard definitions - numbers that I have no ability to prove, nor disprove, but that I would expect would be part of the due-diligence brief that the Carlyle and others will undertake.

The size of this business

Even on the amended numbers this business is large. In both 2010 and 2011 the number of screens is about a quarter of all screens in China. It is a business that should be highly visible and fairly easy for the PE funds buying Focus Media to do due diligence on. Here is a way to do it:

Ask them to tell you a list of all screens. Pick a screen out-of-town. Ask them to tell you what adverts are on it. They should have records because they need to bill the advertiser (if they claim no records you know they are fraudulent). Then take yourself to the cinema. Have some popcorn. If you really want a good time do it on a sample-basis - check five screens and catch up all the films you missed out on.

Who said being an investment banker or PE guy you don't have time to go to the flicks!

Sustainability of Focus Media's margin

Focus Media's theatre screen business has a fat margin. According to the last annual filing the revenue associated with this business was USD50.8 million. The costs USD25.7 million. This is a gross margin a little over 50 percent - considerably larger than display advertising businesses outside China. Indeed this is a fatter margin than any non-Chinese display advertising business I can find.

I guess that is possible if Chinese screen operators are very stupid and lease space to Focus Media at rents that are too low. (Relatively dumb local governments have long been the explanation for JCDecaux's relatively fat margin in street furniture advertising...)

But the margin has been that fat for years. And the multiplex developers are almost by definition large property developers used to screwing as much revenue out of projects as possible. Moreover this company is on-the-numbers very heavily into multiplexes. Between 2010 and 2011 they added 56 theatres and 637 screens. The incremental theatre seemed to have something like 11 screens.

An explanation that large-scale property developers are more stupid than local governments looks difficult to sustain. Maybe they are - but local governments don't stay that stupid (the renegotiated street furniture terms are never as sweet) and Chinese multiplex owners will learn too. The largest Chinese multiplex owner now owns AMC in America. AMC probably know a few things about maximizing the revenue on their screens.

Unless I am mistaken - as the screen owners wise-up (just like local governments wise-up) the margin in this business is going to come down. Unless there is some magic-secret-sauce in this business I don't understand. Sustainability of margin is likely to be a problem.

Revenue per screen

The number of screens started 2011 at 1553 according to the disclosures above. They ended at 2190. A simple arithmetic average suggests the company averaged about 1870 screens.

Revenue for the year was USD50.8 million. That is revenue per screen of USD27,144.

I spent a lot of time trying to work out whether this number was plausible - and found that it was high but still plausible. I found an American media executive familiar with this industry who told me that the revenue per screen in the US was about USD20-30 thousand. Focus Media is on the high-end of that but still within the range.

Advertising rates in China are usually a fair bit lower than the US - perhaps cinema screens are an exception. On these numbers rates look to be about the same as the US.

That Focus Media secret magic sauce

I have no particular reason to doubt the new number of screens that Focus Media claim to run. The old number was false - but according to Focus Media the problem was one of counting methodology - not fraud.

The new number of screens is about a quarter the total in China - that would surely make them one of the major players.

And they are very multiplex focused with average screens per theatre way higher than average and climbing sharply.

Usually I would assume that multiplex owners were a sophisticated lot who did not leave a fat margin on the table for a player like Focus Media. But there is a 50 percent margin here in a business you would normally expect to have a thin margin. After all the eyeballs belong to the theatre owner and not to Focus Media.

They must be doing something special. Some magical secret sauce if you will.

If I were the private equity buyers I would like to work out what that is - because without knowing you can't assume that the secret sauce is sustainable. (My bet is that it would not be sustainable.)

Oh, to be a fly-on-the-wall

As I said in the first post I wish I were a fly-on-the-wall whilst due diligence is done on that company. I want to understand that secret sauce. It is clearly a way of making money and that is what my clients pay me for.



John

The mysterious case of the disappearing competitor: Focus Media edition

JCDecaux - the French multinational giant - is the largest display advertising company in the world. They also claim in their latest annual report to be the largest display advertising business in China.

Every year they publish in their annual report a list of the largest display advertising businesses in the world - their competitors.

Here is that list from the 2007 annual report :

On this list, Focus Media is the 8th largest company in the world in this space.

And here is the list from the 2008 annual report:

Again we see Focus Media - now the sixth largest display advertising company in the world.

Here is the 2009 list:

Peculiarly Focus Media is nowhere to be seen on this list (by the end of 2009 it should have risen to fifth place).

Focus Media is no longer mentioned in JCDecaux's 2010 and 2011 accounts.

Why?

Well I can think of two hypotheses:

The first is that JCDecaux want to sustain their claim of being the biggest display advertising business in China - a claim that is simply not tenable if they include Focus Media in the comparison. Moreover they don't want to increase the credibility with advertisers of Focus Media and its products. After all Focus Media has substantially outperformed JCDecaux in China - growing much faster and at much fatter margins.

An alternative hypothesis is that they don't believe Focus Media's numbers.






John

PS. I first found these lists when researching China Media Express. CCME supposedly competed with JCDecaux in placing adverts on public transport (in CCME's case mostly buses including airport buses). CCME however was a complete fraud and the stock now trades at 2c. Focus Media is obviously real - their displays are widespread.

Focus Media revenue plausibility test: Part two

Focus Media makes a lot of revenue per screen compared to US Television.

Many people in the comments to the last post worked out rough ratios. There are at Focus Media roughly 130 thousand screens (more now, less at the beginning of the year) generating 221 million in revenue in the last six months (see press release).

That is rough $3400 per screen per year per year.

In the fourth quarter of last year the revenue from LCD screens was 150.4 million. There were about 120 thousand screens average over the quarter. Annualized that is almost $5000 revenue per screen.

Television advertising revenue in the US is about $72 billion. 

There are roughly 310 million televisions in the US. (See here suggesting lower or here suggesting higher...)

Revenue per screen is roughly $235.

It depends a little on quarter - but Focus Media revenue per screen is 14 to 20 times higher than US Television revenue per screen.

Almost (but note entirely) everyone I have shown this to thinks that the revenue-per-screen at Focus Media seems high. [That includes many industry insiders.]

Overstated revenue per screen is consistent with interpretation (c) as per this post.

Other possible comparisons

It seemed to some people unfair to compare advertising in lift wells (which sometimes 20 people are forced to watch) with the TV in your kitchen (which may be on in background with one person or nobody watching). Some people thought I should compare with other out-of-home advertising companies.

The problem is that not all screens are born equal.

Screens are more valuable where rich people with high disposable income congregate. That are even more valuable if viewers have a willingness to spend that income.

They are more valuable where you are forced to wait (and hence watch the screen).

They are less valuable where only a few dozen people pass them per hour (say in the lobby of residential building). Also in the lobby of a residential building you see the screen when you are going home. Advertisers would prefer show their adverts to people who are near shops or about to go to the shops.

Probably the single most valuable screens are in airports. Airports are full of relatively well-to-do-people. They are also full of shops with fatter than average margins. People are forced to wait. Often they are travelling and extremely willing to spend on hotels, tourist attractions, luxury goods. Some even have expense accounts.

One comparable is Air Media - who probably have the best-placed screens in China - they dominate the airport space.

One part of that business is directly comparable to Focus Media. It has 42 inch panels which intersperse advertisements and content in airport waiting areas as per this quote from the annual:

We strategically place our digital TV screens in high-traffic areas of airports such as departure halls, security check areas, boarding gates, baggage claim areas and arrival halls, where there tend to be significant waiting time. A majority of our standard digital TV screens are 42-inch plasma display panels or LCDs. As of March 1, 2012, we operated approximately 2,690 digital TV screens in 36 airports in China under various concession rights contracts. These 36 airports accounted for approximately 81% of the total air travelers in China in 2011, according to the General Administration of Civil Aviation of China.

That business generated 21.9 million dollars in revenue in the last year. That is just over $8000 per screen - or more than double Focus Media. However these screens are at least 4 times the size of Focus Media screens and have many times the views.

Bluntly: these are optimally placed large screens. Amongst locations in China really.

By contrast, Focus Media screens have been spotted in the basement of office buildings where the janitors and maintenance staff congregate. They also place screens on every floor of some office buildings - this one is on the 21st floor of an office building in Shanghai:

It has the usual number of people watching it. (Nobody...)

They are in lobbies of residential buildings in third-tier cities - where people watch them before they  go back to their apartment rather than before they shop.

My guess: either revenue per screen at Air Media is low and likely to rise - or the revenue per screen at Focus Media is high or possibly overstated and likely to fall.

==============

Some further calculations:

I work on the 21st floor of an office building in Sydney. It is unlikely that more than 20 people per hour catch the elevator at this floor. (That still makes the lobby busy...)

Work on 9 hours per day, 275 days per year, and you get about 50 thousand impressions per year.

The cost per thousand impressions for a Superbowl advertisement is about $35 (probably less). At Superbowl rates this screen would garner roughly $1500 revenue per annum.

Residential buildings in third tier cities would produce lower revenue.

If the revenue really is over $3000 a screen I doubt it is sustainable.

Being a cynical fellow I keep getting drawn back to interpretation C in this post.




John

PS. Air Media revenue per screen has been falling. I have talked to several people in the industry and they all say the same things. Revenue is growing but only because number of screens is growing. The pricing pressure in this industry is down simply because there are increasing numbers of screens.

Chinese due diligence: Focus Media style

Yesterday's post again raised this disclosure from Focus Media:

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.

The key words here are "relieve a temporary shortage of Renminbi the group experienced".

Approximately two months prior there was a capital raise which raised $295 million. Of that $62 million went to the company and $220 million went to selling shareholders. The remaining $13 million went to the underwriters.*

A looming "shortage of Renmimbi" looks like material information that should be disclosed in a prospectus.

Well it wasn't. Indeed the prospectus made clear that the company had plenty of Renmimbi liquidity but might be short US dollar liquidity to pay dividends of the like.

Without a better explanation (which I have sought) I would think there may be material non-disclosure.

So who were the selling shareholders?

It is interesting to me when $220 million in stock is possibly sold on material non-disclosures. I want to know who the sellers were.

One of the biggest (but not the biggest) selling shareholder was JJ Media Investment Holdings - the vehicle of Jason Jiang, CEO/Controller of Focus Media.

Most of the other selling shareholders were prior shareholders of Target Media which was sold to Focus Media mostly for stock. Those sellers were not insiders so they can't be held responsible for material non-disclosure in the prospectus. Nonetheless it is amusing selling shareholders included both Carlyle and CDH who are now wanting to take Focus Media private.

One last selling shareholder amuses me. It is Neil Nanpeng Shen. He is better known as the managing partner of Sequoia Capital China - but in this context he should be known as the Chairman of the Audit Committee for Focus Media.

Is it possible that the Managing Partner of Sequoia Capital China sold personal shares in a company in which he was the chair of the audit committee and where the prospectus may have contained material non-disclosures?

I am sure there must be an alternative explanation - and I have written to Focus Media to ask them to explain the source of the Renminbi shortage disclosed above. I have received no reply. I am hoping for one soon and I will publish it when received.

The underwriting fee

The underwriting fee was about $13 million. The lead banker was Goldman Sachs. But you knew that anyway.





John

*All amounts rounded to the nearest million.

Focus Media - my new obsession (corrected version)

This is a corrected version of a previous post. In the original I transcribed gross margins for operating margins in two companies. The comparison was fair - Focus Media was much higher margin whichever margin I quoted. It is just that I was quoting the wrong margin.

The announced "go-private" transaction for Focus Media has me obsessed. It seems to cover a whole gamut of my interests, Asian private equity, alleged Chinese fraud, connections with major property developers and numbers and accounts I find surprising. The whole works! It may not be the most important thing in financial markets this year - but it is one of the most interesting.

Readers might need some background here. Focus Media is a display advertising business in China which has analogue and digital poster frames in elevators and shopping centers as well as LCD screens placing advertisements more generally. Most of these adverts are small (the LCD screens are mostly 17 inch according to the annual report and many of the posters are smaller). Here are pictures of a few...

(My source for these photos is a Seeking Alpha bull on the stock here...)

A lot of what used to be counted as LCD screens are simple posters:

The reason for using posters is inconveniences like having no available power supply. There has been some dispute about the number of screens and posters but there is no doubt that the company has a lot of these - they are visible around major cities in China.

The company also claims to have the right to sell advertising on a large number of movie cinema screens. Again there is a dispute about the number of these screens.

The mechanics of Focus's business

Focus Media is a relatively simple business. They rent sites (for instance by entering a lease with the managers of a large tower with elevators they wish to place adverts in). They sell the advertising space and they maintain all their screens and update your posters and deal with the inevitable things like vandalism, theft and the like. For the number of sites that Focus deals with they would need a fairly large number of lowly paid staff for maintenance and another group of staff selling advertisements and a third group negotiating lease arrangements with building and cinema owners. The second and third group will have higher salaries.

The maintenance cannot be neglected because it devalues adverts when kids scrawl little goatie-beards on the pictured women (or worse).

The profitability of Focus's business

The most notable thing about Focus from the accounts is their startling profitability. Their last annual report shows revenues (net of business taxes) of USD793 million and gross profit of 503 million, operating profit is 259 million. This is a 63 percent gross margin and a an operating of margin of 32.7 percent which is at the high end for a media business. In my experience media businesses are 10-35 percent operating margin businesses - with the high numbers reserved for very special franchises. A monopoly newspaper in a city of a million people (say Perth Australia) used to have a 35 percent margin before the internet threatened the monopoly. Most businesses are closer 20 percent. Most display advertising businesses (which are without strongly identifiable franchises) earn closer to 10 percent margins.

Moreover, this is a a nearly 33 percent margin where the company itself describes the landscape as "competitive" in their annual filings. The margins are surprising – but China is a surprising place in many ways – and it is possible that margins are fat because the landlords who lease the space to Focus are stupid. The fat margins may be possible for other reasons I don't understand.

First let me stress though just how fat these margins are. The largest player globally in display advertising is JCDecaux (the French multinational founded by Jean-Claude Decaux). They have - according to their last accounts - €2463 million in revenue and 23.6 percent gross margins. The 63 percent gross margin at Focus is fully 40 percentage points higher than the gross margin of JCDecaux. The net margin of JCDecaux is a mere 8.7 percent - Focus Media margins are 3.7 times higher than JCDecaux.

Moreover JCDecaux has fatter and thinner margin businesses. It has a mid teens gross margin outside their (franchise) street furniture business.

There are several possible explanations for the very fat margins at Focus. The most obvious explanation is that they were early... when you go around to a landlord and offer to rent their space they don't know what that space is worth (because the idea is new to them) and they lease it to you for too little. Over time margins contract because the landlords "wise-up". This is certainly true in the street-furniture business at JCDecaux where the company goes to the local government and offers to maintain their bus-stops for "nothing" and the local government (with the intellectual panache that describes that sector) just accepts. But local governments have wised up over time.

The bears in this stock - and there are many (see the many seeking alpha articles) - would suggest the margins are made up. As an outsider that is pretty hard to test - but going through the claims and counter-claims with a fine comb is the sort of thing that excites a guy like me. (Any private equity party doing thorough due diligence can check those claims.)

The main fraud allegation

The main allegation against Focus came from Muddy Waters - the same firm that exposed the fraud at Sino Forest. MW gave us an 80 page report (that is freely available on their website). Sino-Forest was deep within my area of expertise and I was more-or-less instantly convinced that the whole Sino Forest story was made up. Focus Media is a much harder target for Muddy Waters because the company clearly exists. Their LCD screens and picture frames are pervasive in many large cities in China.

Whilst I was instantly convinced by the Sino Forest case (and hence was happy to short the stock to zero) it is harder to be convinced when the business so clearly does exist.

That said Carson Block and his Muddy Waters firm comes with some credibility because they predicated the complete demise of Rhino International and Sino Forest (both multi-billion dollar firms). Given Carson's street-cred I was surprised that Focus Media stock held up so well after Carson's attack.

Some people clearly saw a lot of value in Focus even if some part of Carson's allegations was correct.

The private equity bid for Focus

The people who saw value in Focus Equity include some of the most important private equity firms operating in Asia who are bidding for the whole company. Here is the release:

Aug.13, 2012 -- Focus Media Holding Limited ("Focus Media") today announced that its Board of Directors has received a preliminary non-binding proposal letter, dated August 12, 2012, from affiliates of FountainVest Partners, The Carlyle Group, CITIC Capital Partners, CDH Investments and China Everbright Limited and Mr. Jason Nanchun Jiang, Chairman of the Board and Chief Executive Officer of Focus Media, and his affiliates (together, the "Consortium Members"), that proposes a "going-private" transaction for $27.00 in cash per American depositary share, or $5.40 in cash per ordinary share... 

The bidders are a who-is-who of reputable private equity firms. FountainVest is run by Frank Tang who used to head China investments for Temasek (the Singapore Sovereign Wealth Fund). He represents Singapore Inc as much as a private individual can. The Carlyle Group is one of the largest private equity firms in the world. I have had my doubts about their China investments before - but they are large and reputable. CITIC Capital is a private equity firm associated with China International Trust and Investment Corporation which is effectively the Chinese sovereign wealth fund. CITIC Capital however is not the Sovereign Fund - rather an associated private fund. By all accounts it is Princeling Central. China Everbright is a Hong Kong listed financial firm clearly with links to the Chinese establishment. Bo Xilai's brother recently quit as a director. This group is a mix of Chinese, other Asian and Western establishment firms.

One bank mentioned in the press release is DBS - which again represents Singapore Inc. The only other bank mentioned is Citigroup - and they have provided a "confident" letter.

So where are we now?

What we have are some high-profile but rat-bag shorts on one side squealing fraud. And on the other side we have a who's who of Asian business wanting to take this private for the not-so-trivial sum of USD3.5 billion.

You see why I am obsessed? Right up my alley. And perhaps a test of my Guanxi vs Analyst thesis.

Is this a done deal?

This sounds like a done-deal. The largest shareholder in Focus is Fosun International - an HK conglomerate. They have publicly called the bid "attractive". The bid team contains Mr. Jason Nanchun Jiang - the CEO/Founder of Focus - and a man critical to the running of the business (apart from anything he controls the variable interest entity). Given that it contains the critical person and the main shareholder wants to accept it is likely the board will go along. And the bid is cheap enough that it is unlikely that - absent absolutely grotesque fraud - nothing that is found on due diligence will dissuade the buyers.

The parties are rich enough that $3.5 billion is a big - but not an intolerably large bite. They are up for it.

It is however subject to due diligence. The letter sent by the buyers to the company is attached to the press release. The last paragraph says it clearly:

13. No Binding Commitment.  This letter constitutes only a preliminary indication of our interest, and does not constitute any binding commitment with respect to the Acquisition. A binding commitment will result only from the execution of Definitive Agreements, and then will be on terms and conditions provided in such documentation.

And so we have a due-diligence period in which some of the most reputable and largest private equity firms will do due diligence on a company that one of the most famous rat-bag short-sellers asserts is a fraud.

Oh to be a fly-on-the-wall

I would love to be a fly-on-the-wall as they work out how to test the Muddy Waters allegations. Due diligence is sometimes (incorrectly) treated as a formality. But in this case the stakes are real. Billions of dollars are on the line and the very credibility of some firms (especially Carlye) are on the line with it. Carlyle has been burnt by some frauds in Asia before. If - after warning by Muddy Waters - Carlyle were to buy this firm and it turned out to be fraudulent the question would arise as to whether Carlyle staff were deliberately buying frauds to loot the Carlyle funds. My guess is that the very existence of Carlyle is at stake.

But Carlyle have competent staff laced throughout their organization. They will do their due diligence - and if the deal closes I think you can presume that Muddy Waters was wrong.

If the deal doesn't close with the backing of the the largest shareholder and at this pricing then you probably have to conclude that Muddy Waters is right. If Muddy Waters is right then the revenue and the margins of this firm are grotesquely overstated and the stock is probably going to settle somewhere below two dollars.

And with that you understand my obsession.






John

Disclosure: I think there is a reasonable chance that Carlyle - and perhaps some of the other firms in this syndicate will walk. In all honesty I have no idea whether they will or not but as the stock will wind up at $2 (or less) if they walk the bet is worth taking. So I am short and risk losing the difference between the current price (25 and change) and the bid price (27) if the deal does close.

The choice of lawyers in Tortola: Focus Media counterparties edition

The main streets of Tortola are a little dusty. When I wandered down them they were surprisingly empty but then it was hot. Very hot. There were irregular English tourists who had wandered away from the coastal resorts for a look-see. You could tell them, they were sunburnt to a strange crimson. There was the odd local seeking those tourists out (and me at the time) to offer us marijuana. There were signs for the local poison (Pusser's rum).

Beyond that there were lots of low-slung, excessively air-conditioned office buildings that contained lawyers. Lots and lots of lawyers.

After all Tortola is tax-haven in the sun with British law. The lack of taxes and the lawyers to protect your rights are the industry in the British Virgin Islands - and lots of people structure their businesses there.

Including the people that Focus Media does business with.

Here is a list of 2009 dispositions made by Focus Media (you will find the original in the latest 20F filing):



2009 Disposition

In 2009, we aborted a contemplated initial public offering for its Internet advertising segment due to the economic recession in late 2008. As a result, between August and December 2009, we disposed of six underperforming subsidiaries in that segment through a series of individual transactions with their respective original owners. Each of the subsidiaries was considered a component of our company, and their results have been included in discontinued operations in the consolidated statements of operations. The results of discontinued operations include net revenues and pretax losses of $127.6 million and $45.4 million, respectively, related to these subsidiaries. We recorded a loss on disposal of $44.1 million.

The following table summarizes the acquired subsidiaries in the mobile handset advertising services segment and Internet advertising segment that were sold back to their original owners in 2009:

		Acquisitions		Date of acquisition				Business segment		Proceeds paid				Date of Disposal				Loss on disposal
1.		Catchstone(1)			2007-4-16			Internet advertising		$	14,489,647				2009-12-22			$	11,560,617
2.		WonderAd(2)			2007-9-15			Internet advertising		$	14,926,003				2009-11-30			$	14,926,003
3.		Jiahua(3)			2007-8-15			Internet advertising		$	7,659,158				2009-12-1			$	7,659,158
4.		Wangmai(4)			2007-9-1			Internet advertising		$	2,749,158				2009-12-14			$	2,749,158
5.		Jichuang(5)			2007-12-1			Internet advertising		$	366,032				2009-8-24			$	366,032
6.		1024(6)			2008-3-1			Internet advertising		$	3,397,124				2009-12-18			$	3,397,124
7.		Dongguan Yaya(7)			2007-10-1			Mobile handset advertising services		$	1,540,612				2009-2-28			$	1,588,110

(1)	The original sellers which subsequently repurchased Catchstone were Only Education Holding Limited and Maxnew Holdings Limited, BVI companies owned by a single PRC individual unrelated to our company.

(2)	The original seller which subsequently repurchased WonderAd was Megajoy Pacific Limited, a BVI company ultimately owned by seven PRC individuals unrelated to our company.

(3)	The original sellers which subsequently repurchased Jiahua were two PRC individuals unrelated to our company.

(4)	The original seller which subsequently repurchased Jichuang was Richcom International Limited, a BVI company owned by a single PRC individual unrelated to our company.

(5)	The original sellers which subsequently repurchased Keylink Global Limited were four PRC individuals unrelated to our company.

(6)	The original sellers which subsequently repurchased 1024 were two PRC individuals unrelated to our company.

(7)	The original sellers which subsequently repurchased Dongguan Yaya were Sinoalpha Limited and Max Planet Limited, BVI companies each of which is owned by a separate single PRC individual unrelated to our company.

All these businesses were acquired and sold back to their original owners. Indeed they were mostly given back to their original owners. Those original owners were mostly BVI entities which the company has said were not related.

In my original post on this matter (which you should read first) I posed three different interpretations of the accounts.

The first interpretation was that these really were unrelated entities and huge amounts of money was lost on these transactions and then the assets were given away. That is the accounts were straight and these were just bad deals.

The second interpretation was that these were undisclosed related parties and the transactions were part of looting Focus Media.

The third interpretation was that the earnings of Focus Media were fake (probably by faking up revenue) and the losses on these transactions were fake losses designed to offset fake profits (and hence make the books balance).

The whole write-up is here. I had no way of distinguishing between these interpretations.

Since then I have done more work.

In particular I have obtained the company registration details from the British Virgin Islands for six of the counterparties. Remember these are unrelated counterparties - they are BVI companies that sold assets to Focus Media and were mostly later given those assets back. As these were unrelated purchases all of these counter-parties should be unrelated. All of them except for Only Education Holdings Limited and Maxnew Holdings Limited because above it discloses that those two companies are owned by a single PRC individual unrelated to Focus Media.

Lets go case by case:

Catchstone was purchased from Only Education Holdings and Maxnew Holdings limited on the 16th April 2007. Only Education was registered on 6 October 2006, Maxnew on 8 January 2007. Both had the same address and phone numbers:

R.G. Hodge Plaza 2nd Floor
P. O. Box 3152
Road Town
Tortola VG1110
British Virgin Islands
Tel#: 1-284-494-4693 Fax#: 1-284-494-4627

That is OK because Only Education and Maxnew were related parties - they were both owned by the  same PRC individual.

Both companies were later struck-off for non-payment of a fee.

WonderAd was purchased from and later given back to Megajoy Pacific Limited, a BVI company owned by seven PRC individuals unrelated to Focus Media. The date of purchase was 15 September 2007.

Megajoy was registered on the 2 February 2007. The registered address and phone number were:

R.G. Hodge Plaza 2nd Floor
P. O. Box 3152
Road Town
Tortola VG1110
British Virgin Islands
Tel#: 1-284-494-4693 Fax#: 1-284-494-4627

The company was later struck off for non-payment of a fee.

By now I am puzzled. In a town full of lawyers these seemingly unrelated parties have managed to choose the same lawyer.

Wangmai was purchased from and later given back to Richcom International Limited, a BVI company owned by a single PRC individuals unrelated to Focus Media. The date of acquisition was 15 August 2007.

Richcom was registered on 25 October 2007. Strangely this company was only came into existence a few months after it had sold a multi-million dollar business to Focus Media.

The registered address and phone number are:

R.G. Hodge Plaza 2nd Floor
P. O. Box 3152
Road Town
Tortola VG1110
British Virgin Islands
Tel#: 1-284-494-4693 Fax#: 1-284-494-4627

Yes - it is the same address. And the same outcome. The company was struck off for non-payment of a fee.

Dongguan Yaya was purchased from and later given back to Sinoalpha Limited and Max Planet Limited. The acquisition date was 1 October 2007. Each of these companies was owned by a separate single PRC individual unrelated to Focus Media.

Sinoalpha was registered on the 12 July 2007. Max Planet was registered on 10 August 2007. They both had the same address and phone number:

R.G. Hodge Plaza 2nd Floor
P. O. Box 3152
Road Town
Tortola VG1110
British Virgin Islands
Tel#: 1-284-494-4693 Fax#: 1-284-494-4627

Yes - that same address.

Sinoalpha has since been struck-off for non-payment of a fee but (believe it or not) Max Planet is a company in good standing.

Pictures of the official search records for all of these companies are appended to the end of this post.

Interpretations

I originally had three interpretations of the disclosure about the 2009 transactions. The idea that all these transactions are straight though becomes harder to sustain.

In a town full of lawyers all these seemingly unrelated parties chose the same lawyer. And they are sloppy about it - they don't pay their registration fees and get struck off. More notably (in the case of Richcom) companies that do not yet exist sell assets to Focus Media and are later given those assets back.

The last example leans hard towards my third interpretation - that fake cash was paid for fake assets (hence indicating that Focus Media has fake earnings). Why?

Because millions of dollars were - on this data - paid to a company that does not yet exist. I am not sure how a company that does not exist opens a bank account and receives real cash. [Not having a bank account to receive the cash received precludes the first two interpretations above...]

But a company without a bank account can receive fake cash [as per the third interpretation].

That final line is of course just a guess [maybe the company that did not exist did actually have a bank account]. But on the data here it looks to be a guess with pretty good supporting evidence.




John


Appendix: Company details

Only Education Holdings Limited:

Maxnew Holdings

Megajoy Pacific Limited

Richcom International Limited

Sinoalpha Limited

Maxplanet Limited

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.

Focus Media: One strange disclosure, three interpretations

Here is a disclosure from the Focus Media 20F filing:

2009 Disposition

In 2009, we aborted a contemplated initial public offering for its Internet advertising segment due to the economic recession in late 2008. As a result, between August and December 2009, we disposed of six underperforming subsidiaries in that segment through a series of individual transactions with their respective original owners. Each of the subsidiaries was considered a component of our company, and their results have been included in discontinued operations in the consolidated statements of operations. The results of discontinued operations include net revenues and pretax losses of $127.6 million and $45.4 million, respectively, related to these subsidiaries. We recorded a loss on disposal of $44.1 million.

The following table summarizes the acquired subsidiaries in the mobile handset advertising services segment and Internet advertising segment that were sold back to their original owners in 2009:

		Acquisitions		Date of acquisition				Business segment		Proceeds paid				Date of Disposal				Loss on disposal
1.		Catchstone(1)			2007-4-16			Internet advertising		$	14,489,647				2009-12-22			$	11,560,617
2.		WonderAd(2)			2007-9-15			Internet advertising		$	14,926,003				2009-11-30			$	14,926,003
3.		Jiahua(3)			2007-8-15			Internet advertising		$	7,659,158				2009-12-1			$	7,659,158
4.		Wangmai(4)			2007-9-1			Internet advertising		$	2,749,158				2009-12-14			$	2,749,158
5.		Jichuang(5)			2007-12-1			Internet advertising		$	366,032				2009-8-24			$	366,032
6.		1024(6)			2008-3-1			Internet advertising		$	3,397,124				2009-12-18			$	3,397,124
7.		Dongguan Yaya(7)			2007-10-1			Mobile handset advertising services		$	1,540,612				2009-2-28			$	1,588,110

(1)	The original sellers which subsequently repurchased Catchstone were Only Education Holding Limited and Maxnew Holdings Limited, BVI companies owned by a single PRC individual unrelated to our company.

(2)	The original seller which subsequently repurchased WonderAd was Megajoy Pacific Limited, a BVI company ultimately owned by seven PRC individuals unrelated to our company.

(3)	The original sellers which subsequently repurchased Jiahua were two PRC individuals unrelated to our company.

(4)	The original seller which subsequently repurchased Jichuang was Richcom International Limited, a BVI company owned by a single PRC individual unrelated to our company.

(5)	The original sellers which subsequently repurchased Keylink Global Limited were four PRC individuals unrelated to our company.

(6)	The original sellers which subsequently repurchased 1024 were two PRC individuals unrelated to our company.

(7)	The original sellers which subsequently repurchased Dongguan Yaya were Sinoalpha Limited and Max Planet Limited, BVI companies each of which is owned by a separate single PRC individual unrelated to our company.

I want you dear readers to read and try to understand this disclosure.

It says that we (Focus Media) were planning to IPO our internet advertising segment but we aborted that plan "due to the economic recession of late 2008". In other words we thought they were businesses worth taking to IPO.

Instead we took seven of our businesses and disposed of them at losses.

Six of them we disposed of to the original owner.

WonderAd and several others were given to the original owners. 14,926,003 dollars was paid for WonderAd. That was also the loss on disposal - so presumably the business was given back to the original owner. Same is true of Jiahua, Wangmai, Jichuang and 1024. Donggyuan Yaya was also given away.

There was a loss on disposal of $44.1 million from these subsidiaries.

Prior to disposal these subsidiaries had $127.6 million in revenue and $45.4 million in pre-tax losses. So they were big revenue earners - but presumably they had over $170 million in costs. In China where wages are low that is a lot of costs - they appear to have been large operations with a lot of staff.

Because they had large losses ($45.4 million pre-tax) and they did not collapse I presume that Focus Media injected a great deal of cash into the subsidiaries before it gave them back to the original owner for whom in most cases the ownership vehicle was an untraceable British Virgin Islands company.

I have three possible interpretations - and without doing due diligence I could not easily be certain which (if any) is the correct interpretation.

Interpretation A: the accounting statements are entirely accurate

In interpretation A the accounts are entirely straight. Focus Media purchased many independent British Virgin Island companies running internet advertising businesses in China.

These businesses had well over $100 million revenue.

However they all failed and cash - probably $40 plus million - needed to be used to fund operating losses.

Given the (not inconsiderable) pain of funding those operating losses they wanted to close the businesses. But rather than close them they found that the original owners were happy to take them back for no consideration. Presumably the original owners can fund the losses and know how to turn the businesses around.

So they gave the businesses back to their original owners for no consideration and closed the book on the whole sorry saga.

Interpretation B: Focus Media management participated in the looting of Focus Media

These businesses were good or bad or possibly even non-existent. However over $40 million dollars was paid for the businesses and the businesses were given back to the original owner (making the original owners $40 million better off). Moreover a further $40 million was injected into the businesses to just zip up the scale of the looting to something even more attractive for the thieves.

That is why you would do it in the British Virgin Islands. No tax to pay on stolen money - and the companies are untraceable. Yipee!

Interpretation C: The money was never there, the losses are fake and they are used to wash fake profits

In interpretation C, Focus Media reports fake profits over its main businesses. These fake profits result in fake cash on the balance sheet (something that is easily found by auditors). So they produce fake losses to offset them.

What better way to fake losses than buy some businesses, have operating losses and write them off?

And where better to locate the fake businesses but the British Virgin Islands where they are untraceable?

In this interpretation the underlying profitability of Focus Media is grotesquely overstated. When the fake transactions stop the fake losses stop and the fake profits get revealed. The poor private equity buyers (and the suckers who lent them 1.5 billion dollars) are left holding a turkey.

Summary

As I said it is very hard to tell which interpretation is correct without doing due diligence. But due diligence is going to be very hard because the losses are buried in untraceable British Virgin Island subsidiaries. I hope Focus retained enough documentation to verify the first interpretation - and I hope the auditor has traced the BVI subs. Moreover I hope the original owners can be found.

Which interpretation is found to be correct under due diligence matters a lot for the take-private deal.

The first two interpretations are acceptable to the PE buyers and if either is true the deal will probably close.

If the acquisitions were bad (as per the first interpretation) then the PE buyers can stop that prospectively. After all PE buyers can do due diligence and do not have to close bad acquisitions.

If the company was looted (as per the second interpretation) then the PE buyers can stop that prospectively - after all Carlyle and Fountainvest should be competent to construct rigorous financial control of businesses that they acquire.

The third interpretation is utterly terrible for Focus Media stock. In that case Focus Media is a Chinese display media company that uses very complex BVI transactions to fake their profits. Real profitability would be low - but ultimately unknowable. The privatisation will fail under due diligence.

Moreover what is left would be a Chinese display media company which fakes their accounts using untraceable BVI entities. What is that worth? Certainly far less than the current multi-billion dollar market cap.

Now of course off the disclosure I can't tell which of these three interpretations is correct. But if the deal fails then intellectually you are led to the third interpretation. The upside for the stock is to $27 - the bid price. The downside? Large.


John