The 10th Annual New York Value Investing Congress takes place in New York on September 8th and September 9th 2014. ValueWalk will be providing coverage of the event- below is a brand new short from Carson Block of Muddy Waters.
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Carson Block is director of research and founding partner of Muddy Waters Research LLC, a due diligence-based investment firm that conducts extensive accounting and on-the-ground investigations of public companies. Muddy Waters won accolades following its research on Sino-Forest Corp., a China-based forestry company listed on the Toronto Exchange. Shortly after Muddy Waters’ report in June 2011, Sino-Forest lost nearly $6 billion in market capitalization, its auditor resigned and regulators halted its shares. The company filed for bankruptcy and in June 2012, the Ontario Securities Commission filed formal fraud charges against Sino-Forest and its senior management for overstating its timber assets and misleading investigators. In total, Muddy Waters has issued eight “strong sell” recommendations resulting more than $8 billion of downward market cap adjustments, four de-listings and six or more regulatory investigations. Prior to forming Muddy Waters, Mr. Block was an entrepreneur in China and worked as a lawyer in Shanghai. In 2007, he co-authored Doing Business in China for Dummies.
Carson Block: Shorting Against Blue Pill Investing
How to protect yourself as a long investor
Age of Venality
Management
incentives are often short term
CEO's are largely charismatic
the more successful the CEO, often the less willing to be held accountable
Andrew Fastow (ENE) won CFO magazine award for excellence in 1999 (enron CFO)
Management is better seen, not heard
Reading call transcripts is better than listening to the calls
- read several quarters at a time to look for disappearing initiatives, changes in language
- are questions evaded?? which ones?
- are the questioners the same, if so, do they seem TOO close to mgmt
best to keep mgmt at a distance
watch out for monetizing management
Boards
symbiotic relationship with CEO's
insulated from negligence liability by BJR, insulated from other liability by D&O insruance
many directors view directorships as perquisites, not responsibilities
"Independent" investigations often shambolic
Lawyers represent the interest of their clients --the people who hire and pay them
Do not count on lawyer reports to uncover anything worthwhile
Auditors:
Auditors represent the interests of their clients
a profession fighting against accountability
level 3 fair value accounting is problematic
key audit work is done by juniors
auditors DO NOT detect fraud
Sell Side/I banks
analyst are not rewarded for skepticism
junior bankers do most of the due diligence
The company's pay for "market research"
Pretty much China is uninvestable --too much fraud and impossible to account for
No fraudster from china has ever been punished for defrauding N. American investors
How to avoid getting burned
Rackspace Hosting, Inc. (NYSE:RAX): investors lost in the word "cloud", Block was short the company
They are a plain old internet host...they are not a cloud company
Larry Ellison - the Cloud is not real! people just replaced the word internet, with cloud (2009 interview)
Sino-Forest Red flags (TRE)
too good to be true gross margins
FCF Negative every single year!!
New short
500.com Ltd (NYSE:WBAI) Chinese company
market cap 1.2b
p/e 37x
legally in a gray area
licensing framework is unclear
resolution is likely to bring competition and compress margins
MoF prohibits cross border sale of online sports lottery tickets
500.com Ltd (NYSE:WBAI) accounts for about 24% of Jiangxi's total lottery proceeds
piper jaffray estimates that online sales of lottery tickets are about 6% nationwide
WBAI reports positie income from lottery winnings
WBAI generated about $2m from lottery winnings
tax status is complex
12.6m of 2013 net income came from a tax benefit (72% of revs)
employee bank accounts used to collect winnings
employee takes winning lottery ticket to be claimed, the winnings are paid into the employee bank account, then transfers it to 500.com, then paid out to winner..... hmmmm??
claims 20m downloads of it app in LAST QUARTER (app stores show they don't even have 2m people download the app last qtr)
Muddy waters is short the stock.
UPDATE 9/10/2014 7:00AM EST The previous version of this article may have suggested that Carson is currently short RAX. Carson was in Jan 2013 but covered the short a long time ago as he thinks the company is now fairly valued now