Muddy Water's Carson Block: Forget Shorting China, Government Protects Frauds
Carson Block, founder of Muddy Waters Research, spoke with Bloomberg Television's Stephanie Ruhle and Tom Keene on "Market Makers" today about his report on Olam International and said that he's lost interest in betting against Chinese stocks.
Block, who compared Olam to Enron, said, "China has gotten harder in the sense that the government has really taken the side of the frauds. The government is working with a number of these companies to try to conceal records that are public. When you are up against that sort of strength of the ability to revise history, it becomes very difficult."
Highlights of the interview are below, courtesy of Bloomberg Television. The video can be seen here.
Block on whether there are less opportunities in China right now:
"China has gotten harder in the sense that as we have communicated a little bit with the media in the past, the government has really taken the side of the frauds. The government is working with a number of these companies to try to conceal records that are public. In some cases, we think revise them. When you are up against that sort of strength of the ability to revise history, it becomes very difficult. That is one of the reasons we're not that interested in China anymore."
On his allegations against Olam:
"Olam has morphed its business from just being a standard ag commodity trader into investing upstream and production assets as well as midstream and downstream, so that's processing and distribution. The problem is, it has been burning cash the entire time it has been public almost. It has not been free cash flow positive since fiscal 2006. What the company tells investors is that these investments that it's making in these upstream, midstream, downstream assets, there is a gestation period and that these will have high ROIs. We looked very closely at a number of capital projects that the company has embarked on and we found that many of them are performing very poorly. The company has seemed to mislead investors about the state in which the number of these projects are in."
On whether Olam's problems are due to a bad business plan or bad accounting:
"It is certainly at least both. Business planning and business execution is generally very poor with Olam. On the accounting side, and this company has an amazing track record with accounting, between fiscal 2006 and 2010, a tremendous number of revisions in its accounting statements between its Q4 annual statements and the audited statements. It is important to note that in Singapore companies publish Q4 statements. Even subsequent to 2010, when you move into 2011, it has had some issues. We look at these accounts and we think, at best, the accounting departments or accounting functions are incompetent."
On comparing Olam to Enron:
"The comparison to Enron, let's be clear. Enron stands for a lot of things. Maybe you could say that Enron in a lot of ways failed because it was legal fraud. In other words, not so much the criminal actions with the off balance sheet debt, but the way that they used accounting gimmicks that were legal to book future income in the present. The problem with doing that, which Olam makes ample use of that as well--in fact, the noncash accounting games that it has taken over the past three fiscal years, equate to about 40% of reported net income over that time. The problem is, if you buy an asset today and to build a model and then book all of the estimated future income today, next year when you go to report, you will have a bad comparison and what might you do? You might go out and buy another asset for the sake of buying another asset."
On whether he's heard from Olam's major shareholders:
"So far I've not had any notes. Our business model is speaking truth to power. There is a lot of power here. It is a little bit scary to be looking at a sovereign and saying you have made a sizable investment in a company that is not actually what it seems to be. We're happy to have a dialogue with Temasek, Cap Guardian, major shareholders. But so far, we have not."
On whether investors didn't do their homework:
"I would not say that. It is extremely difficult to look at this company. It operates in 65 countries. Our business model enables us to focus on a company for months at a time, to do nothing but look at the company. The amount of time and resources we have devoted to looking at Olam is something you cannot expect an investor with a diversified portfolio to do."
On whether he's worried about liability issues:
"We prepare every report as though we are going to litigate it and as though we are going to speak with regulators about the report. I am not trying to sound overly confident, but we anticipate that. If we have to defend it in court and then we will defend it in court. It is the nature of the game."
On when the report on Olam was released to hedge fund clients:
"It gets reported. There is a lot of speculation that we have hedge fund clients. The money that is involved in these trades belongs to people who researched the names. We don't call around and sell these reports. Everybody is involved in the research."
On why he advocates short selling:
"There are several important reasons why short selling is good. We are really one of the most important checks in the marketplace on bad companies, especially those that are misleading investors or outright committing fraud. We have economic incentive to investigate what it is that they are doing, especially when you have companies that are perpetually raising capital from the market and doing so in ways where investors don't understand the true state of these companies, you need short sellers to point these out. You can look at Enron. Jim Chanos was very involved there. That's a big part of why the story got out."
On whether his relationship with Michael Steinhardt and whether Muddy Waters will start looking like a hedge fund: "I need to clarify that. I met Mr. Steinhardt a few months ago--first time I ever met him. It was a big thrill to meet somebody like that. It was a very interesting conversation. He talked with me about how difficult short selling is. You can be right, but still lose money. Might we look more like a hedge fund? I think in a way we are a group of people who pool their capital generally. We kind of operate in a sense like a private fund. In terms of taking outside capital, we have no plans for it. Every now and then we discuss that possibility, but to be honest, I do not think we can continue communicating with the market our short ideas the way we do now if we took outside capital."
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