Tuesday, July 26, 2011

Hollysys - a blog post inspired by the railway crash

Disclosure for people who do not get my sense of humor: We are short Hollysys. 
If you get to the end of the post and do not understand why read the note on the blog as to humor - or just read this.


Hollysys is a Chinese rail technology company listed in the USA (NASDAQ:HOLI).

The stock is having a rough trading day today. As I write the stock is down about 20 percent. My first reaction was the Chinese rail crash but Hollysys has denied its signalling is involved.

That is a relief because Hollysys is an amazing company. And because it did not cause the railway accident it should be able to sweep the board of its inferior competition.

How to approach Hollysys

I approach Hollysys like I approach many amazing Chinese companies - businesses with amazing technology, amazing growth and amazing margins.

Some of the amazing claims made have turned out to be false - but some are yet to be falsified and some of those might actually be true. After all 1.3 billion people should be able to some amazing things.

Hollysys however is possibly the most amazing company I have seen yet.

As this blog is a fan of Fox News I wish to be fair-and-balanced. I report. You can decide.

What Hollysys does?

Hollysys makes control systems. It started in the railways industry and specializes in very fast trains. Here is a description from their website:

HollySys Automation Technologies is a leading provider of automation and control technologies and applications in China that enables its diversified industry and utility customers to improve operating safety, reliability, and efficiency. Founded in 1993, HollySys has approximately 2,400 employees with 9 sales centers and 13 service centers in 21 cities in China and serves over 1700 customers in the industrial, railway, subway & nuclear industries. Its proprietary technologies are applied in product lines including Distributed Control System (DCS) and Programmable Logic Controller (PLC), high-speed railway Train Control Center (TCC) and Automatic Train Protection (ATP), subway supervisory and control platform (SCADA), and nuclear conventional island automation and control products. HollySys is the largest SCADA systems supplier to China's subway automation market, and is the only certified domestic automation control systems provider to the nuclear industry in China. HollySys is also one of only five automation control systems and products providers approved by China's Ministry of Railways in the 200km to 250km high-speed rail segment, and is one of only two automation control systems and products providers approved in the 300km to 350km high-speed rail segment.
HollySys has achieved a wealth load of automation and control experience in the multiple business sectors such as Electric Power, Renewable Energy, Chemical, Petrochemical, Cement Processing, Mining and Metal Processing, Environment Protection, Pulps and Papers, Factory Machinery and Manufacturing, Railway and Subway, and Nuclear Power Instrumentation and Control. For the past 16 years, the HollySys name has always been standing as a symbol of quality and reliability in China. HollySys offers a wide range of automation and control products from PLCs to DCS to help you find the solution for any automation and process control application. Through our sustainable business and continuous development in the area of automation, we are able to provide users with a complete and total automation solution for the industries process sectors.
Our corporate mission is to be one of the major platform providers in Automation and Control with innovative technological products and solution back by the highest quality of services and support. We hope to utilize our expertise in the arena of automation technology for better work, life, and environment. We are now the global supplier of choice for innovative technology backed by the highest level of service and support. When you need products and solutions you can rely on, choose HollySys.

Their website then goes through various businesses that they run and describes their achievements. The achievements are on par with global players in the control-automation business such as Siemens. For instance on nuclear power this is what they say:

Since 1995, HollySys starts providing solutions for the nuclear power plant automation in China and since then, we have been continuously providing digital I&C system for the nuclear power plant. Through hardship of innovation and development, HollySys has now self-developed products and solution for the nuclear power plant control system. With more than 10 years of experience and over 40 successful NPP projects, HollySys has both the ability to become very competitive product suppliers and service providers.
  • In 1997, HollySys developed China’s first computer control system for the nuclear power plant. The system was exported to Pakistan Chashma 300MW NPP and has been successfully operating ever since.
  • In 1998, Qingshan Phase II NPP adopted HollySys DCS system. It is equip with centralized supervision and safety control of the nuclear power plant with system of conventional island design.
  • In 2004, HollySys was the first to enter the field of nuclear safety testing and successfully implemented the project of digital safety testing devices.
  • In 2005, HollySys became the localized sub-contractor of Ling’Ao Nuclear Power Plant phase II, and undertaking the project implementation for digital I&C system.
  • In 2007, HollySys has successfully developed its first generation totally digital I&C system, the HOLLiAS NMS system.
By far, HollySys has 44 signed and completed contracts within our nuclear power business unit covering almost all of the China’s Nuclear Power Plant either in construction or in operation. These have put us in the top league in competition among other competitors in China. This vast achievement wins recognition from our customers, at the same time, have proven the reliability and safety of our solution, and the professionalism in our engineering services that we provided.

They make similarly large claims about their business in other sectors such as control systems for subway automation or factory automation.

One long investor I know visited the plants and was shown a very impressive company. There headquarters photographed on the website - is very impressive.

But as regular readers of this blog know I am a balance sheet kind of guy. When I see such amazing businesses built out of nothing I want to know what assets are employed and how much cumulative R&D there has been. After all HollySys looks like a serious threat to Siemens on its claimed businesses.

Here is the balance sheet from the last annual filing (on form 20F). Numbers are in US dollars and the balance dates are June 30:




Current Assets

Cash and cash equivalents



Contract commitment deposit in banks



Accounts receivable, net of allowance for doubtful accounts of $6,276,670 and $8,408,318



Cost and estimated earnings in excess of billings, net of allowance for doubtful accounts of $744,113 and $1,102,016 (note 5)



Other receivables, net of allowance for doubtful accounts of $178,532 and $214,789



Advance to suppliers



Amount due from related parties (note 18)



Inventories, net of provision of $1,114,140 and $2,393,546 (note 4)



Prepaid expenses



Income tax recoverable



Deferred tax assets (note 16)



Deposit for acquisition of equity interest from minority interest



Total current assets



Property, plant and equipment, net (note 6)



Long term investments (note 7)



Long term deferred expenses



Deferred tax assets (note 16)



Total assets




Current liabilities

Short-term bank loans (note 9)



Current portion of long-term bank loans (note 12)



Current portion of long-term bonds payable (note 11)



Accounts payable



Construction cost payable



Deferred revenue



Accrued payroll and related expense



Income tax payable



Warranty liabilities (note 8)



Other tax payables



Accrued liabilities



Amounts due to related parties (note 18)



Deferred tax liabilities (note 16)



Total current liabilities



Long-term b ank loans (note 12)



Long-term bonds payable (note 11)



Total liabilities





Well lets piece this apart. The company claims $65.3 million in property plant and equipment (PP&E) and it directs us to Note 6. Note 6 breaks the PP&E down further:

A summary of property, plant and equipment at cost is as follows:

June 30,



Land use right












Vehicles and other equipment



Construction in progress





Less: Accumulated depreciation and amortization





Construction in progress consists of capital expenditures and capitalized interest charges relating to the construction of facilities and assembly lines projects. Interest of nil, $206,595 and $1,102,772 during the period of construction for the years ended June 30, 2008, 2009 and 2010 respectively have been capitalized.

During the year ended June 30, 2009, the Company commenced the construction of a new facility with building area of about 150,000 square meters.  As of June 30, 2010, the construction in progress of the new facility was $39 million.   The Company completed this new facility and related construction project in August 2010, and the whole construction cost amounted to approximately $44 million including the cost of land use right of $5 million which had been acquired during the year ended June 30, 2008.  

The depreciation and amortization for the years ended June 30, 2008, 2009 and 2010 were $1,817,657, $2,241,344  and $ 2,683,042 respectively.

We learn that the 65.3 million in net PP&E is $76.6 million gross PP&E - the difference being accumulated depreciation. Of that 76.6 million most is buildings and land use rights. There 13.6 million in buildings, 7.3 in land use rights and another 39.3 million under construction.

Only $3.1 million of machinery is in use. That is kind of funny because this company is a manufacturer of some pretty high end kit. Indeed it is pretty hard to imagine how you manufacture the control systems (sensors etc and the computers to go with it) with only $3.1 million in kit - but the company seems to do so. Those machines should also include all the computers on which staff make the software to run all this fancy kit. The company has $3000 of kit - so there is less than a laptop per staff member in machines - and surely all of this manufacturing requires some machines.

Whatever: this is a miracle of machine efficiency - as amazing as any other Chinese company I have written on.

The rest of the balance sheet is perverse. The company had revenue in 2009 and 2010 of $157.5 million and $174.1 million respectively. Costs estimated in excess of billings are over $60 million. In other words they have done a third of year's work and not been paid. Net income last year was $27 million. Over the past three years net income is about $20 million. The company has many years income in work which it has done but has not yet got around to billion.

That is perverse. You work and work and work and it is not cash - it is just unbilled receivables. They better be sure they can bill somebody and that they will collect it in cash.

If you look at the last quarterly the costs estimated in excess of billings have ballooned to $86 million. They continue working. They do not collect in cash.

Another 10 million - or half the profits for the last three years - is advanced to suppliers. That number is rising too.

There is 23 million of inventories too. I guess that makes sense - they are a manufacturer - but there are next to no machines to work on these inventories with...

Admittedly their liabilities are also larger than would appear normal - there is for instance 33 million in deferred revenue. That is also large relative to profit. I guess working capital management is just different in China...

Revenue in the last nine months is skyrocketing. Its up over 60 percent. Property plant and equipment however is almost unchanged. This company is one of the most advanced manufacturers in the world - and as far as I can see it does this almost without machines.

Reasons to be long this company

About six months ago I was talking to a (former) long in this company and he told me that I should be wary shorting it. It was very close to the Railway department and the Railway Minister. (My friend just assumed I would be short - but truly I am looking for companies to go long...)

Hollysys he said had lots of Guanxi - and that Guanxi might help them make money. He thought it even possible that they had obtained machinery and know how from the Railway Department without having to pay for it.

He really did think that there was a relationship with the Railways Minister that would play well for the company. And not being that familiar with the innards of the Chinese Politburo I was not one to quibble.

The stock however got weaker when the Railway Minister was arrested for corruption.


This company has done about 25 million cumulative R&D in the past three years. This is a lot by Chinese standards but it is tiny by the standards of Siemens. Given the enormous advances that this company has (claimed to have) made in fast train and nuclear power control systems I am getting worried about nuclear reactors controlled on the cheap. Still I report: you decide.


This company is a June balance date. The auditor is BDO Hong Kong. This is an auditor stung a little by scandal lately but then so has every auditor in China.

This one is amazing. Utterly amazing. It might trip up on audit (which is not far away). But this might actually be the real deal - the company with world-class technology on a modest cumulative R&D budget. The company with world class manufacturing where the manufacturing requires next to no machines. The company that does work greater than its accumulated profit and neither expenses nor bills that work. The company that breaks all the rules and still succeeds.

The company that proves that this time it is different in China.

And imagine - because they did not cause the railway accident they are going to be getting a lot more work.



Anonymous said...


Having followed your dissection of a number of Chinese companies, I have increasingly wondered at the complicity or naiviety of the auditors (having been somewhat sympathetic to your post on how auditors can be innocent).

Assuming that not everyone can be complicit in a fraud and that a routine analysis of both the client industry and plant would raise some red flags, what is your view on the quality of auditors in China? It seems that increasingly, auditors are failing to do some basic checks and analyses on their clients. Deliberate? Lazy? Incompetant? Complicit?


John Hempton said...

The quality range of auditors is enormous.

Frazer Frost got sanctioned by the SEC. My view is that was deserved - but FF was by no means the worst auditor.

By contrast I think the big four are mostly honest but duped.

The auditors cover the whole gamut.

Fake Mitt Romney said...

Wow. This looks like an amazing value investing opportunity. How can I buy out this company?

Anonymous said...

my guess is that this is a fraud. please note that net income YTD is 34.5M while cash flow from operations was NEGATIVE 9.2M. But this isn't the problem, it is the nature of the CFO decoupling.

** Notice in Q3;11 (just reported) revenues increased by 21M. During that same YoY comparison, unbilled receivables increased by virtually the same amount. So I would make a small correction to your post - it isn't that they aren't collecting... they AREN'T EVEN BILLING customers anymore for the revenue purportedly being recognized on percentage of completion.

Further, why would a company with $95 million of cash at the end of the most recent quarter, require a $4M desperate line of credit to draw down quarter-over-quarter?

Stay tuned, I am sure there is much more to come here....

John Short ad sinorazum said...

If HOLI is questionable, why is CER bullish on HOLI? They were right on the money with CHBT and last week they are bearish on HOGS.


Anonymous said...

Gotta love Yahoo Finance, who posted this story about your blog with the following headline:

"Hollysys Automation should be able to beat competition, says Bronte Capital"


"Bronte Capital reports that Hollysys has denied that its signalling was involved in the Chinese rail crash. The firm thinks the company offers amazing growth, amazing margins, and amazing technology."

Anonymous said...

According to the Guardian and Hong Kong media, there is a major cover-up underway regarding the causes of the high-speed rail crash. See "Chinese anger over alleged cover-up of high-speed rail crash"

There is no way a crash like that could occur without a major signalling system failure. A lightning strike should not take out a railroad signalling system. Railroad signal systems have been resistant to lightning strikes since the late 19th century.

Anonymous said...

From 11-16-10 HLS International 20K: "We assemble our products from subcomponents provided by others or we outsource the production to qualified vendors. We acquire advanced printed circuit board components from high quality suppliers. We rely on our
manufacturing management department to coordinate the procurement of raw materials and outsourced processing, including
the procurement of components and standard parts (such as cables and connectors), and outsourced processing of Polyvinyl
Chloride (PVC) coating, shells, and printed circuit boards. Our products are subjected to rigorous testing in our facilities prior to shipment." So I guess they would say that they don't need manufacturing equipment because they outsource it all.

They seem to have "acquired" industry-leading technology very quickly thought. They are amazing!

Anonymous said...

John, you wrote that, "One long investor I know visited the plants and was shown a very impressive company. There headquarters photographed on the website - is very impressive"

Did that long see lots of equipment? (this would easily prove/disprove whether they got stuff for free from thegovernment).

I can't understand how I keep missing these companies--it seems like the more companies I try to analyse, the more "good" ones I seem to not get around to in time...

Tom said...

John, how do you approach the decision to short a stock such as HOLI, which can only be borrowed at an insanely high call rate?

A couple of months ago, I took a look at the few remaining RTOs that were still trading at high enough prices to be worth shorting. Only two stocks made it through my screen: AUTC and HOLI.

I was about 99% sure that AUTC is fraudulent, and about 70% sure that HOLI is fraudulent. But I can only borrow AUTC at a call rate of 100%, and HOLI at 50%. Even if I'm right about AUTC, I lose money if the stock takes longer than one year to delist, or if another short squeeze happens.

Is this one of those things that you get more comfortable with after doing it several times? Or do you often find yourself sitting out juicy short targets because they were simply too expensive to short?

James Bankton said...

A big chunk of your argument is on receivables.

The receivables for projects that are multi-year, large projects like nuclear and high speed rails tends to go through ballooning phases as payments are made at fixed milestones in a year.

Especially with the fact that they regularly get work from Chinese government who only pays a few times a year. It is not unusual for income to be non-cash as they'll be paid later.

As for R&D, it doesn't cost that much to employ 3000 engineers in China. It's no surprise their R&D costs isn't as high as established company like Siemans.

Moreover, a lot of their technology are directly transferred and obtained from government and partnerships with Japan, so they do not bear the R&D cost from scratch.

To your point about construction costs. They're constructing a new facility. Who buys equipment and computers for a facility that's "STILL BEING BUILT"?! Only when the buildings are done do you start investing in those two categories. For manufacturers, esp those that have to build the buildings from scratch, it is not unusual to see machinery, software and equipment costs come in later.

I think your analysis is biased.

Jeffrey Rothstein said...

Its amazing that a cursory look at the financial statements of these firms raises really big, bright flashing red flags, yet "smart" people are long these firms, like your friend who seemed to use a sort of plug (guaxni) to explain away the very strange PP&E/R&D numbers.

I priced some servers on Alibaba when I was looking at YOKU, and while hardly being an expert in the field (to assess quality, reliability, installation/integration/maintenance/operating costs), it does seem that just the hardware can be bought for fairly cheap.

But it seems then even if these firms can get equipment for so cheap (or even free/free-ish), they're still carrying them on their balance sheets at WAY too low values relative to what they claim to be using them for/achieving.

Like you say, either these young Chinese firms have achieved productivity and efficiency never before even imagined, or they are lying (about what, exactly, is harder to ascertain).

I find the latter far easier to believe than the former.

Anonymous said...

I think your thesis is a bit weak on this one. But there is certainly a lot of hair. This could also be a company that is moving from a local trader to a manufacturer. But even then the B/S looks suspect. While the thesis that this may be a fraud may be right, the chances of your trade being successful could be different due to external factors (costs of shorting) and internal factors (the company may have "good" inventory and good cash).

On a different note: As a buy side analyst, I have struggled to get heard and have had my worries pushed aside by others probably under pressure to do deals. Your blog has in some ways been a "motivation" as I struggled. Some one called my line of thinking as incongruous -- and I took that as a compliment. My views have been validated more than a few times as, in Andrew Smithers' words " opinions tend to be moved more quickly by events than by arguments." I have survived because of that!

Good work, as always.


Anonymous said...

Ha, you missed their greates invention of semi-invisilbility, as applied to the building on top right part of their ne complex.

Maybe their machinery is using similar technology as to make it hard-to-copy by nefarious competitors?

On the other hand, I'm not sure that applying the technology to the signaling devices was the best idea the sales team had...

Anonymous said...

Huh...I'd love to short this company, but their annual report says that all of their manufacturing is outsourced. They contract with outside manufacturers to produce equipment for them, and basically do the assembly themselves:

We assemble our products from subcomponents provided by others or we outsource the production to qualified vendors. We acquire advanced printed circuit
board components from high quality suppliers. We rely on our manufacturing management department to coordinate the procurement of raw materials and
outsourced processing, including the procurement of components and standard parts (such as cables and connectors), and outsourced processing of Polyvinyl
Chloride (PVC) coating, shells, and printed circuit boards. Our products are subjected to rigorous testing in our facilities prior to shipment.

Anonymous said...

Hi John,
Great Post. Plausible deniability is motto for most in financial services ( it's hard to prove criminal intent in this business). Like you said there are lot of auditors who are worse and the big 4 are duped (my experience during my banking days says otherwise - lax controls and incentive policies),i suspect it's not about reputation anymore.

And now i am glad to know you are worthy of being on any news corp media business

Anonymous said...

John, are you going to post this on Business Insider?

or perhaps a more direct (not sarcasm) version with a link?

seems like your original thoughts got a little obstructed/misinterpreted.

dd said...

Our products are subjected to rigorous testing in our facilities prior to shipment

In facilities costing less than $3.1m, presumably. I had always thought of testing equipment for nuclear industry safety controls as being quite expensive stuff.

NYC Analyst said...

Hollysys has long, large contracts with the government. The lumpiness of their quarterly business is to be expected, and the large contract that was completed in Q2 and will be recognized should balance a lot of that. The situation with the rail crash is another thing...

Anonymous said...

If you go to China and make a DD, you should ask BASF China if they use HOLI-Products. On the website they claim BASF China choose their product (for what? As paperweight?)

Theoretically, they can have products and no machinery. Apple also doesn't produce anything themself)

Anonymous said...

Not sure. Ansaldo STS produces € 1.2bln of revenues on € 100mln of tangible assets, of which € 70mln are buildings.

Joseph McGaughey said...

How are you short holi?
Do you use options or do you sell the stock short directly?

John Hempton said...

The Italian example is new to me and an interesting comparison.

The bigger difference there is that the Italian company has huge work in progress funded by huge customer advances.

There is 657 million euro advances from customers and 403 million in trade payables...

Hollysys works and works and never sees cash.

The balance sheet is really strange at Holly. Antsalto just looks like an outsource engineering company. Its on OTHER PEOPLES KIT.


Anonymous said...

I find your analysis amateurish and laughable. But I acknowledge you will convince the average layman who still thinks Bali and China is the same 'country'!

Holi is more a tech company than you think. The value is in the people ie engineers. These don't get counted in the bal sheet. And yes, once the design is done, almost all manufacturing is outsourced. Final assembly is done back in their hq by ...people..not machines. Testing is simply about hooking up to pc's and switches.

YOu were puzzled by high inventory from no machines?? Please go back to school and read up on some accounting basics if you are going to continue blogging about companies. Next you will accuse all retail and tech companies as fraudulent based on that!

If you knew how business works in China (or Bali?) then you will also know that receivables stretch out for close to a year when dealing with the state owned companies, which make up the most of Holi's clients.

Enough said.

Nemo Incognito said...

Anon July 30 12:39, last time I saw someone that angry was when this blog was discussing Longtop.

Maybe there is value in the engineers but normally that gets crystallized as patents in the form of cumulative R&D and the like. Maybe you could just throw together a company that has massive value and no patents - I could think of a few recent VC deals (Colors?) but any company that has been around for a decent period of time would accumulate some R&D. Those engineers don't get paid to play PS3 all day.

Now, here's another possibility which belies that I do know something about doing business in China. HOLI is controlled by proxies of someone *very* politically powerful. HOLI has zero value add (couldn't those engineers be hired by CRC, China Highspeed, etc? Why work for HOLI?) but can extract rents from these companies because they are told to purchase services of no value from HOLI (consulting contracts, minor design tweaks for serious markups,etc) in order to line the pockets of someone very important.

Now that would be entirely plausible - but given the former head of China's rail buildout appears to be on the sort of career track that gets your family billed for a bullet, I wonder how durable that relationship could be now?

Ultimately, its either a defrauding of investors and the Chinese state and people, or a defrauding of investors.

Anonymous said...

Like I said - I find it laughable but I confess I am annoyed as to how amateurish the analysis is. When told about this blog, I was keen to read and learn something new and smart.

The author clearly knows he has some sort of influence over readers and hence the responsibility to actually understand basic finance concepts.

The author may also join the long queue of being proven right and the stock/company capitulates like some other RTOs (maybe). But at the very least, please come up with something smart and challenging with real original research rather than analysis that can be so easily faulted (a "balance sheet kind of guy"? really?) and circumstantial arguments.

Re nemo incognito's reply ...On R&D wages... wages in R&D may not be capitalised..ie research generally gets expensed...development gets capitalised is the rule of thumb. Now, I don't know about you, but I would think you prefer to see a company not tweaking around accounting concepts by capitalising expenses and instead recognise them as expenses when incurred (not to suggest that I know whether the company had a choice in this matter).

Relationships. Difficult to have a view on the background or be convinced of the possible implications. That goes for all companies hence is not a differentiator for performance I'm afraid. Which Chinese company doesn't have one or more political backers, direct or indirect, or proclaim to have one? Welcome to Emerging Markets 101.

Anonymous said...

Anything new to say after their earnings report?
Their unaudited non-gaap earnings report..

Anonymous said...

John, I am curious about your view here. It's more than a year since you made some pretty explicit comments questioning the accounting and validity of Hollysys operations. It seems your view then (explicit and applied with some subtlety) was it was too amazing to be true, just on what you read and some people you spoke to. But there was no proprietary research to confirm any of your allegations. You were up front and mentioned you had a short on the stock. What is your view now?

Anonymous said...

John, despite some 2 years on, somehow I still recall your analysis and opinion (particularly your readers’ opinions) of a small little stock in those days called Hollysys. To recap Hollysys was one of those Chinese RTOs trading on the Daq, nearly all of which were treated like the plaque in the wake of a number of bad apples (fraud) that started to smell. To make matters worse, Hollysys, a rail equipment technology provider also got caught up indirectly in the aftermath of a major scandal at top of the responsible transport ministry, and followed then by a rail disaster that painted an even more negative picture of Chinese made products and regard for safety systems.

Whilst I as an investor/analyst have not profited or loss any capital based on your blog about the company in July 2011, I am deeply curious as to how the ball got rolling for you in this. Let me be straight; I was one of those that found your arguments on the light side relative to such a bold and vocal call. Let me ask two questions:

Firstly, what analysis did you really conduct on the company and industry upon hearing the ‘idea’ that Hollysys may not be what it claimed to be? I can understand how you got to your line of questioning (and scepticism) based on your elaborated scan of the company’s website and balance sheet plus notes to the accounts. But it does seem like that’s where you drew the line before sharing your views to a broader audience, for which you know you have a certain level of influence. Was there more than what you were willing to share that prompted you to suggest this was a company that was simply too amazing to be true?

Secondly, if there was more than you were willing to share, what has been the disconnect between what you knew but didn’t write versus the real world, in the time since? I haven’t picked up recent research on the company as yet, but the share price ($21 today versus $7.8 when you first wrote in July 2011, massively outperforming a rising market by 3x in that time frame) seems to suggest that you did not catch much wind in those sails over quite an extended period.

Anonymous said...

John, Glenn Chan did a quick follow-up on HOLI.

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