The Alan Jones Facebook experiment

Alan Jones is a right-wing radio shock-jock in Australia - in the tradition of Rush Limbaugh or maybe even Howard Stern. He offends many people (myself included). But then I am an avowed liberal.

He has a moderate but rusted-on audience - about 160 thousand people - or a low single-digit percentage of the population. This is not the the biggest audience by number - but it is the biggest audience by hours listened because the audience is rusted on. They turn the radio on and do not turn it off. He has the largest average audience. He probably also has the most swing because the audience hews so close to his view that he moves markets and votes.

Jones is after all fabulously persuasive with a microphone and an ability to drown out all opposing views. He is truly a "great communicator".

Whether you take offence at "Jonesey" depends partly on your personal politics. Jones does not offend my (avowed conservative/libertarian) business partner (though I doubt BP ever listens to him). He has always been (in  a Rush Limbaugh sense) important to the conservative parties in Australia - he motivates right-wing voters in that swathe of outer-Sydney metropolitan seats which are crucial to electoral success in Australia. Conservatives (at least publicly) tend to like him. The conservative press rally around him.

Alan Jones unsurprisingly is opposed to our unmarried female, athiest and left-of-centre Prime Minister*.  When he said that she (along with the Sydney Lord Mayor) should be sown in a chaff-bag and dumped at sea it was interpreted as a joke. The joke went too far though when he suggested at a closed dinner that the Prime Ministers father (who died that week) had died of shame. An anti-Jones sentiment that had been simmering below the surface for some years came ripping out.

Alan Jones has long been a master of vicious personal attack politics. He is frequently sued for defamation and in Sydney (sometimes even called Jonestown) getting on the wrong side of Alan Jones can be a career limiting move. He has a soapbox and an audience and he frequently attacks his enemies.

Many years of doing this and Jonesey has many enemies - rusted on enemies.

Now Jones is victim of personal attacks mostly organized through Facebook. The tactics that "Sack Alan Jones" with 21 thousand likes on Facebook use don't look that dissimilar to Alan Jones and watching Jones criticize their tactics has a touch of irony about it. The Anti-Jones-anti-mysogeny group Destroy the Joint** (also with about 20 thousand followers on Facebook) uses similar tactics.

There were also over 100 thousand signatures on an electronic "sack Alan Jones" petition.

Now every time someone advertises on the Alan Jones show I get Facebook feed naming the offending party. Advertisers are staying away in droves. Here is a picture presented by Destroy the Joint:

It is not looking good for Jonesey now.

But not so bad either. His audience has gone up prodded a little by controversy (although advertising revenue has plummeted). And the right-wing News Corp press have been relentlessly pro-Jonesey through the whole affair - with the press even saying that the campaign has turned Jonesy into a "free speech martyr". Even the left-wing radio host Phillip Adams tweeted that "media scandals seem to have the shelf-life of yoghurt... Jones has gone from dangling in the wind to back in full swing".

Moreover some advertisers have come back. Local restaurants - ones who do not care if 100 thousand people don't like them as long as a few thousand people do - were very fast to advertise. Indeed because nobody else was advertising they did so in quantity and with great success. (A paid endorsement on Alan Jones will fill any restaurant in Western Sydney...)

Sure, some major brands have advertised and retreated - cowered by hundreds (maybe thousands) of people hitting their complaint page. Personal-attack campaigning by the anti-Jones crowd still works at least on some advertisers.

The Apple Adverts

Strangely Alan Jones started doing straight-to-the-microphone adverts for Apple - the most powerful consumer brand of all. The message was clear - if Apple are not afraid to advertise on Jones show then the blockade must be over.

It turns out that Apple did not buy that advertising. Jones was just giving away free space. The anti-Jones crusaders would argue that the Apple adverts were just part of the Jones deception - a deception that Jones is back in business.

Here is the question: can a couple of Facebook groups with 20 thousand members each and a 100 thousand strong email list maintain the rage? Is social networking more powerful than a fabulous communicator-with-a-microphone and a rusted on audience? Can personal attack campaigning be sustained on Facebook? Note that the Murdoch press (which is very prominent in Australia) is - consistent with its political leanings - backing Alan Jones.

There is a direct stock market way of playing this. Macquarie Radio Networks - the company that controls the Jones show is listed. But honestly the Business Partner and I cannot decide.

So we just had a bet. It is only $50 (we are not big-swingers here) but I think the Jones show will be gone in six months and that social networks provide very high and sustainable advertising values and negative feedback from social networks is a major-corporation nightmare.

The Business Partner - he thinks that over time people will be civil - they can't "maintain the rage". Over time the anti-Jones groups will fade and Jones will come back - maybe a touch chastened and less strong on the personal attack. But he thinks the results of those attacks (by Jones as well as by his critics) is more likely to be temporary. [Besides BP accepts Jones' line that the attack on him is an attack on free speech.]

Five and a half months from now we will declare a winner and $50 will duly change hands.

It is the Facebook mob versus Radio demagogue - a powerful but admittedly uncontrolled experiment in social media versus traditional media. From an investing perspective from this we will learn a great deal about the power and the limits to that power of Facebook.



John

PS. We argue more generally about the value of Facebook. We own a small amount of that stock which I think is unjustifiably cheap - but again the Business Partner disagrees.

*Full disclosure: I don't like our Prime Minister either - but for other reasons.

**The name of "Destroy the Joint" comes from Jonesy's assertion that women (namely the Prime Minister and the Sydney Mayor and a female police chief) are destroying the joint.

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.




John


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...




J

Scepticism and good finance journalism: Focus Media edition

On the 13th of August 2012 Focus Media received a go-private proposal from its founder and a collection of private equity firms.

That was 94 days ago - a bit over three months.

In that time there has been very few announcements from the company.

Second quarter results were announced 22 August. All they said about the deal was as follows:

Announced Receipt of "Going Private" Proposal 

On August 13, 2012, the Company announced that its Board of Directors had received a preliminary non-binding proposal letter, dated August 12, 2012, from affiliates of The Carlyle Group , FountainVest Partners,  CITIC Capital Partners, CDH Investments and China Everbright Limited and Mr. Jason Nanchun Jiang, Chairman of the Board and Chief Executive Officer of Focus Media, and his affiliates (together, the "Consortium Members"), that proposes a "going-private" transaction (the "Transaction") for $27.00 in cash per American depositary share, or $5.40 in cash per ordinary share.  According to the proposal letter, the Consortium Members will form an acquisition company for the purpose of implementing the Transaction, and the Transaction is intended to be financed with a combination of debt and equity capital. The proposal letter states that the Consortium Members have been in discussions with Citigroup Global Markets Asia Limited, Credit Suisse AG, Singapore Branch and DBS Bank Ltd. about financing the Transaction and that these banks have provided certain of the Consortium Members with a letter dated August 11, 2012 indicating that they are highly confident of their ability to fully underwrite the debt financing of the Transaction subject to the terms and conditions set out therein.  

The Company's Board of Directors has formed a committee of independent directors (the "Independent Committee") to consider the proposed transaction. 

No decisions have been made by the Independent Committee with respect to the Company's response to the Transaction. There can be no assurance that any definitive offer will be made, that any agreement will be executed or that this or any other transaction will be approved or consummated.  The Company does not undertake any obligation to provide any updates with respect to this or any other transaction, except as required under applicable law.

On 23 August the company announced that the independent directors had hired advisers to help them assess any bid. To quote:

SHANGHAI, Aug. 23, 2012 /PRNewswire-Asia/ -- Focus Media Holding Limited ("Focus Media" or the "Company") (Nasdaq: FMCN) today announced that a committee of independent directors of the Company's board of directors (the "Independent Committee") has selected J.P. Morgan Securities (Asia Pacific) Limited ("J.P. Morgan") as its financial advisor and Kirkland & Ellis International LLP ("Kirkland & Ellis") as its legal counsel.

There has been no announcement since.

That is 83 days of nothing. Well not quite nothing - the company announced that they were having an AGM but did not mention the go-private proposal.

83 days is a long time for there to be no-progress on a deal which had "highly confident" funding. Surely there is some development - positive or negative - to report in that 83 days.

The Focus Media go-private deal is controversial

Even without 83 days of nothing this deal would be controversial. Muddy Waters - the research firm that exposed the fraud at Sino Forest - has been very critical of Focus Media's accounts.

I have released a many-part series exploring peculiarities in Focus Media's accounts - see Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9, Part 10, Part 11, Part 12, Part 13, Part 14, Part 15, Part 16, and Part 17.

My many part series did not prove that the accounts are fraudulent. It did however demonstrate some peculiar things - for instance the company purchased many seemingly unrelated businesses registered in the British Virgin Islands where all of those businesses somehow had the same address at the same lawyers office. Moreover in at least one instance they closed on the purchase of a business (by purchasing its holding company) before that holding company was even registered.

Here is the rub. Either this deal is real and just very slow or this deal is a complete show pony whereby insiders are dumping huge amounts of their shares - shares valued on a multiple of earnings from highly peculiar accounts.

In one instance the stock should go to $27 - the take-out price. In the other instance the stock should go to single digits (possibly zero) because it is a show-pony dressed up to extract monies from Western investors.

83 days since the latest news, 94 days since the announcement of the deal. Remember that.

The "Fourth Estate" has not been silent

Progress of this deal is newsworthy. This is the largest leveraged buyout deal ever in China - a watershed for the Chinese private equity business. And the media abhor a vacuum.

There have been two key news stories since the deal was announced. Each has acted to support the stock.

The first story was in Basis Point (an industry magazine) and repeated by Reuters. To quote Reuters:

Citigroup, Credit Suisse and DBS Bank are leading the three-part buyout financing, which consists of a $950 million to $1 billion term loan, a $200 million to $300 million bridge-to-bond facility and a $450 million cash bridge, Basis Point reported. 

The term loan is expected to have a five-year tenor, while the bridge financings will have six- to nine-month maturities, the report added. 

The company is looking to put together an underwriter group of six or seven banks and terms of the financing are likely to be finalised in about two to three weeks, Basis Point said.

That story was dated 11 September. They said the deal would take two to three weeks to be finalized.

It is two months now and there is no news. I think we can safely conclude that the Basis Point/Reuters report is wrong at least with respect to the timing.

More recently Prudence Ho and Isabella Steger of the Wall Street Journal said that Merrill Lynch, Deutsche Bank and UBS were going to help finance the Focus Media deal. That story was sourced to "two people familiar with the transaction". In other words anonymous sources.

Those banks were to be joining the three original banks on the deal (Credit Suisse and DBS). Again sourced to "the people".

These anonymous people were very specific: "the six banks plan to provide a total of $1.65 billion in financing, made up of a cash bridge loan, a long-term loan and a high-yield bond".

The Wall Street Journal story was dated 2 November. One of the Ho/Steger anonymous sources said "the banks will sign the formal financing documents next week at the earliest".

Needless to say that has not happened either.

Has the Wall Street Journal been played?

Good anonymous sources are part of journalism - but any journalist should ensure that they are not being played with self-interested falsehoods by these sources.

It looks awful like Basis Point were played. They published the financing was likely to be finalised in "two to three weeks" and it is now two months. The information could have been good and the timetable slipped - but as there was no follow up from Basis Point it is likely the information was flat false.

It is also possible that Ho & Steger (and the WSJ) have been played as well. It might be true that Merrills, Deutche and UBS have all joined forces to close this deal (in which case the Wall Street Journal has a story). But if not the story is a journalist's train-wreck - and should cast into doubt all the work by these fine journalists.

I started writing what I thought a journalist should do with an anonymous source when the source has been lied to them - but there are people far more versed in journalist ethics than me. But forget the ethical issue - this is for financial newspapers a business issue.

The financial press is the only part of the print media that has managed to establish pay-walls around their content. And for good reason too - reading the financial press is about making money and you can justify paying for that.

But when gullible journalists are played then acting on information in the financial press becomes a way to lose money. And what is the point in paying for that?



John

Great Northern Iron and the persistence of worthwhile counterparties

Great Northern Iron is a funny traded instrument. It is a trust. The trust expires on 6 April 2015 when they will have one final cash payment and go to zero.

This is not controversial. The trust explains this on its website:

At the end of the Trust on April 6, 2015, the certificates of beneficial interest (shares) in the Trust will cease to trade on the New York Stock Exchange and thereafter will represent only the right to receive certain distributions payable to the certificate holders of record at the time of the termination of the Trust. Upon termination, the Trust is obligated to distribute ratably to these certificate holders the net monies remaining in the hands of the Trustees (after paying and providing for all expenses and obligations of the Trust), plus the balance in the Principal Charges account (this account is explained in the Trust’s Annual Report within the Notes to Financial Statements). All other Trust property (most notably the Trust’s mineral properties and the active leases) must be conveyed and transferred to the reversioner (currently Glacier Park Company, a wholly owned subsidiary of ConocoPhillips Company) under the terms of the Trust Agreement.

The exact final distribution, though not determinable at this time, will generally consist of the sum of the Trust’s net monies (essentially, total assets less liabilities and properties) and the balance in the Principal Charges account, less any and all expenses and obligations of the Trust upon termination. To offer a hypothetical example, without factoring in any expenses and obligations of the Trust upon its termination, and using the financial statement values as of December 31, 2011, the net monies were approximately $7,927,000 and the Principal Charges account balance was approximately $4,962,000, resulting in a final distribution payable of approximately $12,889,000, or about $8.59 per share. After payment of this final distribution, the certificates of beneficial interest (shares) would be cancelled and have no further value. It is important to note, however, that the actual net monies on hand and the Principal Charges account balance will most likely fluctuate during the ensuing years and will not be “final” until after the termination and wind-down of the Trust. The Trust offers this example to further inform investors about the conceptual nature of the final distribution and does not imply or guarantee a specific known final distribution amount.

The only thing that unit holders in the trust are entitled to is dividends between now and April 2015 - plus a final termination payment.

The "stock" trades are an amount higher than any amount of dividends likely to be received. It is thus an obvious short and many people have written about it (notably including Citron). Here is a typical example.

This is all well known. Buy this "stock" and you are nearly guaranteed to lose money.

Because that is so well known the stock has a 20 percent borrow cost - roughly offsetting the profit you will get from shorting it. In that sense there is a rational market.

But that is the only sense there is a rational market. People own this. They will lose money. Ponder as a might I can't think of who the suckers might be.

Except one group. Computer driven trading firms. They see the high profits (iron ore prices are not low yet) and the 18 percent dividend yield and the algorithms tell them to own this. Maybe them and some really dumb dividend chasing retail investors.

This should distress me - but it doesn't. I like ill informed people making stupid investments in the market and their persistence pleases me. They have a name: counterparties. May there be many more of them!



John

The cost of not calling Kroll

China Kanghui looks like a done deal:

It appears Medtronic closed it.

For the record Mr D Cameron Findlay was the contact officer on the merger agreement and was informed of (numerous) problems at Kanghui.

There was one way that the senior people at Medtronic could protect their reputations and their career. Two words of advice - but it is too late now. For the record here it was:

Call Kroll.

John

My pick for CEO dead pool: Omar S Ishrak at Medtronic

I got a lot of nominations for CEO dead-pool but very few with clearly enunciated reasons and the reasons are what is going to determine the ultimate winner. There were popular nominations (Meg Whitman at HP just because HP is hard, Ballmer at Microsoft for missing every major trend of the last decade).

You can't win with the obvious - indeed I was almost going to suggest that Meg Whitman was a disqualifying guess...

One entry is going to be hard to beat. Someone nominated Cynthia Carroll at Anglo American literally hours before she stepped down. But in that case the writing was on-the-wall. She was a woman and not South African and her company was causing South African politics to spiral out of control. Of course the old-guard were going to gang up on her.

In any game of dead-pool the winner has to be someone with a sterling reputation and a job they should keep for decades. And the demise should be a sudden complete surprise (at least to the company if not to the CEO dead-pool player). What will win is a company where the CEO's main job is to keep his nose clean and keep a highly profitable machine humming along and where the CEO makes a stuff up so egregious that keeping him is not within the realms of possibility.

Such a speculative guess is more likely to be wrong.

So - revealing that I am going for the most outlandish suggestion I could justify (and hence I am likely to either be wrong or to win the dead-pool game) I made my pick.

Without further ado I will introduce you to Omar S. Ishrak, the CEO of Medtronic - the largest medical devices company in the world.

Well he is the CEO for now - but my guess is not for long. After all guessing that is the point of the game.

So who is Omar S Ishrak and what did he do wrong?

Omar Ishrak is the former CEO of GE Health Care Systems now the CEO of Medtronic. He has a PhD in electrical engineering from Kings College.

Medtronic has done some dud acquisitions in the past - and those acquisitions were the main reason for the departure of the previous CEO. The main problem acquisition was Kyphon, a company with a real technology for repairing damaged spines in elderly people. Kyphon got pinged for defrauding Medicare and paid a fine. The real damage however was not the fine - it was that the required change in sales practice caused Kyphon revenues to collapse (and hence meant the acquisition price was wildly inflated).

So Omar has been clear that he will be more disciplined about acquisitions.

You can see this in the following video:




Its worth reviewing what he says in this video:

First [acquisitions] need to have a very clear value proposition which are financial in nature and very granular in their content as to why we do a certain acquisition and we need plans in place that we can deliver on those value propositions.

I think this Omar Ishrak will be forced to resign because he cannot live up to the goals he set in this video (and which he has set publicly before and since).

Indeed the acquisition he is currently doing will prove far more embarrassing than Kyphon - existence of what he is thinking he is buying may even be questioned...

The acquisition in question is China Kanghui Holdings which Medtronic is paying over $800 million for and which I think will produce a write-off of about $800 million within a year. That is, this business will be a total write-off - they will have paid over $800 million for air...

The CEO's position will be untenable after that. After all, bad acquisitions have been a Medtronic problem in the past - which is why the above video starts with the (rejected) assertion that "billion dollar acquisitions" might be a thing of the past.

China Kanghui acquisition background

I can't do any better in describing China Kanghui's business than their official description:

China Kanghui Holdings, through its subsidiaries, engages in the development, manufacture, and sale of orthopedic implants and associated instruments for trauma, spine, cranial maxillofacial, and craniocerebral. The company offers 36 product series of orthopedic implants and associated instruments for trauma and spine indications under the Kanghui and Libeier brand names. Its trauma products used in the surgical treatment of bone fractures include a range of nails, plates and screws, and cranial maxillofacial plate and screw systems; and spine products used in the surgical treatment of spine disorders consist of screws, meshes, interbody cages, and fixation systems. The company also manufactures implants, implant components, and instruments for original equipment manufacturers based on their product designs and specifications. In addition, it is involved in the development, manufacture, and sale of implants and instruments for knee joint prosthesis; and titanium alloy and cobalt alloy hip joint prosthesis. The company sells its proprietary orthopedic implants to third-party distributors, who then sell those products to hospitals directly or through sub-distributors. As of March 31, 2012, it had a network of 335 domestic distributors covering 30 provinces, municipalities, and autonomous regions in China; and a network of 41 international distributors that sell products in 29 countries across Asia, Europe, South America, Africa, and Australia. China Kanghui Holdings was founded in 1997 and is headquartered in Changzhou, the People's Republic of China.

You can see the attraction for Medtronic. It is within their industry. Most importantly it has a network of 355 domestic distributors covering much of China. Omar Ishrak would obviously be attracted to that. He has said many times that the growth of Medtronic will come from China and India: distribution in China is precisely what he wants.

This is a done-deal. Investor relations assure anyone who asks that due-diligence is complete and do not seem interested in negative feed-back (or even passing negative feed-back on). The market is trading the stock with less than 1 percent spread between the market price and bid price. There is nothing it seems that can derail this bid.

It is just that I do not see this deal as having "a very clear value proposition which are financial in nature and very granular in their content," instead I just see a mess. I could be wrong though - Medtronic have done thorough due diligence (at least according to investor relations) and I have done just a little.

China Kanghui's accounts

It is axiomatic that if you generate fake profits over time you will wind up with fake net assets on your balance sheet.

And that you can determine the profits are real by proving the assets are real, or you can determine the profits are false by proving the assets are false.

That is the nature of double-entry accounting.

If you read the accounts and you question the income you are by definition questioning the assets (or visa-versa).

So here are Kanghui's accounts - first the income account in thousand of USD.

Net revenue	51948
Cost of revenue	-14689
Gross profit	37259
Operating expenses:
Selling expenses	-6605
General and administrative expenses	-7692
Research and development expenses	-1933
Operating income	21029
Interest income	2530
Government grants	688
Other income	296
Other expenses	-299
Foreign exchange loss	-1361
Income before income taxes	22883
Income taxes	-3738
Net income	19145
Net loss attributable to non-controlling interests	94
Net income attributable to China Kanghui Holdings’ shareholders	19239

It is a mighty profitable business - on 52 million in revenue they generate 19 million in post-tax profit. The purchase price of over 800 million is an extremely fancy multiple - but they are - it appears - getting something - indeed a world-beating profit-margin in an attractive company.

They are clearly not getting an R&D team of note however - the R&D is less than $2 million and cumulative R&D is a drop in the ocean. It is not original equipment they are after then - it must be the distribution team.

Here is the balance sheet - and whoa is this an amusing balance sheet:

ASSETS
Current assets:
Cash and cash equivalents	60391
Bills receivable	933
Short-term investments	12234
Accounts receivable, net	13915
Inventories, net	17621
Prepayments and other current assets	2135
Deferred tax assets	1444
Amount due from related parties	901
Total current assets	109574
Non-current assets:
Property, plant and equipment, net	41282
Intangible assets, net	9855
Prepaid land lease payments	3624
Goodwill	24681
Long-term Investment	4004
Deposits for non-current assets	752
Deferred tax assets	388
Other assets, non-current	41
Total non-current assets	84627
Total assets	194201
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	3063
Accrued expenses and other liabilities	10389
Income tax payable	922
Deferred revenue	—
Uncertain tax positions	667
Amount due to related parties	181
Total current liabilities	15222
Non-current liabilities:
Deferred government grants	1018
Deferred tax liabilities	2361
Total non-current liabilities	3379
Total liabilities	18601
Equity:
Ordinary shares (par value of US$0.001 per share; 1,000,000,000 shares authorized as of December 31, 2010 and 2011; 136,821,600 shares and 140,401,842 shares issued outstanding as of December 31, 2010 and 2011, respectively)	162
Additional paid-in capital	145057
Accumulated other comprehensive loss	-3115
Statutory reserves	7216
Retained earnings	24847
Total China Kanghui Holdings shareholders’ equity	174167
Non-controlling interests	1433
Total equity	175600
Total liabilities and equity	194201

Inventories are 17 million dollars - not a big number - but over 400 days of cost of goods sold.

We are asked to believe that in the relatively fast changing world of medical technology this company produces world-beating results whilst keeping well over a year in inventory and doing next to no R&D.

Strangely capital equipment is over 41 million - several years of cost-of-goods sold. It is a very strange business indeed that sells medical implant equipment (small devices you can fit easily into the palm of a hand but which cost huge sums of money) which has next-to-zero R&D but plant and equipment equal to over two years cost-of-goods sold.

Moreover without any obvious change in the business the plant and equipment well over doubled in the past year.

My qualms

These accounts ask us to believe that China Kanghui is

(a). Miraculous - learning how to make a substantial medical implant business on very thin R&D,

(b). Hopeless, keeping well over a year inventory - an out-of-control stocking process, and

(c). Suddenly and rapidly becoming massively capital intensive despite producing very small devices that involve no R&D.

There is an alternative hypothesis: the profits are fake, the huge inventories and plant and equipment are a balancing item.

If the alternative hypothesis is correct (and it is only a guess) then I am waiting for and expecting Omar Ishrak's resignation. And I can't wait - I will win the game of CEO dead-pool.

On-the-ground checking

I am not the only person who has thought China Kanghui has funky accounts. Other hedge funds have paid for investigators on the ground in China - and they have tried (unsuccessfully) to report their results to Medtronic.

Alas it seems Mr Ishrak has a protective cocoon around him that makes it impossible to approach him with anything that is negative to his agenda. He probably - at least until this blog post comes out - has no idea that people think he is a misled by his staff if not personally a fool.

But for the benefit of readers let me say what the on-the-ground checking shows. Amongst other things it shows that

(a). The property, plant and equipment in the SAIC (ie Chinese domestic) accounts did not match the SEC filings. [This check is hard to do now because SAIC accounts have become unavailable.]

(b). More importantly it showed that Libeier distributors would not even distribute Kanghui products - casting doubt on the assertion that they own Libeier (and hence casting doubt on the assertion that Medtronic is even buying worthwhile distribution in China).

Of course I could be wrong

The Medtronic people say they have done thorough due diligence. I have just poked around from my office, reading the accounts, interpreting the obvious.

But my gut interpretations of accounts are right often enough, and the on-the-ground research backs them.

For an outlandish guess on  CEO dead-pool this is a pretty good gambit.




John

CEO dead pool

There is an old-and-in-bad-taste game of celebrity dead-pool. The object is to pick famous people who will die in the next six months. Points are scored inversely to age and also for high profile picks that nobody else guesses.

As I said, it is in bad taste.

With a small bunch of hedge fund managers I play a less macabre version of that game. Whether it is in bad taste or not I will let you (dear reader) decide.

We call it CEO dead-pool.

The job is to pick CEOs of large companies (more points for larger companies) who will in the next 18 months either be sacked or forced to resign in disgrace.

Extra points if the CEO had a fine reputation or if the company was very large. Double-points if you can predict the thing that causes the disgrace. [People who play this game get very interested in which CEOs are having affairs whilst espousing moral-conservative values...]

This game is a way of telling which hedge-fund managers really know the companies and management they are invested in. For us it is work - but it has a nice non-monetary way of keeping score. It is highly equalizing between the lowly analyst and the big-name manager. (Some managers excuse their lack of specificity by complaining that there are just too many candidates...)

This is a formal invite for suggestions/entries. A pick of one or two is fine (sent by email). In June 2014 I will announce the winner. Bragging rights are worth something. For a junior being the winner is probably worth a job. (Plenty of hedge funds want young analysts who really know their stuff. And what better way is there to prove you really know your stuff?)

If there are not enough good entries I might reveal my pick - to get the ball rolling...




John

PS. I would love Bess Levin to link this post. I am sure her readers could come up with some really good suggestions...

Hempton at the Smithfield Sunday Sessions

Nick Hempton (my cousin), his eponymous band and Champian Fulton (my friend) are playing at the Smithfield Sunday Sessions - 8.30 pm on Sunday 21 October 2012.

The address:

215 West 28th Street
New York
NY 1001-5907

For starters - here is Nick and his band:

And here is Champian:

Oh - and I am in New York. So I will be there.




John

The Carlyle Group and the Sun Yee On Triad

Yesterday's post did not get much traction because the punch line was at the end.

So here is the short version.

I asked this man (David Rubenstein profiled on the cover story of the recent issue of Forbes),

To complete the following short letter to his clients:

Dear Limited Partners

We have lost some of your money in a company led financially by someone who the British Journal of Criminology asserts fronts for the Sun Yee On Triad.  

I believe this loss is "insignificant" because ...

The basis for this request was the subject of my last post.



John

Carlyle's China problem: some questions for David Rubenstein

I have spent considerable time pondering dumb deals done by Carlyle in China. Indeed I wrote a post that suggested that Carlyle's dumb-deals might be the start of the undoing of the China private equity business generally.

But I have spent more time wondering why Carlyle does nothing to patch what will shortly be a sinking ship.

My post (Guanxi vs Analyst) prompted the only public response I have ever induced from Carlyle - when the Carlyle Managing Director David Rubenstein dismissed my concerns in the Financial Times. To quote the FT:

David Rubenstein, co-founder of Carlyle, the US private equity group, has hit back at critics of two troubled Chinese investments, arguing that the amount involved is “insignificant” compared with its $3bn investments in Asia’s biggest economy. 

Mr Rubenstein, one of the world’s best-known private equity deal makers, told the Financial Times that he was “extremely happy with our investments in China, and I wish we had more of them than we have”. 

The controversy over the Chinese companies, which have been accused of fraud and suspended from trading in Hong Kong and New York, is potentially embarrassing for Carlyle as it prepares for a planned initial public offering. 

I was a little off-put when David Rubenstein dismissed my concerns arguing the amounts involved were "insignificant". Mr Rubenstein has never responded to my (repeated) emails and I cannot tell whether he is cocooned from negative outside opinion.

Bluntly, I think David Rubenstein was ill-advised especially regarding China Agritech - but also possibly regarding other investments that Carlyle has made. The amounts of money may be "insignificant" but the loss can be significant in other ways.

This post gives some background to the loss at China Agritech and asks Mr Rubenstein whether he stands by the opinion that the loss was "insignificant" and whether he would be prepared to say so (in light of information presented) in a letter to his clients.

Background to the China Agritech loss

By way of background I wish to extensively quote an article in the British Journal of Criminology titled Beyond Social Capital: Triad Organized Crime in Hong Kong and China. Underlined sections are my emphasis.

The case is about how the leader of Sun Yee On [a major organized crime group], Jimmy Heung, used the social capital he developed in China in the 1990s to commit an organized ‘financial crime’ in Hong Kong (though it was not proven in court). In this case, Jimmy’s company (Win’s Prosperity Group) and a Hong Kong Stock Exchange-listed company (China Prosperity Holdings) joined hands to manipulate the price of the listed company in the stock market. This case evolved through different phases between April and October 1999, as follows.

Phase 1: Accumulation of shares by ringleaders and associates (April to August 1999) 

This case began with the renaming of a listed construction company, OLS Group, as China Prosperity Holdings (CPH) on 29 April 1999. Coincidentally, both the Chinese and English words for ‘Prosperity’ were the same as in Jimmy’s company, Win’s Prosperity Group. Jimmy Heung and a Mr Tang were the only directors of Win’s Prosperity Group. Tang was also the Executive Director of CPH, but Jimmy, as a triad figure, is not allowed to hold directorship of any listed company. It is assumed that both companies were actually under Jimmy’s control. Between April and August 1999, the masterminds of the crime had gradually accumulated the shares of CPH at a very low price, often below HK$1 (US$1 = HK$7.8). After the accumulation, the ringleaders leaked ‘privileged’ sensitive information to their associates about favourable price movement of CPH so that the associates would rush to buy in. In the first week of September 1999, CPH soared 35.39 per cent to close to HK$1.53 on 8 September...

Phase 2: Leaking of news to the mass media (mid-September 1999) 

In Phase 2, a rumour about CPH was leaked out to selected mass media, which drew the attention of ‘smart guys’ to buy the company’s shares ahead of other investors. The rumour was about CPH’s entering into a conditional agreement to acquire a 33 per cent indirect stake in Jimmy’s Win’s Prosperity Group, which was to develop a Century Vision Network (CVN) project that would capture 200,000 subscribers in the first year of operation and 100 million subscribers within ten years in China. There was also a rumour that CPH would enter into a joint venture with a state-owned enterprise in China. The rumour also said CPH would invest about HK$780 million in this project, but we discovered that the company’s unaudited result for the six months ending 30 June 1999 was only a turnover of HK$60.50 million (CPH company announcement on 9 October 1999). As the rumour spread, the ‘smart guys’ who got the ‘privileged’ information bought up the shares speedily and, consequently, the price soared in a short period of time, drawing more share hunters to buy in amid its profitable investments. Overall, between 2 and 24 September 1999, the Hong Kong Hang Seng Index dropped 3 per cent, but the share price of CPH increased by 238 per cent (CPH company announcement on 9 October 1999).

Phase 3: Company directors’ exercise of share options (17 September 1999) 

As the share price rose sharply, the company directors capitalized their gains by exercising their share options and this practice is absolutely legal. In total, 3 million new shares were allotted to an employee of CPH on 17 September 1999, and 10 million, 3 million and 1 million new shares were allotted to three directors of CPH on 24 September 1999, at an exercise price of HK$0.16 per share, pursuant to an exercise of share options previously granted to them (CPH company announcement on 9 October 1999). Jimmy’s partner, Tang, personally held 10 million new shares. On 24 September 1999, CPH closed at HK$5.05, and was traded between HK$5.0 and HK$6.0 most of the time. That is, the directors could have earned HK$48.9 million, HK$14.67 million and HK$4.89 million, respectively, in this period if they had sold all their shares.

Phase 4: Suspension of trading awaiting company announcement (25 September to 9 October 1999)

In Hong Kong, a company leaking share-price-sensitive information or having unusual trading activities may be requested to suspend its share trading. On 9 October 1999, the Hong Kong Stock Exchange warned that the Exchange was concerned about companies that were leaking information to certain news media instead of making public announcements so as to increase investor enthusiasm for their shares. These companies should release the information necessary to enable investors to appraise them in order to avoid the establishment of a false market. In Hong Kong, if the leaked information is inconsistent with what is announced formally later, the acts may be in breach of the Securities Ordinance. 

CPH was requested by the Stock Exchange to suspend trading on 25 September 1999. On 9 October 1999, CPH was forced to make a public announcement, mentioning a joint venture, through Jimmy’s Win’s Prosperity Group, with China’s Telecommunications Bureau and State Administration of Radio, Film and Television (SARFT). It said the Win’s Prosperity Group had entered into a non-binding agreement to operate the venture with the Telecommunications Bureau, a SARFT subsidiary and other unnamed partners. Under the agreement, Win’s Prosperity Group would hold 33 per cent of the venture, while the Telecommunications Bureau—which controls China Telecom—and the SARFT subsidiary each would have 10 per cent interests. CPH said a final agreement was expected to be reached by the end of October. The following is part of the public announcement:

The CVN Project is in the development stage and may or may not materialise. WPGL [the Win’s Prosperity Group] has entered into two Letters of Intent for the purpose of launching the CVN Project in the People’s Republic of China (PRC). It is unclear if the structure will be changed or not. In addition, WPGL may or may not enter into formal agreements with the PRC telecom partner to arrange for the use of the telephone networks or with the PRC broadcast partner to obtain the approvals for the content to be broadcasted by CVN via the telephone networks in the PRC. As the Letters of Intent entered into are non-binding and commercial negotiations are still being conducted and are not finalised, it is possible that the structure set out in the Letters of Intent could be changed. It is also uncertain whether a formal agreement will finally be reached. If no formal agreement is reached, the CVN Project may not be launched in the PRC. (CPH company announcement on 9 October 1999).

As shown in the announcement, Jimmy’s Win’s Prosperity Group had signed two non-binding agreements with a Chinese telecommunications company. Two points are worthy of mention here. First, it was very difficult and extraordinary for a relatively small Hong Kong company to enter into an agreement with a giant Chinese state-owned enterprise. The Hong Kong businessman, in this case Jimmy, ought to have had outstanding social capital for this joint venture to materialize. Second, very astutely, since these were non-binding agreements, the deal could disappear suddenly without any cause.

Phase 5: Selling of shares by insiders (11–13 October 1999)

When the share price of CPH stood at a high level, the company made a public announcement on the possibility of a profitable venture, which, however, could not be verified immediately. The announcement triggered panic buying by the general public and trading volume soared extraordinarily, but it was time for the ringleaders and associates to sell their accumulated shares. When CPH resumed trading on 11 October 1999 after the announcement, its share price jumped 32.02 per cent to $5.05 from its previous close on 24 September. This provided the syndicate with a timely opportunity to sell their shares. The next day, 12 October 1999, CPH slid 11.38 per cent to $4.475 in heavy trading, suggesting that some investors were actively selling the shares, with insider knowledge that something might happen very soon.

Phase 6: The collapse of the share price (14–20 October 1999)

When the share price of a company is in a panic-buying or selling stage, the government’s watchdog will step in and request the issue to be clarified. The Securities and Futures Commission of Hong Kong challenged the $20 billion valuation of the joint venture as too high, and pointed out that such a venture would not be able to circumvent China’s restrictions on communications investment by foreign companies. The Commission also warned the public through the mass media:

Unequal dissemination of price-sensitive information could lead to insider dealing and the possible formation of a false or misinformed market for these shares . . .. Large changes in prices or turnover may also indicate that there is a false or misinformed market . . . [and the] public may be at risk and suffer loss because they can only trade on the basis of incorrect or incomplete information. (South China Morning Post).

The watchdog contacted the mainland Chinese partner to verify the status of the proposed venture because CPH had refused to provide information about the progress of negotiations. Five days after the company announcement, on 14 October 1999, CPH suddenly announced that the mainland joint venture was aborted, saying that Jimmy’s Win’s Prosperity Group had terminated negotiations with its mainland partner. With the excuse of commercial secrets, CPH declined to disclose the reasons behind the termination, and whether the Commission’s investigation had led to it.  

After the announcement, the share price of CPH plunged 31.84 per cent on the first trading day, 26.22 per cent on the second day and another 12.88 per cent on the third day. The company’s share price surged to HK$5.05 after the announcement of the joint venture but collapsed 61.18 per cent to HK$1.96 after the termination of the negotiations, very close to its price before the early September rally (see Figure 2). To let the public forget its past devious dealings, not surprisingly, CPH changed its name to Prosper eVision Limited a few months later, on 5 June 2000. No one was prosecuted in the end. Moreover, the present study has not identified any evidence of money laundering involving the triad or Chinese stakeholders. Nonetheless, as money laundering is not uncommon in mainland China (Song 2002; Zhang and Chin 2008), the price fluctuation would provide a valuable and timely opportunity for money launderers to clean their illicit income through legitimate transactions in the stock market.

What is described here is appears to me to be a conventional (though very large) pump-and-dump scheme. 

*The scheme was (it is asserted) controlled by Jimmy Heung (who the author describes as the leader of the Sun Yee On Triad). For reference Jimmy Heung's Wikipedia page also asserts he is the leader of the Triad. 

*The front-man for the scheme is (it is asserted) a Mr Tang (of whom little details are given). 

*The scheme (it is asserted) involved Chinese State Owned Enterprises who entered into and then did not consummate non-binding agreements which were marketable on the Hong Kong Stock Exchange.   

*That the (asserted) malfeasant company in the end changed its name to Prosper eVision to help the public forget the dirty-dealings. 

My obsession here is with the mysterious Mr Tang. The article does not tell you who he is. However cursory exploration of the SEC database will tell you that this Mr Tang is the same Mr Tang who later appeared as the Chief Financial Officer of China Agritech.

This SEC filing announced his appointment as the CFO of China Agritech and gives a brief CV:

On October 22, 2008, Mr. Yau-Sing Tang was appointed as the Chief Financial Officer of the Company. Mr. Tang, age 46, was most recently chief financial officer of Carpenter Tan Holdings Ltd., a retail chain in Mainland China which is applying to be listed on the Hong Kong Stock Exchange. Prior to that, he was the founder and managing director of GC Alliance Limited, a CPA firm in Hong Kong. From April 2003 to December 2005, he was executive director and chief financial officer of China Cable and Communication, Inc., which was listed on the OTC Bulletin Board. Mr. Tang received his Bachelor of Social Sciences (Honors) degree from the University of Hong Kong. He is a fellow of the Association of Chartered Certified Accountants in the U.K. and the Hong Kong Institute of Certified Public Accountants. He is also a member of the Institute of Chartered Accountants in England and Wales and the Taxation Institute of Hong Kong.

This release reveals that he was previously the CFO of China Cable and Communication. Following the trail you can find this filing which gives his CV at that company.

Yau-Sing Tang joined the Board of Directors in February 2003, and assumed the post of Chief Financial Officer and Chairman of the Board of Directors shortly thereafter. Mr. Tang served as Chairman of the Board until October 2003, when he assumed the position of President of the Company. Since January 2002, Mr. Tang has served as Chief Executive Officer and Executive Director of CCCL.  

Since November 2000, Mr. Tang has served as Managing Director of GC Alliance Limited, a Certified Public Accountants firm in Hong Kong. Prior to that, Mr. Tang served as Deputy Chairman and Chief Executive Officer of Prosper eVision Limited (Stock Number 979), a company listed on The Stock Exchange of Hong Kong Limited and CCCL. Mr. Tang has over 17 years of experience in accounting, finance, corporate finance and management, especially management of listed companies in Hong Kong, Australia and companies listed on NASDAQ. He is a fellow member of both the Hong Kong Society of Accountants and the Association of Chartered Certified Accountants and holds a Bachelor Degree in Social Sciences (major in Management Studies) from the University of Hong Kong. He is also the Chief Executive Officer and Executive Director of CCCL.

Note that this Mr Tang was the Chief Executive of Prosper eVision - the previously mentioned pump-and-dump.

Carlyle's China Agritech problem summarized

T. Wing Lo, a criminologist writing in the (peer reviewed) British Journal of Criminology asserts that Mr Tang fronted a major stock fraud for the leadership of the Sun Yee On Triad.

He was later the Chief Financial Officer of China Agritech - a company listed on the New York Stock Exchange.

This was a company Carlyle invested in and lost money.

Mr David Rubenstein dismisses that as "insignificant".

Perhaps he would like to finish this letter:

Dear Limited Partners

We have lost some of your money in a company led financially by someone who the British Journal of Criminology asserts fronts for the Sun Yee On Triad.  

I believe this loss is "insignificant" because ...

My view

Carlyle has major problems in their investment process and competence in China. This should be dealt with by head office (and head office is being ill-advised if they believe the problems are "insignificant").




John