Research

HAILIANG EDUCATION

SELL: Bad teacher?

Gillem Tulloch · 18 October 2018

In the best-case scenario, Hailiang Education (HLG US) is a financing vehicle for its parent company, with cash being siphoned into related parties. In the worst-case, it’s a fraud; and there’s a substantial body of evidence, although circumstantial, to support this: Its financials have similar traits to past frauds, such as unnecessary capital increases and a failure pay dividends; the replacement of a Big Four auditing firm with an obscure auditor; numerous concerns raised by auditors; three CFOs in two years; allegations of underhand dealings with ASA Resource; public listings possibly orchestrated to avoid proper scrutiny; and finally, a shambolic…
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A&G SCREEN UPDATE

And lessons learned from Folli Follie

Gillem Tulloch · 1 October 2018

The newly released forensic report on Greek jewellery retailer Folli Follie concludes that it was making up 90% of its sales in China. Our Accounting & Governance Screen suggests that the company had been faking sales since FY09, hiding the evidence in receivables, inventories, prepayments and cash. In reality, the company had been loss-making for close to a decade. Fortunately, only a dozen or so European companies have similar traits, which we detail within. The A&G Screen has expired and you must login and download the latest version if you wish to check your portfolio or search for companies with…
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IN-BRIEF: HAIDILAO (6862 HK)

Watch the relations

Nigel Stevenson · 28 September 2018

Half of Haidilao’s raw materials are bought from related parties, accounting for 25% of total operating expenses. This recently listed hot pot restaurant chain has a seemingly compelling investment story but there is huge scope to shift profits around the wider group. One of these related party suppliers, Yihai (1579 HK), reports that half its revenues come from Haidilao. Unfortunately, Yihai has similar traits to past frauds which could make it a short-seller target. This might undermine confidence towards the entire group. Instead of accumulating cash on its balance sheet like a fraud, Yihai needs to start investing, or increase…
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IN-BRIEF: CHINESE SPORTSWEAR

Another one bites the dust

Gillem Tulloch · 13 September 2018

Yet another sportswear company has blown up. In June, Hosa’s share price mysteriously collapsed 90% in a day. It has since been targeted by a short-seller, delayed its dividend, failed to submit interim financials and is now suspended. Hosa’s financials have similar traits to the nine previous frauds highlighted in our recent report on the Chinese sportswear sector, lending credibility to our argument that companies faking their sales have a unique set of financial characteristics. Furthermore, background research shows that many of Hosa’s management had links to companies embroiled in past scandals. We have devised a slightly more generic scan…
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IN-BRIEF: COMPLICIT AUDITORS

PWC gives Sunac and R&F a free pass

Nigel Stevenson · 29 August 2018

Imagine if fund managers could immediately revalue new investments to what they considered fair value. It would make a mockery of the industry and be considered unethical. In RARE circumstances, such as a forced sale, accounting rules allow buyers to book an immediate gain on the revaluation of acquired assets. Unfortunately, highly indebted Hong Kong audited companies are using this loophole to inflate their profits and equity. PWC has set the benchmark by allowing Sunac and R&F Properties to push through questionable revaluations of acquired assets. Incidentally, embattled commodities trader, Noble Group used similar gains on acquisitions to pad its…
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A&G MASTER SCREEN

New Product Launch

Gillem Tulloch · 23 August 2018

We’re pleased to launch our Accounting & Governance (A&G) Master Screen, a major new addition to our product line-up. This enables users to evaluate portfolio accounting risk, and to search for companies with specific accounting traits. A significant development is the introduction of positive accounting flags, as opposed to negative ones. This will, hopefully, help users find companies with desirable accounting traits, not just problematic ones. The screen has been pre-loaded with over 10,000 companies globallly, based on the latest year-end scores from six of our accounting modules, including Profit Manipulation (Beneish and Montier), Fake Cash Flow, Excess Capital, Acquisition Accounting and Debt…
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IN-BRIEF: GDS (GDS US)

SELL: Too bad to fake

Mark Webb · 15 August 2018

GDS was targeted by short-seller Blue Orca in a report published on 31st July, prompting a 47% share price decline. We find the claims regarding revenue and profit manipulation weak. After all, who would fake something that looks this bad? As for the allegations concerning overpriced acquisitions and undisclosed related parties, they have not been adequately addressed by management. Meanwhile, the practice of holding surplus cash offshore is not uncommon although it is undermining profitability. Our A&G Screen suggests that the company has likely manufactured operating cash flows and under-stated capex in order to present the most favourable cash flow…
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IN-BRIEF: PINDUODUO

Distorted metrics undermine premium valuation

Nigel Stevenson · 3 August 2018

Online market place Pinduoduo (PDD US) appears to have employed questionable accounting in order to engineer a successful IPO. Sales and gross profits may have been inflated by failing to properly account for coupon costs, while profits and cash flows have been flattered through the accounting treatment of a co-operation agreement with Tencent. Important metrics such as GMV might also be misleading given inconsistencies in reported numbers. We are unable to get a proper understanding of the business and financials owing to poor disclosure within its prospectus. The company is a US foreign listing which could lead to limited corporate…
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IN-BRIEF: CHINA TOWER

AVOID: Financially engineered

Nigel Stevenson · 30 July 2018

We struggle to summon enthusiasm for the upcoming IPO of China Tower which appears financially engineered to exploit minority investors. The core problem is the conflicted position of the three Chinese telcos which will remain its controlling shareholders and only customers. Indeed, rental rates were cut just prior to the IPO, partially offset by a reduction in depreciation. Long-term pricing will be what the telcos decide to pay, while future capex may be higher than expected. Another major concern is China Tower’s exceptionally low profitability with returns on capital of about 2% well below its cost of capital, and we…
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CHINA EVERBRIGH INT

SELL: Paper Profits

Mark Webb · 5 July 2018

China Everbright Intl Ltd (CEIL) has one of the worst track records in Asia for cashflow generation relative to profit. CEIL gains this dubious distinction because it applies accounting rules for its service concessions in a manner that accelerates profit recognition relative to cashflow. Limited disclosure means investors may be unaware of CEIL’s lacklustre cash profit performance. If we strip out our estimate of front-loaded earnings, 2017 profit falls 61%, its PE rises to 36x and its ROIC is only 6%. Our target price of HK$5.40 is based on 2x adjusted book value and gives 50% downside. SELL. GET PDF…
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