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).
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.
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.
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)
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)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Short-term bank loans (note 9)
Current portion of long-term bank loans (note 12)
Current portion of long-term bonds payable (note 11)
Construction cost payable
Accrued payroll and related expense
Income tax payable
Warranty liabilities (note 8)
Other tax payables
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)
Land use right
Vehicles and other equipment
Construction in progress
Less: Accumulated depreciation and amortization
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?
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.
Wow. This looks like an amazing value investing opportunity. How can I buy out this company?
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....
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.
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."
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.
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!
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...
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?
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.
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.
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.
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...
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.
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
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.
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.
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...
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)
Not sure. Ansaldo STS produces € 1.2bln of revenues on € 100mln of tangible assets, of which € 70mln are buildings.
How are you short holi?
Do you use options or do you sell the stock short directly?
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.
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.
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.
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.
Anything new to say after their earnings report?
Their unaudited non-gaap earnings report..
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?
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.
John, Glenn Chan did a quick follow-up on HOLI.
Post a Comment