Saturday, 20 January 2018

Book Review: 5 things I learned from David Einhorn's Fooling Some of the People All of the Time



About the Author:

David Einhorn is founder and president of Greenlight Capital, a value-oriented hedge fund that returned 16.5% a year from 1996 till 2016. He is best known for correctly identifying Lehman's balance sheet deficiencies ahead of their downfall in 2008 though his track record of spotting accounting fraud extends far beyond Lehman. 

About the Book:

This book details Einhorn's struggle to expose fraud at Allied Capital despite his possession of overwhelming evidence. 

"But the most troubling material concerns an issue that is bigger than Allied and Einhorn's battle: it's the way criticisms of corporate behavior are received in the marketplace. Many, including the SEC, appeared inclined to shoot the messenger."
- Bethany McLean, Fortune

I could not agree more.

I highly recommend this book to investors who are interested to find out more about the dark underbelly of Wall Street. As plenty of accounting concepts are discussed in the book, basic understanding of accounting principles will greatly aid understanding.

Here are my 5 learning points:

1) Don't trust the brokerage reports blindly

Einhorn details how analysts brush him aside and continue to issue "BUY" calls even when presented solid evidence of accounting fraud. The worst analysts named would not even consider external sources of information and relied solely on management forecasts and communications.

It appears that there is a fundamental conflict of interests as the companies covered can also be clients of the brokerage.

I have previously written a short piece on exercising caution over analyst reports in the Singapore context (here).

2) Don't trust your fund manager blindly

Einhorn was requested to meet the founder of Wasatch, a mutual fund with a large long position in Allied Capital. For a fund that supposedly follows "a disciplined and unique process that utilizes extraordinarily thorough due diligence", it is amazing that they had not even bothered to read up on a very public allegation on their holdings prior to meeting Einhorn.

I cannot imagine being that lazy and irresponsible with someone else's money.

3) Don't trust your regulators blindly

Einhorn had presented evidence of Allied Capital's misdoings to many authorities including the relevant regulators: the Securities and Exchange Commission, the Small Business Administration, and the US Department of Agriculture.

Egged on by Allied, the regulators' swiftest actions were to investigate Einhorn for market manipulation as they refused to investigate his claims. Even when the regulators were finally forced  to act by other agencies, the SEC merely validated Einhorn's claims but did not punish Allied.

Such inaction is not unique to the US - remember Iceberg and Noble Group?

4) Insider Purchase =/ no Fraud

While insider purchase can and should be looked at positively, it does not preclude the firm from fraud. As Einhorn pointed out, the size of purchase is the key. Using 1 week's worth of salary to purchase stock does not mean anything to the insider compared to how much they can make from the fraud.

5) Short selling is not evil

The media often portrays short sellers as evil doers looking to bring down companies for their own benefit. In truth, short selling serves a genuine market function especially in managing bubbles. At its best, short sellers also act as the first line of defence against fraud.

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material

Sunday, 7 January 2018

The Fall of Singapore Post since 2015

2017 was a fantastic year for all investors as prices went up across almost all asset classes. This was true for most investors in Singapore's stock market unless you somehow managed to pick up duds like.. Singapore Post.


At S$1.25 per share, SingPost's share price had declined 41.6% from its peak in January 30th of S$2.14. Frankly, it is quite amazing that a company with monopoly in mail management and a hand in logistics and ecommerce can fare this badly in a bull market that had picked up other logistics players like Global Logistics Property (GLP) and Poh Tiong Choon at rich valuations. 

This post details the amazing story behind the downfall of SingPost. Lets look back to 2015 to begin the explanation:


SingPost's woes started when Dr Baier abruptly resigned as CEO of SingPost in December. In hindsight, it was an amazing decision on Dr Baier's part because any half-decent board would probably have sacked him in light of the events since. 

That being said, SingPost did not have a half-decent board. Despite having more board of directors (12 in 2015) than bigger SGX listed Government Linked Firms like major shareholder SingTel, they had somehow managed "administrative oversight" over something as simple as declaring independent directors' interests in acquisitions. 

More will be shared on Alibaba and especially TradeGlobal later.

10 October 2016 - Ms Fang Ai Lian, accountant with extensive director background, comes on board as Lead Independent Director
10 October 2016 - Ms Kong Sau Wai Elizabeth, lawyer with experience in corporate transactions, comes on board as Independent Director
10 October 2016 - Mr Bob Tan Beng Hai, accountant with links to several government linked firms, comes on board as Independent Director

As expected, the Special Audit was particularly damning on SingPost failing to declare directors' interests in acquisitions. It was revealed that lead independent director Keith Tay had declared his lack of independence to the board on mulitple occasions. Nonetheless, he remained part of discussions. I can only conclude that the board did not deem it a priority to exclude him from discussions and inform shareholders of the same.

The Special Audit was also damning on SingPost's M&A practices. The following statement should be sufficient enough to explain:

"SingPost has no prescribed policy, process or procedure for the evaluation and approval of M&A transactions"

Frankly, this is ridiculous considering the amount and frequency of SingPost's M&A activity.

I would not recommend reading the Corporate Governance Review as it is full of consultant lingo with no value add apart from justifying their fat pay cheques. Professor Mak wrote a post "Deciphering SingPost’s Corporate Governance Review Report" which I recommend interested investors to read instead. Long story short, the review affirmed Professor Mak's initial concerns that corporate governance practices were sub-optimal.

New chairman Mr Simon Israel adopted recommendations from the Corporate Governance Review and began to refresh the board of directors with 3 new faces. 

SingPost ranked 14 on 2015's Singapore Governance and Transparency Index. Naturally, they finished 328 in 2016's edition.

1 April 2017 - Ms Lim Cheng Cheng, CFO of Singtel, comes on board as Non-Executive, Non-Independent Director
1 June 2017 - Mr Steven Robert Leonard, SGInnovate CEO, comes on board as Independent Director

Remember the acquisition of TradeGlobal back in 2015? After consecutive and continued losses since the acquisition, SingPost had decided to admit they made a huge mistake and book a massive impairment. The subsequent Summary Report alluded to previous criticism over weak board oversight over M&A deal and detailed how due diligence was poorly conducted. Most importantly, it recommended policy improvements on M&A dealing which were accepted.

SingPost added 2 more new directors and ended the year with 10 directors of which 7 are newly elected since 2015. There is now stronger shareholder alignment with SingTel and Alibaba holding 3/10 seats.

With these developments, it is hoped that SingPost can finally clean up the slate and end it's self inflicted leadership nightmare from 2015 to 2017.

Conclusion

Interestingly, SingPost is not the only postal company struggling with M&A. Japan Post had paid $4.9 billion to buy Toll Group in 2015, and had to take a $3.6 billion write down less than 2 years later in April 2017. 

Even more interestingly, if Toll Group looks familiar to you, that is because SingPost's new CEO hails from Toll Group. I guess the bright side amidst all this drama is that having been on the other side of the M&A game, Mr Coutts might be wiser towards not overpaying for acquisitions.

(Author is not vested in SingPost from 2015 till the time of writing)

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.

Wednesday, 27 December 2017

New Counter: Dream International (HKG:1126)

Equity: Emperor Capital (HKG:717)

Business: Toys OEM
Markets exposed: Global
Stock exchange: HKex
Purchase price: HKD 3.159  (including transaction costs, excluding FX costs)
Purchase month: December

10% per annum thesis: 

Dream International is an undervalued fast grower. Earnings growth in the coming quarters might serve as a catalyst for revaluation, which in turn has the potential to transfer Dream International into a multi-bagger.

Introduction:

Dream International is a Original Equipment Manufacturer for Toys. They manufacture for companies like Disney, Funko and Spin Master.

In terms of Geography, North America represents Dream International's biggest market. The majority of their production is done in Vietnam.

Considerations:

1) Management-Shareholder Alignment

Chairman and CEO Mr Kyoo Yoon Choi is also Dream International's controlling shareholder with 67.22% ownership of Dream International. With the largest shareholder personally taking care of management, Management-Shareholder alignment is naturally in place.

2) Fast Grower

Dream International has been growing its net profits from 2012 to 2016 at an incredible CAGR of 25.9%. Considering that 1H results are typically weaker than 2H for Dream International, it appears that 2017 might be another record year for profits.

Source: Dream International's Financial Statements, complied by Author

Part of the reason for Dream International's soaring profits is an improvement in margins in an industry where competitors are increasingly squeezed for profits. In my opinion, there are 2 main reasons for this:

2.1) Successfully moving majority of production to Vietnam where operating costs are lower
2.2) Increasing Profitability of the Plastic figures product segment

Revenue from the Plastic figures segment has been growing at an even more astounding CAGR of 65% per annum. 

Source: Dream International's Financial Statements, complied by Author

To make matters even more exciting, the Plastic figures segment appears to have stronger margins than their traditional Plush stuffed toys segment.

Source: Dream International's Financial Statements, complied by Author

There are several catalysts to maintain Dream International's streak of growing profits. For one, Dream International is looking to continue expanding production in Vietnam especially in the Plastic figures segment. On the demand side, we also have Frozen 2 hitting the big screens in 2018. This should increase demand from Disney for Plush stuffed toys.

In the longer term, we have other positives like Disney's takeover of Fox's many valuable intellectual property (such as X-men, Deadpool, Avatar). Marvel had admitted in 2015 (here) that they were not pushing X-men merchandise simply because they would have had to share fees with Fox. It is therefore highly likely that Disney will begin pushing for more merchandise sales now. As demand from North America forms the bulk of Dream International's revenue, the US tax cut should also increase discretionary consumption of toys.

3) Valuations

Dream International has been (and still is) trading at a discount to peers.

Source: Compiled by Author

This valuation discount is irrational in my opinion, given the earnings growth and relative out-performance in returns metrics of Dream International. However, seeing that Dream International's share price had risen 50% over the past year, I believe the market is now coming to terms with Dream International's undervaluation.

A revaluation of Price to Earnings ratio to 10 without any further earnings growth will see Dream International trading at HKD 5. 

Risks:

A) Corporate Governance

Dream International does not have the best corporate governance structure. 3/9 of their directors are executive and non-independent, and controlling shareholder Mr Kyoo Yoon Choi is both Chairman and CEO.

This might lead to potential abuse of power through poor directors-management delineation of power. That being said, such corporate governance structure appears to be more common in Hong Kong and I have found no such instance of abuse in Dream International thus far in my research. For example, remunerations to directors appear acceptable considering the profitability of the firm.

Conclusion:

This is my 2nd foray into the Hong Kong market after Emperor Capital. As I remain unproven and untested in the Hong Kong market, I have also limited Dream International to below 6% of my portfolio. Hopefully, both these ventures into HKex will prove fruitful.

Christmas has passed so I will end off by wishing everyone a Happy New Year!

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.