Friday, June 3, 2011

Muddy Waters: the finest take on a Chinese fraud yet

Carson Block and his team at Muddy Waters Research have just released a report on Sino Forest - a huge Canadian listed company - or is that a huge Canadian listed fraud?

There is a cottage industry in doing forensic analysis of Chinese frauds. I have analysed many and put only a smattering on the blog.

But I have never seen anything this big or this amazing.

Read the report. I am in awe.



Amphimedon said...

Reading now, hilarious stuff.

John, I'd love to read your take on the Bitcoin phenomenon.

John Short ad sinorazum said...

Could you explain what is exactly so special about the report? Size of the fraud? The way the fraud was perpetrated? I don't understand half of the report.

Anonymous said...

It was very well done. What other tsx lsited companies smell fishy? HF , ZUN, MGO. Theres never just one cockroach

Astronomie said...

It was good to read your post, Just wanted to see some pitchers of your research.

Rocky said...

Can I second Amphimedon's suggestion. Another great post John. now the bitcoins....

Anonymous said...

Agreed. A great piece of work from MW. Certainly the biggest exposed Canadian listed fraud since Bre-X.

Anonymous said...

Any opinions on the Groupon S1?

One thing I find interesting is that they are reporting gross revenues based on the purchase price of the coupon. And then they "pay" the merchants from that. So, if you buy a $100 coupon, Groupon claims $100 as their gross revenue, and then pay the merchant $50.

They maintain they are the primary obligor, which is why they can do this. In fact, accounting guidance states that they can only be primary obligor only if they are the party that provides the end product or service, which they clearly do not do. They don't have any sort of risk, so they are more like a distributor.

If this were the case, their revenues would be ~$350 million in gross revenues instead of the headline $700 million.

Bunch of other problems with their S1, but that to me is a biggie.

Liam said...

According to, Paulson & Co were holding 14% of the shares of Sino Forest, valued at US$646M before the plunge.

If true, that's got to hurt....

nik said...

Whole new level of fraud - very thorough investigation which might be indicative of the level of DD that will be required with some of these stocks from now on. It seems the easy targets have all mostly been knocked over (RINO, CCME etc. - they seem too easy in retrospect)

This story just keeps on getting bigger

I hope MW made a mint out of this, but I couldn't see any shares to borrow or options.

patrick said...

nice work by MW..i hadnt looked at this company till yesterday, just taking some numbers off the conf call gave me a EV/hectare of USD 6,600 per hectare of woodland vs about USD 211 for abitibibowater. seems pretty clear there is a fraud here but how in h*ll did the valuation get this wacked out to begin with? isnt like their trees are any better than this just an extreme example of people buying a piece of shite because is/was related to China?

Frozen in the North said...

the report seems to show one thing; That frauds can survive a long time when "properly structured" as Madoff showed the world.

Nick said...

On that Groupon S1 comment - what's the problem?

I don't think it as if they are trying to HIDE the fact that their COGS is 50%??

Unless you value a company purely on sales whether their sales are gross or net is irrelevant.

The question is what is their sustainable margin.
If you take the gross sales figure the margin will be half the figure if you used the net sales figure.

It's not rocket science.
Unlike seeing the wood for the trees in China.

Anonymous said...

Chinese stocks, bitcoins, Groupon...

so many frauds to pick from...

Anonymous said...

SNOFF US trading

Potato said...

Made the mistake of trusting other people's research on this one myself. Bought just this week after TD's last report claimed they were happy with the governance here.


Anonymous said...

Stock rallies from 2.45 to 6.40

draghkhar said...

Wow, this is an impressive report. I really got a kick out of the diagram of the phantom cash flow on page 11 and the figure on page 21 (I don't want to spoil it, just go look).

I find it far more persuasive than the company's rebuttal, which consists of ad hominem attacks and legal hair-splitting (e.g., we never said we trucked an ungodly amount of lumber through rugged mountain terrain - we just sold it to someone else who did it for us!)

I'm starting to sense a pattern that goes beyond TRE or even all the companies Muddy Waters, Alfred Little, John Hempton, and others have exposed. And I wonder: how deep does this rabbit hole go?

Anonymous said...

The Groupon issue is as @Anon3:05 mentioned (good pickup b.t.w) they are using gross revenues under the guise of a
"primary obligor". If you read the EITF 99-19 guidance on revenue recognition around ( this its pretty clear that Groupon isn't the primary obliger. As such the reporting in the accounts should be on a net revenue basis.

So does it matter? We'll it matters if they are using aggressive GAAP accounting on the revenue line to try and get IPO away at a good price. What looks better 645MM or 270MM revenue?

It also matters if its indicative of other aggressive accounting practices in the accounts.

Wooda Coulds Shoulda said...

Patrick, valuations vary a lot for timberland based upon these factors:

1. what type of timber is it (what's the end use)

2. ease of harvesting

3. proximity to end user (market)

Timberwest's (TWF) valuation per hectare was $1400 or so at the time it got taken out (April of 2011).

Those who worship at Muddy Waters' altar (or Alfred Little's, Andrew Left's, any other short seller) without doing their own number crunching remind me of the lemmings who believed everything that ever came out of Mary Meeker's or Henry Blodget's mouth at market top of the big tech bubble.

Anonymous said...


As you seem to understand the phantom illustration, can you please explain what it is demonstrating?

Is the allegation in the illustration one involving the timing of revenue recognition (eg. company recognized revenue midstream but the author of the report thinks it should have been booked on final payment)?

Is it claiming a double-booking of revenue (ie. one time on credit sales 'into' the AI and then once again based on actual remittance)?

Does the illustration allege the company has fabricated revenue altogether, and that no monies were ever paid it by the 'AI' whatsoever?

Or does the illustration allege that a shifting of resources from one subsidiary to another was counted towards revenue while leaving the associated assets on the consolidated books?

Exactly what is even being alleged in that particular diagram?

Anonymous said...

Seems a lot like a very long version answer to one of those standard interview questions... how many ping pong balls can you fit into a 747?

"In short, unless this sale of 2.2 million cubic meters of broad leaf timber from Yunnan was
fulfilled illegally (in excess of quota and without all of the requisite permits) and accomplished
with an army of Chinese farmers and shipped out via a secret under-ground train tunnel running
below the mountains, it either never happened or was grossly over-inflated."

Anonymous said...

I was unlucky to buy into TRE a few weeks ago so i'm clearly not happy with what has transpired.

The jury is out on this one! I live in Toronto (i'm a commercial banker) and Sino's board is quite impressive and while i know it is quite possible that even good BODs can find themselves in these situations, I just want to raise the point that Mr Muddy Water's should also be challenged.

While Muddy Waters and his team have uncovered similar frauds, there is very good evidence to suggest that he is quite deliberate in playing up some of these "shorts" simply for the purpose of deflate and short!!

Reference these two articles on ONP (Orient Paper)

John Hempton said...

I feel for you having purchased Sino Forests two weeks ago.

But it comes down to this: 2.2 million cubic meters of timber - is MANY times government quotas in the area.

MW has the quotas - and the documents are provided.

That is 36 thousand truck loads.

Most jinkers (a jinker is the right word for a log truck) do about three trips a day (and that is a long day - forests are often on mountain roads).

Lets be nice. Call it 360 days a year, 3 trips per day -

That is about 40 trucks a day. Real number MUCH MUCH higher - because it would be 2 trips and not 360 days a year.

This is a pretty simple test.

If you think MW has something to prove here you are blindly optimistic.


Potato said...

John: did you see the company's refutation of that bit, that the sale was of standing timber?

I still don't know what to believe at this point. The release this morning looked better, but the documents are behind a registration wall, and we've learned (from you!) that you have to to the bank to get verification of cash balances anyway, and that still hasn't been done.

Anonymous said...

I understand the batting average in the investing world is not expected to be 100% for any investor.

However, when someone like Mr. Muddy Waters makes a Fraud claim as he has in his report, I would expect that every possible precaution and personal humility would be shown especially when screaming fraud allegations.

Sino Forest has already dismissed some of the most basic don't have to "truck" sales of standing timber....they are standing! Which also means no harvest which equally means no impact to quota. That's fairly simple logic - all disclosed on the MD&A.

While there are other allegations (especially the AI and VAT issues) that Sino must respond to, at least Sino's BOD have somewhat of a code of conduct by which they are accountable for.

Precisely what code of ethics is Mr. Muddy Water's responsible for.....screaming Fraud is a very serious allegation and the fact that Mr. Water's has been successful at identifying several frauds should not give him the leeway to screem fraud at anything that looks suspicious - some humility please!!

In my mind - the jury is out on both Sino and Mr. Muddy Waters. At least I know what Sino is accountable for, Muddy Waters - not so much!

Anonymous said...

I got a snake. One time i fed it some beer. It was slithering this way and that. It was all Fuc%$ up.

Anonymous said...

Those who are expressing some skepticism: fair enough. In principle I agree with that approach. I'm short the stock, so I too have been doing my own due's not looking good for Sino Forest in my opinion.

Here's why:

(1) There have been questions about the business way before Muddy Waters came on the scene - I did some digging and found there were a few sellside (yes the cheerleaders) analysts (who could not make sense of the financial numbers vs. operational reality. At least a couple initiated with a 'sell' rating..not something you do on the sell side unless you really really have to.

(2) Anyone with an understanding of financial statements and business economics would agree that financially speaking, Sino Forest is a Ponzi (not in the moral/legal sense), in that the business funds its operations via other people's money; it has never generated free cash flow, and hasn't funded itself via cash flow. And this is assuming the numbers can be trusted. If not...well it's much worse.

(3) The Dundee Analyst who has been the strongest advocate of Sino Forest (and Muddy's biggest basher) cite shady figures like Benjamin Wei to make his arguments, and point out very narrow difficulties Muddy Waters faced with ONP, while omitting that ONP is having accounting issues come to light a few months ago. The Dundee Analyst is either an idiot or in cahoots with Sino Forest.

(4) Sino Forest's response has been at best a PR disaster, and at worst (and I think more likely) evidence something is amiss. If the truth will set them free, why make the supporting docs gated? I personally requested access to the 'data room' Monday, and have not heard back. Also, Sino's mgmt team has stayed away from the spotlight, only to level insults at Muddy, rather than addressing the accusations head on, in a transparent, comprehensive manner.
They also continue to refuse to disclose their customers citing the usual mgmt pat answer , "competitive reasons".

There is more but you get the gist.

Tom said...

What's impressive is the size, pedigree, and longevity of the alleged fraud.

Previous Chinese RTO frauds were generally under $200 MM in market cap, merged ("listed") within the last few years, and could be debunked by visiting a single factory and showing that it was a Potemkin factory.

This one was an order of magnitude larger, has been around for over a decade, and allegedly has widely-dispersed operations in many Chinese provinces.

As for nik's point -- to a certain extent, the easiest targets have been knocked out. But even those that have not been exposed have suffered along with all the RTO stocks in a general sectorwide decline (most now trading around 3-5x P/E). There's not a lot of money to be made in them anymore.

Notice, for example, that CCME and LFT were trading at above 10x P/E when they were exposed. People went after them because they offered the juiciest returns. Sino-Forest was also trading at a "legitimate company" multiple.

Anonymous said...

"There have been questions about the business way before Muddy Waters came on the scene - I did some digging and found there were a few sellside (yes the cheerleaders) analysts (who could not make sense of the financial numbers vs. operational reality. At least a couple initiated with a 'sell' rating..not something you do on the sell side unless you really really have to."

Interesting, Reuters shows Sino has 10 analysts, and only 1 is a hold. The rest are either buys or strong buys.

Who were the firms with the sell ratings, and what happened to them?

Simon Forrest said...

Regarding your question on sell side analysts: Note this was in the past, but nevertheless, the comments/concerns were eerily (I kid you not) similar, though expressed in a more diplomatic fashion.

you can email me at and I'll share who.

Anonymous said...

Hi John,

Still going into crowded rooms and Yelling, "fire" I see.

You have mad your money, but you are wrong yet again.

Had fun battling against your flawed analysis on Fairfax Financial, back in the day.

Didn't have a position in TRE, but will probably by now, thankd to this "opportunity". LOL


DYU said...

Hi Jordan, you almost sound the CEO... that said, no one has a perfect track record.

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