Wednesday, September 12, 2012

Chinese due diligence: Focus Media style

Yesterday's post again raised this disclosure from Focus Media:

In March 2006, Weiqiang Jiang, the father of Jason Nanchun Jiang (the CEO/controller of Focus Media), 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 is unsecured and was provided to us at no interest. The loan will become due and payable in full on June 30, 2006.

The key words here are "relieve a temporary shortage of Renminbi the group experienced".

Approximately two months prior there was a capital raise which raised $295 million. Of that $62 million went to the company and $220 million went to selling shareholders. The remaining $13 million went to the underwriters.*

A looming "shortage of Renmimbi" looks like material information that should be disclosed in a prospectus.

Well it wasn't. Indeed the prospectus made clear that the company had plenty of Renmimbi liquidity but might be short US dollar liquidity to pay dividends of the like.

Without a better explanation (which I have sought) I would think there may be material non-disclosure.

So who were the selling shareholders?

It is interesting to me when $220 million in stock is possibly sold on material non-disclosures. I want to know who the sellers were.

One of the biggest (but not the biggest) selling shareholder was JJ Media Investment Holdings - the vehicle of Jason Jiang, CEO/Controller of Focus Media.

Most of the other selling shareholders were prior shareholders of Target Media which was sold to Focus Media mostly for stock. Those sellers were not insiders so they can't be held responsible for material non-disclosure in the prospectus. Nonetheless it is amusing selling shareholders included both Carlyle and CDH who are now wanting to take Focus Media private.

One last selling shareholder amuses me. It is Neil Nanpeng Shen. He is better known as the managing partner of Sequoia Capital China - but in this context he should be known as the Chairman of the Audit Committee for Focus Media.

Is it possible that the Managing Partner of Sequoia Capital China sold personal shares in a company in which he was the chair of the audit committee and where the prospectus may have contained material non-disclosures?

I am sure there must be an alternative explanation - and I have written to Focus Media to ask them to explain the source of the Renminbi shortage disclosed above. I have received no reply. I am hoping for one soon and I will publish it when received.

The underwriting fee

The underwriting fee was about $13 million. The lead banker was Goldman Sachs. But you knew that anyway.


*All amounts rounded to the nearest million.

Tuesday, September 11, 2012

Focus Media: some follow up to the post about the loan from Jiang Weiqiang to the company

In the the second to last post I raised a disclosure about Focus Media needing a $2.5 million loan from the CEO's father to "relieve a temporary shortage of Renminbi":
In March 2006, Weiqiang Jiang, the father of Jason Nanchun Jiang (the CEO/controller of Focus Media), 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 is unsecured and was provided to us at no interest. The loan will become due and payable in full on June 30, 2006.

I wondered whether the Jiang Weiqiang was the civil servant who worked for the State Council Information Office. Despite gossip from usually well informed sources in China I doubt the link. The reason (links after this post) is that the man who is presumably the father-of-the-groom in Jason Jiang's wedding photos does not resemble the government official.

That said, I am far more interested in content of the disclosure than the personage of the dad.

The company reveals that in March 2006 it was facing a "Renminbi shortage".

This is a super-profitable company generating great gobs of cash in China (presumably great gobs of Renminbi). It is surprising they had a "Renminbi shortage" however I went looking for 2006 accounts to see if I could piece it together.

The March 2006 accounts

Here is the balance sheet from the March 2006 results which show a healthy cash balance both at December 2005 and in March 2006 with no obvious expenditure that would cause a Renminbi shortage in that period.

                         Focus Media Holding Limited

                         (U.S. Dollars in thousands)

                                                       2006-3-31   2005-12-31
                                                          US$          US$
                                                      (unaudited)  (unaudited)
     Current assets
     Cash and cash equivalents                          $41,863      $36,653
     Investment in available-for-sale securities         34,792       34,836
     Accounts receivables, net                           37,275       22,235
     Inventories                                            605          480
     Prepaid expenses and other current assets            7,786       45,364
     Amount due from related parties                      2,982        2,073
     Total current assets                              $125,303     $141,641
     Rental Deposits                                     13,245       11,819
     Equipment, net                                      70,993       43,695
     Acquired intangible assets, net                     30,881        1,158
     Goodwill                                           406,791       13,298
     Long term investments                                1,118           -
     Other long term assets                                 221           -
     Deferred tax assets                                    193          743
     Total assets                                      $648,745     $212,354

     Current liabilities
     Short term bank loans                               $1,247         $991
     Short term other loans                               6,778           -
     Accounts payable                                     8,280        5,848
     Accrued expenses & other current liabilities        71,414       11,747
     Amount due to related parties                        2,496           -
     Income taxes payable                                 2,188        2,108
     Total current liabilities                          $92,403      $20,694

     Minority interest                                      460          246

     Shareholders' equity
     Ordinary shares                                         25           19
     Additional paid in capital                         530,088      177,420
     Deferred compensation charge                            -          (247)
     Retained earnings                                   22,430       12,997
     Accumulated other comprehensive income               3,339        1,225
     Total shareholders' equity                        $555,882     $191,414
     Total liabilities and shareholders' equity        $648,745     $212,354

Cash has gone from $36 million to $41 million over the quarter. There was an acquisition in the quarter (Target Media) but they paid for that partly in stock and partly by doing a capital raise. (The observant will notice shareholder equity going from $191 million to $556 million.)

Bluntly, the acquisition Target Media could not cause a cash shortage - it was USD44 million in cash and the rest in stock. USD44 million was less than the cash raised.

In other words there is nothing in the accounts that quarter that suggests a pressing Renminbi shortage in March 2006.

I thought that there might be a Renminbi shortage because all of the above cash was held in USD. That would be unusual - but it was at least theoretically possible, however the prospectus issued in January 2006 disabused me of that notion. That prospectus raised US Dollars but the company in the prospectus said that the accounts were pretty well entirely in Renminbi (including the cash). To quote:
Foreign Exchange 
We maintain our accounts in Renminbi and substantially all of our revenues and expenses are denominated in Renminbi, while we report our financial results in U.S. dollars. Fluctuations in exchange rates, primarily those involving the U.S. dollar against the Renminbi, may affect our reported operating results in U.S. dollar terms...

It goes on - but we are informed this cash was all in Renminbi.

So I am left puzzled as how there could possibly be a Renminbi shortage which required the CEO to touch up his dad for a loan? I have no plausible explanation.

Two theories - both ugly - though only one very ugly

I have two theories to explain this sudden loan to cover "Renminbi shortage" when there was no Renminbi shortage in the accounts.

The first theory is that dad never lent $2.5 million to Focus Media however dad (or somebody else) was repaid $2.5 million from Focus Media - and the "loan" was just a mechanism for disguised looting. However in this case the dad might not actually be the beneficiary - it could be anyone associated with a large management team - just dad's name was put in as a place-holder.

The second theory is that Focus Media never had sufficient Renminbi cash because all the Renminbi cash generation and cash holdings are fake. In this case the company had US dollar cash from selling to US shareholders (also known as suckers) and had a "for-show" business in China which does not actually generate cash, but does generate plausibility to gain more suckers (and hence raise more US cash). In that case they needed Renminbi cash to keep the whole charade going.

I can't see any other plausible explanation but I am open to suggestions.

The first theory is ugly - it is the theory that Focus Media is being continuously looted. If that theory is correct then it bad for shareholders - but not awful. That theory is that Focus Media is hugely cash generative, only it is being looted by management. In that case the deal can close because once they own it the PE buyers can grab control of all that cash flow and put existing management on a very tight leash.

The second theory however is devastating for shareholders. It is the theory that there is no cash generation here at all - just pretend cash generation. If they really did want for a few million Renminbi the whole business can't be worth very much at all. Probably less than 100 million Renminbi based on demonstrated lack of cash generation. This theory is awful for shareholders because if that is true this stock settles BELOW ONE DOLLAR when the big goes away.

Note to the arb funds

There are a lot of arb funds who hold this stock. Don't think for a moment your downside risk is the stock goes back to $20.

If this is just a looting story (and that really a possibility) this stock goes to $27 and the deal closes.

But if the $2.5 million loan from Dad was necessary because this company actually generates no cash then the stock should settle somewhere between zero and one dollar.

I don't know the answer. Truly. But this is a company with very strange accounts - and there is a high risk the stock is a true debacle.

Arb this at your own risk. I for one will stay on the other side of your trade.


One reader sent me a link to some wedding photos for Jason Jiang and his very pretty bride. The Father-of-the-Groom (presumably the man on the far right) does not resemble the man in photos of the senior Chinese officials. So I withdraw the suggestion made to me by several well connected Chinese sources that there is a family link to officialdom.

Monday, September 10, 2012

Focus Media giving away cash?

I am becoming obsessed by the disclosures about the businesses Focus Media disposed of in 2009. The full disclosure is in this post - and an explanation as to why Focus Media's accounting must be wrong is in this post.

But to summarize - Focus Media disposed of seven businesses in 2009.

All businesses were disposed of at a loss.

Six of these businesses were given away for no consideration at all. In one consideration of a low single digit number of millions of dollars was paid.

A majority of these businesses were given back to their original owners.

A majority of these businesses are in British Virgin Islands subsidiaries.

And the accounting for these transactions is messed up.

That said, the cash flow statement from the latest 20F provides more information.

Here is a section from the cash flow statement:



Investing activities:
Purchase of equipment
Cash of disposed subsidiary
Proceeds from sale of a subsidiary
—    116,872,231  7,296,097  
Purchase of subsidiaries and earn-out payment paid to acquire subsidiaries, net of cash acquired
Investment in an equity method investee
—    —    (61,003,263
Deposit refunded to acquire subsidiaries
329,516  —    —    
Proceeds from disposal of fixed assets
196,115  471,128  671,950  
Increase in restricted cash
—    —    (199,346,126
Cash paid for short-term investments
Sale of short-term investments
865,589  29,290,296  1,044,680,415  

Net cash used in investing activities

I want you to notice the highlighted line...

In those susbsidiaries disposed of in 2009 there was embedded 27,315,949 dollars in cash.

These subsidiaries were given away.

If you interpret the accounts literally this company has been giving away cash.

I have a handful of explanations for this behaviour but plausibility is becoming strained. Perhaps Focus Media's investor relations department can help (I have sent them this post in advance but have received no reply).

Anyone else with an explanation could you please put it in the comments.


Sunday, September 9, 2012

Puzzled at the wealth of Chinese civil servants - Jiang Weiqiang and Focus Media edition

In March 2006, Weiqiang Jiang, the father of Jason Nanchun Jiang (the CEO/controller of Focus Media), 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 is unsecured and was provided to us at no interest. The loan will become due and payable in full on June 30, 2006.
Now the only Jiang Weiqiang I can find works as a civil servant for one of the most powerful of Chinese departments - the State Council Information Office. Here is an English language CV:

Jiang Weiqiang

Director-General, International Bureau, State Council Information Office

Jiang Weiqiang and his State Council Information Office colleagues was set to play a leading role in Beijing's media courtship of Africa ahead of the fourth Forum on China-Africa Cooperation in Sharm el-Sheikh, Egypt in November 2009. At the FOCAC Media Seminar in Beijing, 15-19 July, Jiang tried to develop a united front with African state media organisations. He insisted that the message of China-Africa cooperation should be taken directly to the people and not depend on Western media, which he described as anti-China and anti-Africa. Representatives from 27 African countries attended, as did Assistant Foreign Minister Zhai Jun and Liu Yunshan, Politburo member and Director of the Central Propaganda Department. 
Trained as an engineer, Jiang entered the People's Liberation Army in 1970. While serving, he studied English at the Luoyang PLA College of Foreign Languages, responsible for training intelligence agents. In 1991, Jiang left the PLA to join the SCIO, the administration overseeing China's state media, including the People's Daily newspaper and Xinhua news agency. Xinhua is planning its own multi-billion dollar global and African media expansion.

My questions: is this the same Jiang Wieqiang? And if so (and it seems so) how does a Chinese civil servant come up with USD2.5 million to make an unsecured interest free loan to a business controlled by his son?

I seek help from anyone with a well-followed Weibo account. If this can be crowdsourced in China then I might get good answers.

Thanks in advance.


Friday, September 7, 2012

Focus Media: calculating losses on disposal

I have been thinking a little about the last post - where I quoted Focus Media's accounts. They purchased several business for very precise dollar consideration. For example they purchased WonderAd for $14,926,003 and they disposed of it (to the original owner) later for  a loss of $14,926,003.

This was after the the businesses had operating losses in aggregate larger than original consideration paid.

I interpreted this as WonderAd being given back to the original owner.

Now I am not quite sure. My concern is best seen by example:
Suppose I buy a business for $10 million. 
Moreover suppose it has $3 million in property plant and equipment (subject to depreciation) and $7 million in goodwill. 
Then a year later it loses $12 million in operating losses. $11 million of that was "cash losses". The other million dollars was depreciation. [Obviously I will need to inject some cash to cover the cash losses...] 
Now I give it back to the original owner for no consideration. What is my final loss on disposal? 
The  $7 million of goodwill has never been written off (so that is a loss on disposal). 
Also there remains $2 million of property, plant and equipment. ($1 million has already been expensed through the operating losses). 
This gives a loss on disposal of $9 million not $10 million,
My loss on disposal does not equal the purchase price. It is sort of logical it shouldn't. After a year of running the business the assets and liabilities of the business will not be the same as when I purchased the business - and hence the loss on disposal should not equal the acquisition price of the business.
Except by luck. A lot of luck...
I thought at first it might be possible if the business had no depreciable assets. Then the depreciation adjustment as per this example would not be there.
But the business would also not have to have variance in receiveables, payables etc. Otherwise all these would go into calculating the loss on disposal.
If the loss on disposal equals the purchase price an awful lot of luck would need to be involved.  
Now lets get back to the disclosures in the last post.

WonderAd was purchased for $14,926,003 and disposed of with a loss of precisely $14,926,003.

Either the accounting is wrong or there is luck to six significant figures.

And Jinhua was purchased for $7,659,158 and disposed of with a loss of precisely $7,659,158.

Either the accounting is wrong or there is luck to five significant figures.

And Wangmai was purchased for $2,749,158 and disposed of with a loss of precisely $2,749,158.

Either the accounting is wrong or there is luck to five significant figures.

I could go on - but in order to make this work I need either no depreciable assets or luck to maybe 25 significant figures.

I figure the accounting is probably wrong.

And it is not as if these are small businesses. These subsidiaries declared over $127 million in revenue and over $170 million of costs during 2009.

A business with that much revenue and that much has receiveables and payables that change all the time. It has depreciable assets such as computers, and furniture. It has obligations.

I have struggled for another explanation - but as far as I can see the accounts need to be restated. Does anyone else have an explanation?

Whatever - this company has restated the accounts many times and so far these have not dampened the ardour of longs. One more restatement won't hurt.

Hop-to-it Deloitte.


There is an alternative explanation for this mistake. They just made up the losses - because they needed fake losses to offset fake profits as explained in this post. Because they made up the losses they missed the subtlety that loss on disposal does not equal acquisition price.

This is a key issue for the due-diligence.

I would prefer think they just got the accounting wrong as they have before (and with no real impact on the stock). However if they have made up these losses it is extremely bad for the take-private transaction. If they are fake (that is made up) losses they are there to balance fake (as in made-up) profits. When the fake losses go away the real (lack of) profitability will be exposed and the company will not be able to service the debt that the PE firms load it with.

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.


Tuesday, September 4, 2012

Death, Ferraris and naked exotic girls: racism, politics and garbage data in China

The Western Press is following a mid-ranking story in Chinese politics with more than average fervour because it is so salacious.

Ling Jihua - an aide to Hu Jintao - it seems will have a hard time being elevated to the Politburo Standing Committee. Why? Because his son (Ling Gu) died in a high speed car crash in a Ferrari.

This post is about the propaganda part of the story as reported by the South China Morning Post:
The semi-naked passengers were ethnic Tibetan and Uighur students from Beijing’s Minzu University, one of whom was now paralysed.
Now a Ferarri Spider 458 is not exactly a big car. And playing with not one but two semi-naked students in such a confined space whilst driving at (say) 200 kilometres per hour stretches my imagination (but then I am a happily and conventionally married man so maybe my imagination does not go very far).

It seems significant that the other passengers were a Tibetan and an Uighur - their race matters.

Bill Bishop - a fairly astute China watcher - tweeted that he was sceptical of that detail - a detail released to cause maximum damage to Ling Gu's (and hence Ling Jihua's) reputation. Bill Bishop's scepticism is well-founded. If you are going to do a character assassination doing it in a race baiting manner works in China as it does in other countries.

That said, I asked the best connected China watcher I know whether he though the story as presented (two naked students of minority race in a small car) was plausible. This China watcher knew Ling Gu personally. And the response came back that that seemed just like the kid.

The death is real. But like everything else in China it all comes wrapped in a story where you have to question every detail.

And even when you question them its hard to decide what parts of the story are true.

That is how it is with most Chinese data. Spin beats truth enough of the time to make you question everything.


PS. I have been reliably assured that the Chinese gossip version of this story is that the women were high class hookers - and the deceased's dad is responsible for much Tibetan and Uighur policy.

Friday, August 31, 2012

The mysterious case of the disappearing competitor: Focus Media edition

JCDecaux - the French multinational giant - is the largest display advertising company in the world. They also claim in their latest annual report to be the largest display advertising business in China.

Every year they publish in their annual report a list of the largest display advertising businesses in the world - their competitors.

Here is that list from the 2007 annual report :

On this list, Focus Media is the 8th largest company in the world in this space.

And here is the list from the 2008 annual report:

Again we see Focus Media - now the sixth largest display advertising company in the world.

Here is the 2009 list:

Peculiarly Focus Media is nowhere to be seen on this list (by the end of 2009 it should have risen to fifth place).

Focus Media is no longer mentioned in JCDecaux's 2010 and 2011 accounts.


Well I can think of two hypotheses:

The first is that JCDecaux want to sustain their claim of being the biggest display advertising business in China - a claim that is simply not tenable if they include Focus Media in the comparison. Moreover they don't want to increase the credibility with advertisers of Focus Media and its products. After all Focus Media has substantially outperformed JCDecaux in China - growing much faster and at much fatter margins.

An alternative hypothesis is that they don't believe Focus Media's numbers.


PS. I first found these lists when researching China Media Express. CCME supposedly competed with JCDecaux in placing adverts on public transport (in CCME's case mostly buses including airport buses). CCME however was a complete fraud and the stock now trades at 2c. Focus Media is obviously real - their displays are widespread.

Focus Media - the key post: Four interpretations of the accounts

Focus Media is - on the published accounts - a very profitable company. It has 63 percent margins gross margins and net margins over 30 percent (all cash returns) in a business where industry comparable net margins are generally substantially lower.

However, over time, Focus Media has taken some enormous write-downs. Here are the five year profit and loss accounts:

For the years ended December 31
  (In thousands of U.S. Dollars, except share and per share data)
Selected Consolidated Statements of Operations Data:
Net revenues:(1)
LCD displays
  $184,643  $244,540  $208,799  $297,642  $444,365  
  27,444  60,719  30,346  37,777  56,374  
Poster frame(2)
  85,472  146,751  98,962  121,893  185,449  
Movie theatre
  5,259  10,335  9,436  18,095  50,835  
Traditional outdoor billboard
  32,046  66,843  49,621  40,908  55,597  

Total net revenues
  334,864  529,188  397,164  516,315  792,620  

Cost of revenues:
LCD displays
  52,648  80,451  76,418  67,513  85,847  
  23,502  61,834  24,170  23,432  20,582  
Poster frame(2)
  28,086  59,815  95,401  84,487  110,370  
Movie theatre
  2,941  6,598  7,063  13,849  25,753  
Traditional outdoor billboard
  25,555  50,346  38,022  32,409  47,092  

Total cost of revenues
  132,732  259,044  241,074  221,690  289,644  

Gross profit
  202,132  274,144  156,090  294,625  502,976  

Operating expenses:
General and administrative
  42,452  79,162  88,833  79,760  127,013  
Selling and marketing
  53,523  82,258  79,787  103,722  147,717  
Impairment loss
  —    377,629  63,646  5,736  —    
Other operating expenses (income), net
  (7,615183,113  13,111  (14,144(16,138

Total operating expenses
  88,360  722,162  245,377  175,074  258,592  

Income (loss) from operations
  113,772  (452,018(89,287119,551  244,384  
Investment loss
  —    —    —    1,288  —    
Interest income
  9,239  7,130  4,946  7,260  15,539  
Interest expense
  17  —    —    —    717  

Income (loss) from continuing operations before income taxes
  122,994  (444,888(84,341125,523  259,206  
Income taxes
  5,912  25,278  13,780  22,336  54,761  
Loss from equity method investee
  —    —    —    —    43,633  

Net income (loss) from continuing operations
  117,082  (470,166(98,121103,187  160,812  
Net income (loss) from discontinued operations, net of tax
  28,048  (300,672(111,61283,078  —    

Net income (loss)
  145,130  (770,838(209,733186,265  160,812  
Less: Net income (loss) attributable to noncontrolling interests
  694  (1503,524  1,991  (1,865

Net income (loss) attributable to Focus Media Holdings Limited Shareholders
  $144,436  $(770,688$(213,257$184,274  $162,677  

I want you (dear readers) to study these as they are key to the whole Focus Media story and this is the key post in this sequence.

In 2008 for instance Focus Media had gross profit of $274 million. But it also had an impairment loss of 377.6 million and other operating expenses (associated with discontinued businesses) of a further 183 million. On top of this it had a loss of 300.7 million from discontinued operations.

This wound up in the small manner of USD770.7 million in loss for the year.

I stand to be corrected but that is one of the largest losses ever incurred by a public company in China. Whatever - it is a very big number.

Write downs and losses from discontinued operations were a feature of 2009 as well.

The profits and losses (just taken from the above table) over the last five years are as follows:

2007 - USD 144.4 million
2008 - USD 770.7 million LOSS
2009 - USD 213.3 million LOSS
2010 - USD 184.3 million
2011 - USD 162.7 million

The aggregate profit for Focus Media over five years is a net loss of over half a billion dollars.

This is very strange. Focus Media is a hyper-profitable business that makes huge losses.

They made these losses on businesses that they have purchased and disposed of (at a loss) and businesses that they have purchased and discontinued after operating losses.

Some of the disclosures regarding the disposals are unusual. For instance there are many instances I can find of a company being purchased for a lot of money and then given back to the original owners (see the discussion of 2009 dispositions for a few examples).

When a business is purchased for a lot of money and then given away to its original owners you would expect the SEC to raise their eyebrows. However Focus Media has insisted in multiple documents that the recipients of this largesse are not related parties.

Four possible interpretations of the accounts

I am going to give you four possible interpretations of the accounts. I am not doing due diligence on this company, I have no access to inside information and can only make educated guesses as to the probability that any of these interpretations is correct. However as the company has been audited you would have to guess that (A) below is most likely.

Interpretation A - the accounts are straight

The first interpretation is that the accounts are absolutely straight and the company is absolutely straight. As these accounts are audited by Deloitte this is the situation you would normally expect.

In that case this is a stupendously profitable company where the profits over the years (and then another half a billion dollars) have been squandered by existing management on a bunch of really bad acquisitions.

If Interpretation A is correct the Private Equity buyers will get a fantastic deal with this transaction. After all - they will be buying a stupendously profitable company and the PE buyers - if they have any skill at all - will take over the capital allocation. The really bad acquisitions will stop.

Interpretation B - the company is being looted through deliberately awful acquisitions

The second interpretation is that this is a hugely profitable company that has over time over half a billion dollars in operating profits - but the management of the company are venal and have stolen this money by buying assets from friends (or related parties) at inflated prices.

When I see a set of accounts that look like this looting is the first thing I think of. After all - audited accounts for 2011 show that this is a really great company - however over time that greatness has accrued primarily to the people they have purchased assets from.

I guess that is why the SEC wanted - in their correspondence - to assure themselves that the parties that sold assets to Focus Media were not related parties. I have no particular reason to believe or disbelieve the assurances of Focus Media on that issue other than that I would expect Deloitte to have examined the matter.

If Interpretation B is the case then the PE buyers should still probably close the deal (they will be buying a stupendously profitable business). But PE buyers will have their work cut out. The current management (who it appears have done a fantastic job of running the business) are - in this interpretation - crooks - who need to be watched abnormally closely. You probably want to leave then running the business - but you certainly don't want them near the money.

[If this interpretation is correct the management probably won't stick around anyway - they have already got rich on looting...]

Interpretation C - that the disclosed losses are a cover for political corruption

A third interpretation is that the money was deliberately lost by the company through all those acquisitions and the losses funded bribes.

In this interpretation the company did not really “lose” the money. Its payments was bribes that if honestly accounted the company might have expensed.

If this interpretation is correct then the private equity buyers will walk. Firstly, if properly accounted the bribes would be expensed - and that would bring the business down to a normal level of profitability. This is - in interpretation C - not a massively profitable business.

Moreover Carlyle in particular cannot run this business – because after the change in ownership the recipients of the bribes won't stay bought – and Carlyle - as owners - can't buy them again because it would expose Carlyle to the Foreign Corrupt Practices Act. The FCPA is probably the most commonly criminally enforced white-collar crime provision in the US. A reputable American firm does not want to go there.

Interpretation D - the company is faking its profits and balancing its books through fake losses on acquisitions and fake losses on discontinued business

Interpretation D suggests that no looting is involved. Instead the company has consistently faked its revenue up by reporting as revenue money it never received and never will receive.

The problem with reporting as revenue money never received is that over time the books don't balance. Auditors go looking for the cash and it is not there because it was never received.

In that case the company has to pull some stunts to make the books balance. The easiest way is to take their fake cash and make a fake acquisition. That makes the fake cash disappear into fake goodwill.

Over time you have to write off that fake goodwill otherwise the auditor will go looking for the attached asset. To make sure the auditor can't look for the fake asset you either close it or give it away. Then it is gone for good - but you get a write-off as you do this. In this interpretation those write-offs have tallied over a billion dollars.

In this case the PE buyers don't want to buy the company. They are buying a business that is break-even not profitable. The acquisitions made (and losses taken) are simply the way in which the books balance.

Muddy Waters and interpretation D

Muddy Waters published quite a deal of material that was consistent with but did not prove interpretation D. Some of this is well known. For instance this company has a habit of buying assets for large sums, running them for a while and giving them back to the original vendor. That is certainly consistent with Interpretation D.

Moreover some evidence exists that the revenue numbers are on the high side. For instance the seemingly high level of revenue per screen (as per this post) is consistent with Interpretation D. Previous disclosures where they appear to have overstated the number of screens are also consistent with Interpretation D.

To the Private Equity buyers: in doing due-diligence on this company you need to think about Interpretation D and how you test for it. Because if D is right then - dear Private Equity buyers - you are buying a turkey.

What is the stock worth in interpretation D?

Interpretation D is the interpretation with the sharpest negative implications for the stock. What is says is that the entire numbers of this company are garbage - and the real profitability - evidenced over the last five years - is likely negative or somewhere near it.

If interpretation D is correct the stock should settle at a very low value. (I have some ideas on how to work out the value but they are quite speculative... diligent readers might make some estimates themselves. My estimates come in under $2 at a maximum...)

For consideration.


General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.