Thursday, September 6, 2012

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:

Date of
Business segment
Proceeds paidDate of
Loss on
Internet advertising
$14,489,647  2009-12-22  $11,560,617  
Internet advertising
$14,926,003  2009-11-30  $14,926,003  
Internet advertising
$7,659,158  2009-12-1  $7,659,158  
Internet advertising
$2,749,158  2009-12-14  $2,749,158  
Internet advertising
$366,032  2009-8-24  $366,032  
Internet advertising
$3,397,124  2009-12-18  $3,397,124  
Dongguan Yaya(7)
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.


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.



Anonymous said...

This transaction stinks to high heaven.

Had it happened later when there was more of a focus on China frauds this company would have gone down.

I can't believe the SEC did not investigate.

Current shareholders should take the buyout deal. It is better than staying with suspect management. And of course, this is a Neil Shen deal.

uair01 said...

I guess you already heard about this.

"Chinese Business Leaders Condemn Citron

Citron is an “investment analysis company” owned by Mr. Andrew Left, a man with a long record of fraud, deceit, and unlawful behavior. Citron’s reports take advantage of the information asymmetry between China and the US, and boldly tell lies, knowing that their American readers have no way of verifying them."

Some kind of backlash that was bound to happen. But the comments don't give them much sympathy:

John said...

Aren't you afraid of a certain Mr Lee starts a site? ;-)

Anonymous said...

John, you use the present tense in Interpretation C. Where are the fake profits going today?

New acquisition spending in the years following 2008.
2009: "Nothing significant"
2010: $5.3m
2011: $8.7m, with an additional $15.5m of future earn-outs.

They've claimed over $250m of net profit from 2009 to 2012-Q2. They haven't been spending it in acquisitions. There wasn't any major reduction in screen counts or per-screen revenues.

To resolve this with Interpretation C means that the fraud must have been accelerating, right?

StanCard said...

not to say these transactions aren't most likely fraudulent, but focus media didn't necessarily have to inject any cash into these companies, as they could be non cash costs eg. asset writedowns.

Assuming Focus bought these businesses at book value, that means they had $44mn of book value. And if the business for some reason is no longer viable and you have to write everything down you would end up with roughly $44mn of losses (which was their reported loss). Thats your entire book value wiped out, and the business is therefore worth zero. Since its not worth anything, they just gave the businesses away. The whole thing still stinks, but technically, no extra cash infusion was needed and it does explain why they gave the businesses away.

Anonymous said...

Frauds pretty much always accelerate. When you're borrowing from Peter to pay Paul, you always want a bit extra just in case... Which means you then need to borrow more from Paul to repay Peter!

John Hempton said...

StanCard - not true my friend. Losses were larger than acquisition price and larger than total assets.

Losses had to be paid for in cash. I did not match the cash exactly because of the problem you spotted.


Tom said...

Kai-Fu Lee works in the Internet sector in China. And most of the "Chinese business leaders" who signed onto his letter are also from ... surprise! ... The Internet sector.

The Internet sector depends on faith, to a greater extent than any other sector of the economy except banking. They're looking for angel funding. Then they're looking for VC funding. Then they're looking for investors dumb enough to buy their IPO at inflated prices and cash everyone out.

Their greatest fear is that someone will come along and point out that the emperor has no clothes. Especially someone with a great deal of credibility, from having exposed so many frauds in the past. Because then, the angel/VC/IPO pyramid will collapse.

Anonymous said...

Fascinating footnotes:

Form 20-F 5/6/08 p. 99: “[In connection with the Target Media acquisition] … we have also agreed to permit The Carlyle Group to appoint an observer to our board of directors for a limited period of time.”

Form 20-F 5/6/08 fn 3 p. F-17 “On March 28, 2007, the Group acquired Allyes Information Technology Company Limited (“Allyes”), the leading internet advertising company in China. The purchase price included cash of $70,000,000 and 19,969,080 ordinary shares having a fair value of $154,281,112…”

Form 20-F 6/20/11 p. 72: “In January 2010, certain employees and management of Allyes and certain members of the Company’s management and directors entered into a definitive agreement with the Company and Allyes to buy-out an aggregate 38% interest in Allyes from the Company for a cash consideration of $13.3 million. On July 30, 2010 … the Company sold to Silver Lake Media the Company’s entire remaining 62% ownership interest in Allyes at a cash consideration of $124 million.”

Form 20-F/A 4/24/12 p. 120 “In January 2010… in order to encourage Allyes Online management to invest (and thus remain with the business), Jason Jiang [Focus’ founder and CEO with @ 18% ownership] and Kit Low, who... was in the process of being appointed its chief financial officer, offered to invest their own capital in Allyes under the same terms that Focus Media was offering to Allyes’ management. By making this offer, Messrs. Jiang and Low attempted to show their confidence in Allyes’ business, so that they could encourage the remaining Allyes team to invest, stay in their positions, and commit to Allyes’ success… This transaction was part of initiatives we are taking to incentivize management to enhance the future business model of Allyes and thereby to seek long term sustainable growth for the Group and investors."

Form 20-F 5/6/08 Fn 17 p. F-28“In March 2006, Weiqiang Jiang, father of Jason Nanchun Jiang, 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 was unsecured and non-interesting bearing. At the end of June 2006, the Group paid $2.5 million to Everease and they remitted this fund to Weiqiang Jiang on our behalf to repay the loan outstanding.”

Could this be the same Jiang Weiqiang who was the Director-General of the International Bureau of the State Council Information Office?

Happy shorting!


Birdman said...

The sad reality is that the fiction extends into the buyout itself. Just as was the case with Harbin, the numbers make no sense if you actually believe the headline numbers. Very much as the revenues were bogus and the earlier acquisitions were too is the privatization deal a construct of imaginary numbers.

Were any of us the fly you described we would probably appreciate the controlling shareholders discounting their shares a billion dollars and only makinng 200 million on the fraud. We might see Carlyle taking 40 -50% of the transaction cost back in fees. We might see the China development bank pissing off 5-600 million because the Vice Chairman said it was a good idea.

The players didn't walk a multi billion dollar offer into the public arena without a bit of DD. The unanswerable question is whether they can make the numbers work fully understanding that the US valuations are unsupportable.

The conceit of your presentations is that you presume some new found level of honesty that cloaks Carlyle et al, but was absent earlier. This is a deal FMCN is convinced will make significant money and they are also convinced they can get it done. IMHO

Anonymous said...

This is an awful deal for the pe firms. They will get ripped off.

But even if they become aware of this during due diligence they will close the deal.
As you mentioned in a previous post Focus Media is linked to the chinese establishment.
The western pe players don't want to damage their precious relationships by breaking the deal now. So many well connected people have something to gain from this deal. You don't want anybody to loose face, do you ?

And it's only clients' money after all. The fiction can go on for years before anybody needs to write-off the investment. Most individuals involved in the deal will be with other companies by then.


Anonymous said...

Pe firms are desperate to do a high profile china deal. Otherwise they get heat from LPs for sitting on so much cash and charging mgmt fees for doing nothing for so long.

Does it matter to them if fmcn is real or not?

m said...

Is it possible that these PE firms would buy this company to cash out the insiders as basically a form of massive bribe, so they can then do other profitable or questionable business in China?

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