Sunday, November 18, 2012

Journos and short sellers getting it wrong

The last post I suggested the Wall Street Journal may be being played by stock promoters (re Focus Media). I still think that.

Many thought I was being harsh on journalists. In particular they rightly pointed out that the shorts were spectacularly wrong on Harbin Electric and the journalists (with a notable exception) were consistently right. I never wrote about that stock but I confess to having lost money on the short - and was surprised at the takeover. My inside-Asia rumour mill was insistent the deal would be done but I did not believe them. [There inside-Asia rumour mill does not insist the Focus Media deal will be done.]

Harbin reminds me (as if I need reminding) that it can go wrong for short sellers (especially the vocal kind).

But it can go wrong for journalists as well. The stock market has a way of reminding us we can all be wrong.

In the journalists-can-stuff-up light I will repeat the single most infamous instance of journalists being played by stock promoters. This was Leslie Stahl's Sixty Minutes piece on Biovail (a Canadian pharma company with extremely dodgy accounts). Stahl swallowed hook-line-and-sinker the view that there was a conspiracy of short sellers determined to spread lies about the stock and destroy the company (and hence the value of mom-and-pop investments). It was pitched as evil hedge funds versus Main Street.

And it was entirely wrong. Biovail was faking its accounts and it eventually dismissed the CEO Eugene Melnyk. Melnyk was later banned from public companies in Canada and paid large fines in the US. But not until well after he completely hoodwinked Leslie Stahl.

All the short allegations were correct.

Sixty Minutes has now taken down the piece which means I cannot replay it to you in all its ignominy. However to the best of my knowledge they never apologized to the people they defamed.

To be fair though not all journalists fell for it. Joe Nocera of the New York Times was sceptical of the Sixty Minutes piece almost straight away. The Ludwig von Mises institute (not my usual source) sided with Nocera.

In other words there were good reasons - at the time Sixty Minutes went to air - to doubt the story Stahl presented.

Sufficient evidence and getting it wrong

We are all going to get it wrong sometimes.

Financial markets however are full of people with an incentive to report falsehoods whether it be stock promoters (as per Eugene Melnyk) or - dare I say it - the odd short-seller. Because so much money is involved you can safely assume that most sources are dripping with vested self-interest. And some are flat lying.

The hurdle rate for a financial journalist is thus high. "Anonymous sources close to the deal" is something that journalists should take with caution. Double caution in China where the fraud level is high.

When financial journalists get it wrong they facilitate criminal activity.

Just ask the haplessly played Leslie Stahl. Her report increased the profits of insider-sellers of Biovail at the expense of her Main Street audience. Oops.

I think the Wall Street Journal has been played here just like Leslie Stahl. And I could be wrong too.

Give it four weeks and I will report back.


PS. I have spent a lot of time trying to work out what went wrong with Harbin. Harbin Electric's accounts did not meet the plausibility test. The company was actively misleading on many occasions - and yet the deal did close and whilst the above mentioned Asia-rumour-mill tells me the deal will be a failure it will not be an abject failure.

There was something there at Harbin and it was not obvious in the accounts.

Here is my best theory as to what happened.

In some Chinese cities you were not allowed to buy land unless you had an industrial business to put on that land.

So people started fake businesses to buy and speculate on real land.

Later they reverse-merged the fake business (complete with fake accounts) into the US market.

That was for most of these fake businesses the end of it.

However in some instances (Harbin and at least one other) the land appreciated so much that the company was worth owning even though its business was largely fake.

And so a go-private transaction made sense.

The shorts were right that the accounts were nonsense. But they were wrong on the thing that mattered. There was value there - just not the value everyone thought!

You can be wrong in ways you never predicted. The unknown unknowns if you will...



  1. Interesting theory about the land value of HRBN, I was never able to figure out wtf happened there. Now you got me wondering what the at least one other company is... :)

  2. There ought to be a right-of-reply -- a right to respond to negative reporting about you, in **at least as prominent** a location as the original article.

    Famously, Ed Murrow offered Joseph McCarthy a right-of-reply when attacking his persecutions. McCarthy took him up on that offer, and used it to dig himself in still further.

    But it would've been quite different if SAC and Camelback had been offered a right-of-reply. If they had any sense of humor, they could've run a piece where they interviewed Joe Nocera and Jim Chanos and educated Americans on just why it is that short-sellers are needed in the markets.

    American newspapers and magazines bury their errors in a "Corrections" section that nobody reads. The Economist acknowledges their errors in the section where they originally made the error -- so that regular readers will be aware of it.

  3. A very interesting theory on HRBN. However, I'm not sure it makes sense to me. I agree completely that the industrial business was almost surely a grossly inflated fraud. But for a management team who had no problem inflating the accounts of the industrial business, why wouldn't they simply dispose the valuable property to an undisclosed related party for a pittance. Surely that would have been easier. I wonder whether this was more about bribing the CDB, which seems to have become the Chinese fraud bail-out fund. It would have allowed the insiders to accumulate lots of stock for a guaranteed large gain.

  4. Some of us tend to become euphoric in the face of success - your post is a good reminder of the need for arrogance balanced with humility :)

  5. I heard a reasonable rumor (in that it came from someone in the know) that the SEC is doing a massive investigation on Focus Media, which is what is driving the buyout stuff. I guess the question is whether Focus is trying to prop up the stock for a bout of giant selling before this comes out or if they are really serious about taking the company private to avoid the ramifications of said investigation.

  6. John,
    I truly admire your thoughtful introspection! It should make your investors well-assured seeing your post-mortem thought process in action, and your tenacity in the search for truth.

  7. I can assure you that Camelback (now Gradient Analytics) never received an apology from 60 Minutes.

  8. Looks like there is a fair dose of skepticism regarding this deal in the market:

    Only wish that I could afford the DataExplorers numbers.

  9. You still short FMCN? I think Carson Block is right: whether or not FMCN's financial reports contain material misrepresentations no longer matters because the Chinese government - hence the Chinese banks - has committed its resources to helping Chinese companies evade excessive scrutiny (i,e, privatize.) I think your assumption that the FMCN deal would fall apart during the due diligence phase was flawed as management can and probably will obtain financing from Chinese institutions if US banks pull out. According to Bloomberg, "Short interest on Focus Media has declined to 4.7 percent of total shares outstanding, from 81 percent a year ago." That isn't necessarily an exoneration of FMCN's financial reporting, but I think it does reflect the reality noted by Carson Block - i.e., shorting Chinese stocks has become significantly more risky. I don't know if Muddy Waters is still short, but based on Carson Block's comments, I'd venture a guess that he is among those who have covered.

  10. There may be some truth to that last comment. Looks like financing may be signed this week...$17bn-lbo-with-nine-banks/21056602.article