Slater and Gordon: hubris, a roll-up and "work in progress"

Good article from The Sydney Morning Herald:

"The Undoing of Slater and Gordon"

Some snippets:

At one point last year it was the world's biggest listed law firm, a $2.7 billion multinational behemoth, a brand recognised by three out of four Australians. But that was before things went horribly wrong - before, as The Australian Financial Review described it, "one of the biggest falls from grace in Australian business history".

.... Slater & Gordon made world history by listing on the sharemarket, a move made possible by a change to Australian law. (Only a handful of law firms followed Slaters, and only a few have survived.)

The float was controversial, inside the firm and out. The seven most senior partners, led by Andrew Grech, and including Peter Gordon (the mercurial lawyer and custodian of the firm's working-class values, who is unrelated to founder Hugh Gordon), became multimillionaires overnight, leaving other partners feeling shut out. "It was a confronting situation to be told, 'I am worth this many shares and you are worth this many,' " one senior lawyer told Good Weekend. Outside the firm, there was much hand-wringing in the legal community about a lawyer's hierarchy of duties, which are firstly to the court and secondly to the client. Where would the shareholder fit in this brave new world of law?

Since 2007, Slater & Gordon had spent half a billion dollars on 40 firms and had become known as a "roll-up" - a company that grows by eating other companies.

Business history is littered with the corpses of bloated roll-ups, because in order to grow, they have to keep munching away, making bigger and bigger deals, which almost always proves unsustainable. In Australia, market-watchers had seen this before. The Ferrari-driving Eddy Groves, who ran around in his cowboy boots buying childcare centres for his company ABC Learning, engaged in classic roll-up behaviour before he went broke. Several analysts Good Weekend spoke to drew comparisons between Slater & Gordon and ABC Learning. Crikey has described the similarities between the two as "extraordinary".

Slater & Gordon specialises in "no win, no fee" personal injury cases. This means it does not get paid until a case closes, something that typically takes 18 months to two years. If you sell cakes, you report your revenue when you sell a cake. But how does a law firm report revenue? Slater & Gordon decided to record revenue as cases progressed (Work in Progress), estimating the likelihood of success and how much work had been done. It recorded this as revenue, even though it was yet to get any - and, in some cases, would never get paid.

There are several theories about why Slater & Gordon ended up where it is today, with shareholders wiped out, the banks at Grech's heels, and the staff, many of them in financial distress, furious. One is that the firm, as it grew to be one of Australia's top 100 companies, should have upgraded its auditors and senior finance people. Another theory is that Slater & Gordon was in trouble converting its Work in Progress and needed a big acquisition - Quindell - to satisfy the market's relentless desire for a "growth narrative".

Another is that the "gang of four" Slaters managers - who had been there most of their working lives, Grech since 1994 - were reinforcing each other's views and started to believe they could do no wrong. And then there's the sense that there wasn't anyone, in the end, who could stand up to Grech. "It was hard to say no to Andrew at that point in time," one insider told me. "The person who historically said no to Andrew was Peter [Gordon]. When Peter left, who was there to say no?"

And the last theory, of course, is that the cause is one of the oldest authors of failure, a flaw both ancient and common, one that manifests sometimes in snakeskin cowboy boots and sometimes in a suit. "I can tell you what happened," says former Slater & Gordon lawyer Steven Lewis. "One word. Hubris."


The articles in the Financial Times about Quindell can be found here.

A previous blog post about the collapse of ABC Learning Centres can be found here.

Noble Group, an overview

Great article in The Financial Times about Noble Group (I wrote several articles about them in the past):

Commodities: Noble’s House of woe

Some snippets:


Today the market value of the company — which is listed in Singapore — has collapsed to $1.1bn, its chief executive has left, and Mr Elman, 76, has announced he will step down as executive chairman in the next 12 months. In February, it reported annual losses for the first time in more than 20 years after taking $1.2bn in writedowns and charges, largely related to the value of long-term contracts it has been accused of overstating by short sellers, hedge funds and a former employee turned financial blogger.

Noble, which acts as a middleman for oil, coal, iron ore and metals deals, is now tapping its shareholders for $500m of cash and trying to sell prized assets in its efforts to pay down debt and free up capital for its trading operations.


“Noble compounded its problems with aggressive accounting,” says Craig Pirrong, a finance professor at the University of Houston who has written on the industry for Trafigura. “The accounting issues took a big toll on management’s credibility, and that made it very difficult to climb out of the hole.”


Mounting debts and high costs began to weigh on the company as bets in niche markets such as carbon credits backfired. As a listed company, it wanted smoother earnings to keep the stock market happy, former employees say.

Noble did this by recognising upfront a portion of gains from long-term marketing and supply agreements and recording their value on its balance sheet, say ex-employees. This technique, while legal under accounting rules, has seen only limited use among Noble’s rivals who say it is risky because the volatility of commodity prices means the amount of cash eventually received from the deals can be lower than the recorded profits.


Noble's 5-year price chart:

Alibaba investigated over accounting practices (2)

In addition to yesterdays posting about Alibaba, I like to point to a posting on "China Accounting Blog" (which is anyhow always a good source of information for all accounting matters related to China): "BABA v the SEC".

There are three issues at hand, all described by Paul Gillis:


The first relates to consolidation policies and practices (including accounting for Cainiao Network as an equity method investee).  

The second issue is related party transactions. BABA certainly has plenty of them and they have been a major concern for shareholders, especially since Alipay was taken out of the BABA structure.

The third issue relates to the reporting of operating data from singles day (November 11, the biggest online commerce day of the year in China). 


Regarding the third issue I also refer to an old posting.

Alibaba investigated over accounting practices

From Bloomberg: "Alibaba Facing SEC Investigation Over Accounting Practices"

Some snippets:


Alibaba Group Holding Ltd. fell the most in four months after the e-commerce giant said it’s being investigated by the U.S. Securities and Exchange Commission over its accounting practices and whether they violate federal laws.

The regulator is looking at data reported from the company’s Singles’ Day promotion, Alibaba’s biggest shopping day, and how Alibaba consolidates results from affiliated companies, including logistics partner Cainiao Network, the Hangzhou, China-based company said in its annual report. Alibaba said it’s providing documents and cooperating with the probe, which is also examining related-party transactions.


Not a new issue, I blogged about this issue before.

Many brokers are reiterating that "the auditor is PWC", but what they're missing (or conveniently ignoring) that its not actually PWC who's auditing them, but a local Mainland Chinese affiliate ...

AirAsia's accounting issues (2)

I wrote before about this issue, more than four years ago:


"AirAsia had previously drawn criticism from many parties as to why it never equity accounted the losses suffered by its associates and there were calls for greater transparency over the financial numbers recorded by the associates. The airline subsequently explained that with AirAsia having written down to zero its investments for both TAA and IAA in AirAsia's balance sheet, it did not need to recognise any further losses made by TAA and IAA as it had no accounting obligation to make good on those losses."

 I find the AirAsia's accounting much too aggressive. Thai AirAsia and PT Indonesia AirAsia are two strategic investments in which AirAsia has a large share (almost 50%) and to which AirAsia is lending large amounts of money. Conservative accounting would really require these losses of RM 254 million to be accounted for.

 There are several possible outcomes, in each of it AirAsia has to take the loss:

• Their Thai or Indonesian operation goes bankrupt, in this case AirAsia has to write off its loans
• The equity of their Thai or Indonesia operation is replenished, AirAsia has to write of its losses
• The Thai or Indonesian operation turns highly profitable, again AirAsia has to write of its previous losses against these profits

Finally, four years later, AirAsia had to recognize its previous losses in its Indonesian subsidiary when it announced its results:

From the options I gave above, it turned out to be the second option, AirAsia was forced by the Indonesian authorities to replenish the shareholders funds in its Indonesian subsidiary.

This one-off event dragged down the quarterly results substantially, the PBT was a loss of RM 462 Million, almost exactly the prior year absorbed losses.

I concluded my previous posting by:


There is still the other accounting issue, AirAsia has booked as "profits" RM 659 million deferred tax assets. This is tax it does not need to pay in the future if it makes profit. Again, a very aggressive way of accounting.

In other words, AirAsia is not accounting for losses that have occurred in its strategic investments, but it is accounting for possible future profits.

This does not seem right to me.


It still does not seem right to me, although I am not an accountant.

AirAsia did not incur those losses the last quarter, what they did was invest more money in their subsidiary.

By not recognizing the losses they have (in my opinion) artificially boosted their earnings over those years, but now they finally had to account for it (at least for their Indonesian subsidiary).

 

AirAsia X has booked RM 470 Million in "profits" due to deferred tax assets while it has not booked a single year of "normalized earnings" (corrected for one-off items) in its existence.

 

AirAsia and AirAsia X might have convinced their auditor who signed the accounts over those years, but they haven't convinced me. Surely this can not be the correct way to do things.

 

AirAsia drops 10%, due to research report?

The share price of AirAsia dropped yesterday about 10%, back to its 2010 levels. According to The Star's article:


".... on concerns about the outbreak of the Middle East Respiratory Syndrome (MERS) and its impact on air travel but greater concerns could be about the weak ringgit.

AirAsia could also be hit by the depreciating ringgit as sizeable fixed costs are in US dollar while bulk of earnings are in ringgit, analysts said."


I received news from a reliable source that a research report from Gillem Tulloch of GMT research might (also) have to do with it.

I don't have the report, nor is it publicly available (behind paywall).

According to one broker (edited):


"The issue raised include the ability of Indonesia AirAsia (IAA) and AirAsia Philippines (AAP) to repay their debts of RM 2.8 Billion.

Tony strongly believes he can get back around one billion ringgit after he locks in new investors in both IAA and AAP. Within the next three months. The process is further ahead in the Philippines than in Indonesia. But until we see the one billion ringgit, there will always be concerns and risks that the deal could fall apart. All I have right now is Tony's word that things are progressing well.

... the longer-term issue is, whether AirAsia will be able to get IAA and AAP to be sustainably profitable.

With foreign shareholding >50%, it's vulnerable to a massive sell off. ".


The accounting issues are not new, I wrote for instance almost four years about the same (here).

We will see how this will pan out, when more details about the research report will be published, and AirAsia will react to that.

Hopefully in a more professional way than the previous time (here and here):

It looks like Paul Dewberry was right after all and Tony Fernandes could not prove him wrong.

To end this posting on a positive note, the board of directors of AirAsia X has suspended their wages for 2015, which is a great gesture. I hope other Bursa listed companies follow suit, when the need arises.

Chairman "had something to do", company down USD 19 Billion

Losing a few Billion, it can happen to the best, but losing USD 19 Billion in 24 Minutes, that is pretty tough, even if it is just paper value.

The company in question is Hanergy Thin Film Solar Group Ltd., listed in Hong Kong.

FT reported:


“Chairman Li [chairman and majority shareholder] did not attend the AGM,” said T.L. Chow, an external spokesman for Hanergy. “He had something to do.”


FT has written several times about this company, for instance about its suspicious group structure and the frequent trading between holding company and subsidiary:

FT also reported about the remarkable rise of the share price in the last ten minutes of each trading day (which used to be for years a familiar pattern in the Malaysian context):

David Webb also warned about bubbles and suspicious accounting practices:

Hanergy accounts for revenue and profits on a "percentage of completion basis", which is earlier than actual invoicing. At 30-Jun-2014, Hanergy had net tangible assets of HK$8,023m, of which $4157m was gross amounts due from contracts with Hanergy Affiliates (revenue which had not been billed) and $1914m was receivables from Hanergy Affiliates. It had also made prepayments to Hanergy Affiliates of $1540m for photovoltaic modules for solar power plants (Hanergy is going downstream), most of which had not been delivered. Add that all up and you see that $7611m, or 95% of the net tangible assets, are accounts with Hanergy's parent group. So not only is Hanergy in a bubble at 15 times its NTAV, but most of the NTAV depends on its parent group not defaulting. The listed company pays its parent in advance, but gets paid in arrears, heavily supporting its parent.


Bloomberg reported that shorting of speculative shares can horribly backfire:


Short sellers bowed out on Hanergy Thin Film Power Group Ltd. at just the wrong time.
Wagers against the Chinese solar-panel maker fell to 3.1 percent of its outstanding shares on Monday, the lowest level since December 2013, just before the stock slumped 47 percent in 24 minutes on Wednesday in Hong Kong to erase about $19 billion of value. Short interest dropped from 2014’s high of 5.1 percent, data compiled by Markit Group Ltd. show, as bears capitulated amid a 162 percent gain in the stock this year.

“Those who shorted Hanergy in the past got squeezed because it kept going up,” Andrew Sullivan, head of sales trading at Haitong International Securities Group, said in Hong Kong. “While there was a wall of money supporting the stock, it was very difficult to short.”

1MDB accounts "are audited by an international firm" (2)

In the previous blog post on this subject I wrote about the pretty bad state of audits, even if performed by the "Big Four" companies.

But how would the situation be if an audit company is warned in detail about possible fraud or other financial irregularities, surely auditors will step up their game, zoom in on the situation at hand and give a proper report?

According to short seller Carson Block the answer is an astonishing "no".

In "Beware the false reassurance of corporate probes" (free registration might be required) published by the Financial Times he writes (some snippets):


When it comes to defending themselves against accusations of wrongdoing, management teams and their complacent boards follow a well-worn routine. Their immediate reaction is to issue a blanket denial and announce that an independent committee of directors will investigate the accusations. The committee duly appoints an independent law firm to oversee the investigation, and the consulting arm of a Big Four accountancy to pore over the books.

Too often, such investigations are worthless endeavours that lead to more pain for investors. Frequently, companies are exonerated by their boards but subsequently tumble into bankruptcy or announce earnings restatements or evidence of other serious problems.


Directors are not inclined to embarrass themselves by exposing serious problems that had long been under their noses. That would invite shareholder lawsuits, regulatory scrutiny and professional embarrassment.

Nor are they likely to relish the prospect of clashing with management when the chief executive is often the one who put them on the board in the first place. Board members may even be conspirators in the fraud. If they are based in China and have little connection to the US, they are unlikely to face prosecution.

Time and again, investigators report that they have found no evidence to support claims of wrongdoing. The question that investors need to ask themselves is: how hard did these investigators look for clues that might have revealed something was amiss?

The firms hired to support the probe are often given a deliberately narrow brief. For example, there might be tight restrictions on the investigators’ ability to investigate the sources of the company’s cash balances.

Fraudsters have repeatedly duped independent committees and their advisers by showing that they control large cash balances. Often, they do this by borrowing the funds. If directors make it impossible to detect such ruses by limiting investigators’ access to evidence, nobody knows; the entire process is shrouded by the cloak of attorney-client privilege.

Accounting firms are also rife with conflicts of interest. Their main line of work is auditing public companies. This makes them unwilling to heap embarrassment on management teams and boards. To do so would be bad for business.


That doesn't sound that promising. Block gives a concrete example:


In 2011, Sino-Forest Corporation, a China-based company listed on the Toronto Stock Exchange that Muddy Waters had accused of falsifying its revenue, spent approximately $50m on such an investigation, hiring PwC as a consultant. The result was a clean bill of health. In a press release announcing the completion of the investigation, the independent committee said the company was unequivocally “not the ‘near total fraud’ and ‘Ponzi scheme’ as alleged by Muddy Waters . . . Sino-Forest is a real company.”

Unfortunately, investors who bought Sino-Forest bonds following the committee report saw their prospects for recovery plunge when the company declared bankruptcy four months later.


The problem is not confined to emerging markets. In the US, numerous independent board investigations have issued clean bills of health, only to be proved wrong later on.

A report into wrongdoing at Enron, carried out by a law firm hired by the company, was later described as “a whitewash” by an Arthur Andersen investigator. When Global Crossing ordered an investigation into allegations levelled by a former employee, the report came back clean. Yet the company fell into bankruptcy and settled with the SEC over an accounting scandal.


The solution according to Block:


Boards that truly want transparency should stop hiring law firms to conduct these investigations in private and under legal privilege, and open their work to genuine scrutiny.


Hopefully 1MDB will follow this advice for increased transparency, it is long overdue.

1MDB accounts "are audited by an international firm"

Article from The Malaysian Insider:


Debt-laden 1Malaysia Development Berhad (1MDB) insisted today its accounts are audited by an international firm, saying it reserves the right to sue those making malicious and slanderous statements against the government-owned strategic investor.

The company broke its silence after senior banker Datuk Seri Nazir Razak yesterday told its board to appoint independent auditors or resign over a RM42 billion debt. "

The Board would like to stress that 1MDB accounts are audited by an international audit firm, Deloitte, " it said in a statement issued in capital Kuala Lumpur tonight.

It said that Deloitte signed off 1MDB’s 2013 and 2014 accounts without qualification and similarly KPMG signed off the 2010, 2011 and 2012 accounts with no qualification.


Accounts audited by international audit firms, members of the "Big Four".

What possibly could go wrong?

Well, let's start with "The dozy watchdogs" written by The Economist, some snippets:

PwC’s failure to detect the problem is hardly an isolated case. If accounting scandals no longer dominate headlines as they did when Enron and WorldCom imploded in 2001-02, that is not because they have vanished but because they have become routine. On December 4th a Spanish court reported that Bankia had misstated its finances when it went public in 2011, ten months before it was nationalised. In 2012 Hewlett-Packard wrote off 80% of its $10.3 billion purchase of Autonomy, a software company, after accusing the firm of counting forecast subscriptions as current sales (Autonomy pleads innocence). The previous year Olympus, a Japanese optical-device maker, revealed it had hidden billions of dollars in losses. In each case, Big Four auditors had given their blessing.

And although accountants have largely avoided blame for the financial crisis of 2008, at the very least they failed to raise the alarm. America’s Federal Deposit Insurance Corporation is suing PwC for $1 billion for not detecting fraud at Colonial Bank, which failed in 2009. (PwC denies wrongdoing and says the bank deceived the firm.) This June two KPMG auditors received suspensions for failing to scrutinise loan-loss reserves at TierOne, another failed bank. Just eight months before Lehman Brothers’ demise, EY’s audit kept mum about the repurchase transactions that disguised the bank’s leverage.

The situation is graver still in emerging markets. In 2009 Satyam, an Indian technology company, admitted it had faked over $1 billion of cash on its books. North American exchanges have de-listed more than 100 Chinese firms in recent years because of accounting problems. In 2010 Jon Carnes, a short seller, sent a cameraman to a biodiesel factory that China Integrated Energy (a KPMG client) said was producing at full blast, and found it had been dormant for months. The next year Muddy Waters, a research firm, discovered that much of the timber Sino-Forest (audited by EY) claimed to own did not exist. Both companies lost over 95% of their value.

Of course, no police force can hope to prevent every crime. But such frequent scandals call into question whether this is the best the Big Four can do—and if so, whether their efforts are worth the $50 billion a year they collect in audit fees. In popular imagination, auditors are there to sniff out fraud. But because the profession was historically allowed to self-regulate despite enjoying a government-guaranteed franchise, it has set the bar so low—formally, auditors merely opine on whether financial statements meet accounting standards—that it is all but impossible for them to fail at their jobs, as they define them. In recent years this yawning “expectations gap” has led to a pattern in which investors disregard auditors and make little effort to learn about their work, value securities as if audited financial statements were the gospel truth, and then erupt in righteous fury when the inevitable downward revisions cost them their shirts.

The modern audit does not even provide an opinion on accuracy. Instead, the boilerplate one-page pass/fail report in America merely provides “reasonable assurance” that a company’s statements “present fairly, in all material respects, the financial position of [the company] in conformity with generally accepted accounting principles (GAAP)”. GAAP is a 7,700-page behemoth, packed with arbitrary cut-offs and wide estimate ranges, and riddled with loopholes so big that some accountants argue even Enron complied with them. (International Financial Reporting Standards (IFRS), which are used outside the United States, rely more on broad principles). “An auditor’s opinion really says, ‘This financial information is more or less OK, in general, so far as we can tell, most of the time’,” says Jim Peterson, a former lawyer for Arthur Andersen, the now-defunct accounting firm that audited Enron. “Nobody has paid any attention or put real value on it for about 30 years.”


Those conflicts of interest

Even so, the misaligned incentives built into auditing all but guarantee that accountants will fall short of investors’ needs. The beneficiaries of the service—current and prospective shareholders—pay for it indirectly or not at all, while the purchasers buy it only because they are required to. As a result, companies tend to select auditors who will provide a clean opinion as cheaply and quickly as possible. Similarly, accountants who discover irregularities may be better off asking management to make minor adjustments, rather than blowing the whistle on a misstatement that could embroil their firm in costly litigation.


I invite the reader to Google on search terms like "Deloitte" "accounting" "scandals" or "KPMG" "accounting" "scandals", and one would see a huge list of incidents regarding these two audit firms. PwC or EY , the other companies in the "Big Four" don't seem to be any better, for that matter.

Qualified opinions on 6 listed companies

From MSWG's weekly newsletter of May 8, 2015:

AUDITORS ISSUED QUALIFIED OPINIONS ON 6 COMPANIES LISTED ON BURSA MALAYSIA
 

No	Name of Listed Company	Date of Announcement	Auditor	Basis of Opinion (Salient Points)
1	NPC Resources Berhad	30 April 2015	Ernst & Young	Insufficient time to perform sufficient audit procedures as the audited financial statements of three foreign subsidiaries were only available close to the date of the financial statements of the Group were approved by the Board.
2	Silver Ridge Holdings Bhd	30 April 2015	Baker Tilly Monteiro Heng	Unable to obtain sufficient and appropriate audit evidence on the recoverability of receivable.
3	Stemlife Berhad	30 April 2015	Ernst & Young	i)  Non-compliance with the requirements of MFRS 4 (Insurance Contracts) for the assessment of insurance liabilities and revenue associated with insurance contracts; and ii) insufficient access to the financial information and management of an associate.
4	Wintoni Group Berhad	5 May 2015	SJ Grant Thornton	Unable to physically sight the Group’s computer equipment.
5	China Ouhua Winery Holdings Limited	30 April 2015 & 5 May 2015	Helmi Talib & Co.	Unable to ascertain whether the net recoverable amount of an asset acquired in China will exceed the total purchase consideration.
6	Ire-Tex Corporation Berhad	5 May 2015	UHY	Unable to validate the existence of sales of RM5 million to 2 related parties which were subsequently impaired.

MSWG’S COMMENTS:

It is a bit out of the norm though not totally surprising that within a short period of time there were 6 public listed companies where their independent auditors had qualified their opinions on their audited financial statements highlighting issues of concern for investors to take note.

 

It may also serve as a ‘red flag’ or early warning signal to audited financial statement readers particularly shareholders, investors and potential investors who may need to make more informed investment decisions.

Shareholders can query external auditors at general meetings

The issue if shareholders can ask questions to the external auditors was raised in the (rather heated, but very interesting from a corporate governance point of view) debate in Singapore regarding Noble Group.

Mak Yuen Teen wrote a clear answer to that matter in the Business Times (Singapore). Some snippets:


External auditors are appointed by shareholders, their report is addressed to shareholders, and they have a fiduciary relationship with them. It would be odd if shareholders appoint external auditors who report to them, but cannot ask questions about how they did the work.

.....  there is not much point in having external auditors present at general meetings - and companies being charged for it - just for them to issue boilerplate responses.

For example, shareholders at the Noble AGM could have asked questions about how the external auditors arrived at their audit opinion, the appropriateness of the accounting policies and assumptions used by the company, and how they audited the investments in associate companies such as Yancoal and biological assets.

As a matter of decorum, shareholders should direct their questions about the external audit or about other matters through the chairman of the meeting. The chairman should provide the opportunity for the external auditors, committee chairmen and others to answer these questions as appropriate.


To all readers who visit AGMs/EGMs and have questions regarding accounting matters, please feel free to follow the above advice. I assume the rules are the same in Malaysia.

On a side note: I hope to have time in the future to comment on Noble, which might also be worthwhile in the Malaysian context: although no company on Bursa has yet been targeted by a "shortseller", one day that surely will happen, better to be prepared for it, both for regulators and companies.

Patimas: will there be justice?

On March 21, 2014 Patimas Computers Bhd. was delisted from Bursa Malaysia.

An investigative audit by UHY Advisory has shown lots of very serious irregularities, just to mention a few:

 

Next to that there was a court case between Patimas and one of its business relations, Omni Quest, the judgement of which also contained lots of material:

Patimas was audited by Ernst & Young, this was their statement made on April 26, 2011 regarding the annual audited accounts of 2010:

Pretty scary, since the irregularities were going on for so long, and one of the top 4 accounting firms did not find anything wrong in the accounts.

Further more we see things that are normal in a company going under, for instance many director changes, from their 2013 audited accounts:

And the usual rumours start to appear, two instances where Bursa queried the company:

PATIMAS IS RUMOURED TO GET CONTRACT WORTH RM160 MILLION
AZIM ZABIDI IN TALKS WITH FOREIGN PARTY TO REVIVE PATIMAS

Rumours that must have played their part in supporting the share price and volume:

And insiders selling in a big way, when the troubles start to appear:

Will the authorities take appropriate action within a reasonable timeframe? Time will tell.

Anthony Bolton: I was wrong about China

"Anthony Bolton (born 7 March 1950) is one of the UK's best known investment fund managers and most successful investors, having managed the Fidelity Special Situations fund from December 1979 to December 2007. Over this 28-year period the fund achieved annualised growth of 19.5%, far in excess of the 13.5% growth of the wider stock exchange, turning a £1,000 investment into £147,000."

The above taken from Wikipedia. Pretty impressive, isn't it?

And then he did something he now definitely regrets:

"In 2009 he announced his return to fund management and in April 2010 moved to Hong Kong to begin managing the newly launched Fidelity China Special Situations PLC, an investment trust listed on the London Stock Exchange."

SCMP wrote recently an article with a rather harsh tone:

"Anthony Bolton retires with unfond memories of China"

"... despite his bullishness on China he was unable to repeat his successes with his China investments - to no great surprise from older hands here who felt he didn't have enough knowledge of the market to succeed in the short term.

He retired from Fidelity at the end of March. At a function to mark his retirement Bolton criticised standards of corporate governance on the mainland. Initially he thought corporate governance issues in China were about whether the chairman and the chief executive positions were held by the same person, or whether independent directors held a majority on the board.

"I found that corporate governance is a euphemism for 'are the figures real and is the management lying?', that is, fraud.


A longer and more detailed article in the Financial Times: "Anthony Bolton: ‘I was wrong about the market in China’"

“The most disappointing thing for me – and I am happy to admit it – is that I was wrong about the market in China,” the manager said during a press briefing on his last day in the office on March 31.

“I thought it would go up for four years but it has gone down for more than four years.”

Eventually he did outperform the relevant index, but in absolute terms, the performance is nothing to shout about:

Someone who has performed (very) well by investing in China is Malaysian Cheah Cheng Hye (founder of Value Partners), about whom I wrote here.

London Biscuits: something seems wrong (2)

It should be interesting to compare the numbers from London Biscuits with those from Apollo Food, a company in the same industry.

Apollo:

London:

These are some key numbers from 2013 of the two companies, all in millions of RM:

                       Apollo     London
PPE                     115         517
Revenue                 223         290
Depreciation              9          16

In other words:

• Apollo has a Revenue/PPE ratio of 1.9, while London has a ratio 0.6
• Apollo's depreciation (as percentage of PPE) is 7.8%, while London has 3.1%

Huge differences, the numbers of London Biscuits are really very strange.

If London Biscuits depreciation would be around 7.5% of its PPE (a percentage that sounds roughly right to me), then depreciation should have been RM 39 million, instead of RM 16 million. PBT would then have been a loss of RM 4 million, instead of a profit of RM 19 million. And that is just the adjustment for 2013.

Apollo Food by the way has a rather pretty set of numbers:

London Biscuits: something seems wrong

KiniBiz raised the red flag over London Biscuits latest audited accounts:

"Confectionary maker London Biscuits Bhd (LBB)’s latest annual audited accounts recorded yet another year of significant property, plant and equipment (PPE) acquisition cost, raising questions over its PPE expenditure which now averages RM63.64 million in the last five years.
 .....
 Additionally, the company has seen a net loss from PPE disposals for the past five years, recording a loss of RM1.76 million in 2013. Since it was listed in 2002, LBB has only seen a net gain from PPE disposals once in 2008, recording RM501,284."


I think that indeed the amount in PPE is worrisome. I have made a simple comparison between 2003 and 2013, all amounts in millions RM:

                   2003        2013
Revenue              53         290
PAT                   9          15
Depreciation          6          16
Dividend              2           1


PPE                  80         517
Shareholders Funds   71         299
Cash                 10          27
Debt                 36         263

Some observations:

• Revenue is 5.5 times larger in 2013, but PAT has hardly grown
• Dividend is even cut, to almost nothing
• PPE has grown astonishing, 6.5 times larger
• Shareholders Funds of RM 299 million looks impressive, but only RM 120 million is retained profit, money has been raised with the IPO, with Private Placements, Rights Issue, ESOS, etc.
• The growth in debt minus cash is highly worrisome
• Although the company claims to be profitable, cash flow seems to be consistently negative

Two questions:

• How is it possible that a company that claims to be profitable and hardly pays any dividend needs such a large debt?
• How is it possible that the company needs RM 517 million PPE, to generate a revenue of only RM 290 million?

My guess is that this could all be caused by systematically understating of the depreciation on the PPE. My reasons for this:

• In 2003 depreciation was 7.5% of PPE, but in 2013 only 3.1%.
• In 2003 revenue was 66% of PPE, in 2013 only 56% (I would have expected the reverse pattern due to economy of scale, more efficient machines, etc.)
• Almost all PPE disposals are done at a loss.

Too low depreciation would explain [1] overstated profits and [2] overstated value of the PPE

Ze Moolah has paid attention to London Biscuits, here pointing at the ever growing debt and here pointing at the ever growing PPE.  He wrote the first warnings more than three years ago. Unfortunately (for investors in London Biscuits), it looks like he is right again.

Please also check the following link, a interesting posting by "kcchongnz".

10 Worst Corporate Accounting Scandals

The 10 worst corporate accounting scandals, from this website.

Some fun facts:

• Fortune Magazine named Enron "America's Most Innovative Company" 6 years in a row prior to the scandal.
• At the height of the scandal Kozlowski threw a $2 million birthday party for his wife on a Mediterranean island, complete with a Jimmy Buffet performance.
• After posting the largest quarterly corporate loss in history in 2008 ($61.7 billion) and getting bailed out with taxpayer dollars, AIG execs rewarded themselves with over $165 million in bonuses.
• In 2007 Lehman Brothers was ranked the #1 "Most Admired Securities Firm" by Fortune Magazine.

AirAsia's accounting issues

http://biz.thestar.com.my/news/story.asp?file=/2011/8/23/business/9346263&sec=business

 

AirAsia likely to equity account associates’ profits in 2013

"Low-cost carrier AirAsia Bhd will only start equity accounting its share of profits from Thai AirAsia (TAA) and Indonesia AirAsia (IAA) when the amount of unrecognised losses from these associates have been reversed, the airline told StarBiz."

"Analysts added that another consideration would be the impending listings of TAA and IAA, which would see an equity injection and allow them to re-capitalise."

"AirAsia had previously drawn criticism from many parties as to why it never equity accounted the losses suffered by its associates and there were calls for greater transparency over the financial numbers recorded by the associates. The airline subsequently explained that with AirAsia having written down to zero its investments for both TAA and IAA in AirAsia's balance sheet, it did not need to recognise any further losses made by TAA and IAA as it had no accounting obligation to make good on those losses."

I find the AirAsia's accounting much too aggressive. Thai AirAsia and PT Indonesia AirAsia are two strategic investments in which AirAsia has a large share (almost 50%) and to which AirAsia is lending large amounts of money. Conservative accounting would really require these losses of RM 254 million to be accounted for.

There are several possible outcomes, in each of it AirAsia has to take the loss:

• Their Thai or Indonesian operation goes bankrupt, in this case AirAsia has to write off its loans
• The equity of their Thai or Indonesia operation is replenished, AirAsia has to write of its losses
• The Thai or Indonesian operation turns highly profitable, again AirAsia has to write of its previous losses against these profits

There is still the other accounting issue, AirAsia has booked as "profits" RM 659 million deferred tax assets. This is tax it does not need to pay in the future if it makes profit. Again, a very aggressive way of accounting.

In other words, AirAsia is not accounting for losses that have occurred in its strategic investments, but it is accounting for possible future profits.

This does not seem right to me.

How to Spot Dubious Accounting?

In general poor quality earnings, typified by

• Increasing earnings
• But no increase or even decrease in cash (in China this might be manipulated)
• Rise in Inventory (inventory might be worth less than valued)
• Rise in Receivables (might include fake receivables or difficult to collect)
• Rise in Debt (often short term)

There are other things to look for, for instance:

• Rights Issues that make no sense: companies that claim to be highly profitable, but need lots of cash in the form of Rights Issues
• No dividends or very low dividends
• High Margins: normally that is what we want as investors, but in competitive industries margins that are much higher than competitors are a potential red flag
• High Sales compared to low Property, Plant & Equipment, if the last one is too low, than the Sales are possibly bogus
• Interest Received versus Interest Expenses, if the company claims to have a lot of cash versus debt, but the Interest paid is much higher than Interest received, than something is likely wrong
• Basic Numbers checking: for instance Bernie Madoff claimed to turnover a larger amount of options than the total amount that was traded.
• Related Party Transactions: always a source of potential problems
• Dubious brokers and accountants (note that Top Tier accountant companies have been involved with huge frauds, they are not a guarantee that all is well)

A selection of interesting articles from Bronte Capital, all China related, how to "kick the tires" of a Balance Sheet and Profit & Loss statement:

http://brontecapital.blogspot.com/2011/07/hollysys-blog-post-inspired-by-railway.html 

http://brontecapital.blogspot.com/2011/05/those-clever-people-at-china-fire-and.html

http://brontecapital.blogspot.com/2011/05/longtop-and-remarkable-capital.html

http://brontecapital.blogspot.com/2011/04/gulf-resources-sometimes-you-only-need.html

http://brontecapital.blogspot.com/2011/02/china-agritech-more-miracles-in-plant.html

http://brontecapital.blogspot.com/2011/02/china-media-express-what-disconcerted.html

And the danger of short selling:

http://brontecapital.blogspot.com/2011/05/steve-madden-counter-example.html