Thursday, November 22, 2012


After one of the most high profile saga, which is still ongoing - our favourite Tiger Beer / Ice Mountain love triangle and breakup, we have yet another major story hitting the Singapore stock market. Isn't 2012 exciting? Only this time, it's not a love story, and is looking more like a tragedy!

Olam International, an integrated global agricultural commodities player listed in Singapore has been slammed by short selling research house Muddy Waters. The stock crashed 10+% but only to recover most of the gains after Olam's outspoken CEO Sunny Verghese halted stock trading and hosted two conference calls to quash Muddy Waters' claims.

Now this is where it gets interesting. Muddy Waters issued a strongly worded letter to Sunny and Olam's Board of Director mocking them for not doing the right things.

Here's an excerpt:
Olam’s disproportionate reaction is extraordinary in our experience. Should Olam come to collapse (as we believe it will), its use of much-needed cash to buy back shares at this time should give rise to questions about whether fiduciary responsibilities have been breached.

This disproportionate reaction was with reference to Olam's trading halt and conference calls after Muddy Waters' criticism. Yes, Olam said they would buy back shares when they do not even generate cash and has SGD 8bn in debt, an amount more than twice its shareholders' equity, which a significant portion itself was raised from the equity markets. You see, Olam's business never actually generated much cash since it got listed. It kept asking for more money to keep going. No wonder Muddy took note and he was not the first. Some CLSA analyst raised alarm bells 2 years ago.

Here's another interesting part:
You and your investors should note that attempting to silence critics is not a plan of corrective action. In no way does it make Olam stronger... Companies that attack criticism the way Olam does fail to understand that raising money from the public is a privilege. Because Olam has received significant investment from the government of Singapore (this blogger's note - OUCH!), Olam’s mismanagement of the public trust is that much less forgivable.

This really reminds me of David Einhorn's seven year battle with Allied Capital, a complex finance company that operated a sham business but was only brought to the brink of bankruptcy by the sub-prime crisis. Einhorn shorted the stock for seven years to prove he was right amidst threat of lawsuits, getting his phone tapped and constant ridicule by Allied's management.  In an almost identical plot development, Olam is now suing Muddy Waters for defamation.

Well you can argue that suing is the appropriate course of action. After all, our Ministers sue when people mis-represent the truth about them. When truth is mis-represented, you have to set things right. The key is: when truth is mis-represented. So what's the truth? Is Olam a great commodities supply chain manager or Alamak! (Gosh!), Olam's a sham?

To understand shams, we look at past shams such as Enron, Autonomy, Olympus etc. Below are three things that keep popping up in shams:

1. It's VERY complex. To make money, the business model must be complicated.
2. The accounting is creative. Not illegal per se but controversial.
3. There are a lot of big transactions. M&As, affiliated buys and sells, asset injections, you name it.

Unfortunately, Olam hits all 3 counts. It's complicated. Olam claims that it operates in over 60 countries handling 20 commodities including cashew nuts, cocoa and coffee, just to name a few. It also claims that its business model enables it to extract value from selective integration and from its capable midstream supply chain management to bring commodities from seed to shelf.

Hmm, so it's an integration, but we have to be selective, must differentiate (dy/dx) to integrate ( ∫ ) - math lovers note the pun. And midstream supply chain know-how to bring seeds to shelf, so... how... I mean what does it mean? Integrated but midstream supply chain? But can do from seeds to shelf? Sounds like a mid-river mudfish that can jump better than carps and swim faster than sharks. I guess oxymoronic business models do perhaps add value if you incorporate them into Shakespeare's tragedies. Parting is such sweet sorrow, let me selectively love you wholeheartedly, my dear Juliet.

It's complicated. So was Enron. That was a real grand complication, like those in Patek Philippe watches. Enron was buying and selling energy via a myriad of transactions, sometimes to itself and making money out of it. People who don't understand are stupid, simply couldn't get it and do not deserve to ask questions.

Enron was also "good" with its accounting. In fact it was the best. It was booking upfront revenue for contractual agreements of energy purchase that are supposed to come over 20 years. Btw this was an accepted accounting practice back then. Its auditor, Arthur Andersen approved it! Of course, Arthur Andersen died, holding hands with Enron till the end.

Now, Olam has "biological gains" which refer to profits coming from valuation gains of its assets such as livestocks and plantations as they grow up and start to produce milk, oil, whatever, which the owner can then sell, some years down the road. So our beloved Government (not forgetting the Capital G) was forthright sincere in their plea to encourage emotionless Singaporeans to make more babies. It's for biological gains and for our own good. That explains their big investment in Olam as well.

Emotionless Singaporeans

To clarify, biologic gains is an accepted accounting practice. Olam did not break any rules. Other companies use that too, like Wilmar, another commodities play listed on SGX (Singapore Stock Exchange), where a bunch of sham Chinese co.s also got listed.

So that's the innovative accounting part.

On transactions, we must first understand that to grow big you need to do deals. Reputable companies such as IBM and P&G grow to become global leaders by buying complementary businesses, growth companies and even competitors. Scale is everything. Olam is pursuing a golden strategy. Muddy waters, pls go do some filtration!

In the past few years, Olam bought 20 companies or more with USD 1+bn, the largest two being Timbercorp, an almond producer, for USD 200+m and Gilroy Foods, a vegetable producer, for USD 250m. It is also building a huge fertilizer plant for close to a billon dollars in Africa. Bear in mind that this was a mid size company with only a few hundred million in equity at that time. Why such bold moves?

As the saying goes, no venture no gain and so the Board and CEO Sunny thinks Olam (and himself) can "show hand" and pull this off. And their investors will fully back them. I guess prudent risk-taking is not in Olam's dictionary of oxymorons.

No disrespect to Mr Sunny, but it is really hard to bet that this firm of 18,000 staff have enough talent and expertise to execute 20 M&As and multiple mega projects flawlessly. IBM, a firm with 400,000 staff makes somewhat the same no. of acquisitions and projects (somewhat over the same time frame) and is trying real hard to squeeze out synergies.

Well, we have yet to see Olam touting the synergies gained. But I must say that its small SGD 100+m of goodwill for all these buying might be evidence that Olam did not overpay all that much, though there were accusations of too many bookings of negative goodwill.

But with mega and multiple deals, eyebrows are always raised. Frauds usually have to have the deal/transaction element. The Japanese medical device and camera company Olympus comes to mind. Olympus had been cooking its books for years and kept doing shady deals to hide losses. The last deal, its USD 2bn acquisition of Gyrus, another medical device company, which was supposed to pull it all off and cover all tracks, was so big that it finally blew in the fraudsters' faces. But they just might pulled it off if not for Michael Woodford, the British CEO turned whistle-blower.

In this light, Olam's big deals do cast doubts. Does it really cost a billion to build a fertilizer plant in Africa? Why another $600m of buying up biscuit makers and sugar mills after buying 20 companies. Shouldn't we pause for digestion? Even Jabba the Hutt sleeps a day or two without eating right?

Having said all that, we must be cognizant that Muddy Waters had its misses. It got one big hit with Sino-Forest but that's about it. There was Focus Media, the elevator TV maker, that it got wrong. Focus Media was no sham and is now privatized bcos the money's too good to share with other shareholders. Not to mention New Oriental Education, the Chinese test prep course trainer. The stock plunged 60% after Muddy says short and is now almost back to where it was. There is no shorting for seven years to make a point and tell the truth like Einhorn. Maybe for Muddy, the whole point was only to market the sell recommendation as loud as possible and make some cheap money. Then that's not so honourable.

So the verdict is not out. Olam may not be Olamak. Though I have to say Olam probably won't make it to my list of recommended stocks or most value investors' lists, for that matter. Huge debt, perennial negative free cashflow, multiple equity financing and an un-understandable business model. Sorry, not my cup of tea. It may or may not be a sham, we won't know until we know, but it is definitely not a value stock.

Wednesday, November 14, 2012

And Patek

After Rolex, we have to talk about the world's most coveted watch brand: Patek Philippe. Or just PP or Patek in short. Meanwhile for those who are here for the first time, this is actually part of a bigger analysis on Swatch. Do read from the first post.

Patek Philippe belongs to the few exquisite Swiss watch brands in the world of high horology, which is a chim (difficult) word for timekeeping. To borrow an avid watch lover blogger's words (again): some of these brands in the uppermost echelon of the watch world are spoken with hushed reverence. In my interpretation, it probably means they exist solely to perfect the art of watchmaking and nothing else.

This is a ranking of the top super luxury brands that I found randomly using Google:

1. Patek Philippe
2. Blancpain
3. Vacheron Constantin
4. Breguet
5. Audemars Piguet
6. A.Lange & Sohne

What is meant by perfecting the art of watchmaking? Well, some of these watches are designed with multiple grand complications (very difficult movements) such as the perpetual calendar (a watch that can tell the date, day accurately for 100 years, taking into account of leap years), the minute repeater (a watch that can tell you the exact time by chimes) and the chronograph (a mechanical stop watch, which doesn't really meet the grand complication hurdle but never mind), just to name a few.

The more complications, the more difficult it is to design a mechanical watch. Brands like Patek Philippe, Vacheron Constantin (VC) or Audemars Piguet (AP) take pride in their ability to design and integrate complications into their watches. Whereas Rolex appeal to the masses and the mass affluent with stories of human triumph, simple and useful innovation and popular conspicuous designs, these super luxury brands impress with their wilfulness in achieving perfection.

For most Earthlings, it doesn't really matter if a watch can keep a perfect calendar for the next century taking into account leap years or chime 11:59 PM soothingly but for these top echelon brands, this is their pursue of excellence. It's not about usefulness or utility, it's about creating impeccable masterpieces. Obviously there are people who do appreciate and are willing to pay for such works of art, mostly UHNWIs or Ultra High Net Worth SIngaporeans who also happen to like to buy overpriced shoebox apartments.

As with other artform, there are a few attributes that are common amongst these brands such as a long history (Vacheron Constantin was established a quarter millenium ago), rarity - every model is produced in very limited quantities, usually only a few hundred, and originality - most of these brands do not import any movements or components but take pride in producing almost every component in-house. As such, some of these upper echelon brands have actually been "downgraded" as they now belong to bigger groups (Blancpain and Breguet are owned by Swatch Group) and hence are deemed to have lost that original touch. Although this doesn't seem to apply to the said Vacheron Constantin, which is now owned by Richemont.

But why does Patek stands out above the rest? Shouldn't those that are still independent (basically PP, AP) be as good? I would attribute Patek's success to three reasons:

a. Marketing
b. Ingenuity
c. Luck

Without a doubt, Patek is one of the most powerful marketing machine mankind has ever seen. With taglines such as, "Begin your own tradition" and "You never actually owned a Patek Philippe, you merely look after it for the next generation" etc, you have to give it to them. Like we discussed in a previous post on property, how do you put a price to a family heirloom? It's supposed to be priceless!

Building on this, Patek goes out to hire famous fathers and sons to appear in their commercials, further enhancing the marketing effect. Not to mention, the controlling Stern family own father and son are true to life examples of its own marketing belief. Hence all the more people buy their stories and their watches!

But, Patek's marketing is more ingenious than that. It is believed that the firm intricately strategizes its launches and production of models such that their rare watches will do well in auctions. They make only 200+ models and 50,000 watches every year ie on average, some models can have only 250 pieces in existence! Although most popular models should go into thousands of pieces. PP is also known for its sudden announcement of production cuts for popular models such that these models will then subsequently fetch exorbitant prices in auctions.

Furthermore it has its own museum which participates in auctions to re-acquire their old watches, brush up their stories and re-market to the world, again enhancing the inspiring tales of their traditions. Its own museum had also successfully created some record prices in the past.

No other brands come close to what Patek has done with its marketing and its auction strategies. Of course, this has invited speculators as well as the criticism of honest watch lovers, some of whom then tend to favour others that remained true to just making really, really good watches.

That is not to say Patek is inferior in technology. Amongst the trinity as it is known in the watch world (Patek Philippe, Vacheron Constantin and Audemars Piguet - PP, VC and AP), Patek is still the one that has best history of innovation (though far less than Rolex, a lower ranking brand in this aspect). The most important being the perpetual calendar, which PP invented. Its minute repeater is also perhaps the most intriguing and produces the nicest chimes which contributed to its popularity.

Success = Luck + Perseverance

Patek has persevered in its marketing and ingenuity since 1851, capable employees in the firm making things happen, esp so in the last 30 years. The last piece of the puzzle I believe is simply Lady Luck smiling. With the Queen of England publicly expressing fondness for Patek and the Popes of the past owning Patek's timepieces and the famous story of Henry Graves winning the bet on making the world's most complicated watch which was commissioned to PP, luck has undoubtedly also played a role in Patek Philippe's ascent to the No.1 coveted brand in Swiss watches.

Saturday, November 03, 2012

Of Rolex

I supposed a full analysis of Swatch and the Swiss watch industry would never be complete without talking about the two most prestigious brands: Rolex and Patek Philippe. Hence this post and the next are here to fill the gap. Interested readers can start from the first post on Swatch.

Rolex is undoubtedly the most renowned brand in world of watches. In fact it's so popular that most youngsters today would eschew Rolex, believing that it's over exposed, too loud or simply too common. Some would even think that it has degraded to an "Uncle Brand". Only uncles who want to show off would buy that gold Rolex watch that is easily recognizable and the perfect way to brag about the wealth that they actually do not possess.
The Rolex logo and the model Uncles like

I read at another blog where an avid watch lover blogger aptly wrote that when people see his Rolex, there would be almost as many who would go, "Eeee, another Rolex, this guy is all about showing off." versus "Wow, cool, it's a Rolex GMT Master II!".

To understand the story of Rolex, we need to study its history (trust me, it's fascinating) and its founder. Btw, the Rolex wiki also has a good short writeup for those who want the full story.

It is worth noting that major Rolex innovations and events stopped some 50 years ago but what has transpired before that is so profound that it lasted half a century and hence till this day, Rolex is still the No.1 watch brand selling almost a million pieces per year (to be exact, experts estimate 800,000) and Rolex has a revenue of USD 6 billion, an almost 20% market share in the luxury watch market. On average, each Rolex sells for USD 7,000+.

Rolex today remains unlisted and is owned by a foundation with part of its profits going to charity. Its financials are not public and much of what the company does remains illusive to analysis. What we do know is its illustrious history.

Rolex SA was founded by Hans Wilsdorf in 1905, with a dream to make the best reliable watches for people and for those in important and noble but sometimes dangerous professions. As a result of his passion, ingenuity and a lot of business mind, Rolex has a good list of world's firsts, including the world's first waterproof watch, first automatically changing date (apparently in the past, you have to change the date yourself, every day!), first watch to show 2 time zone (GMT) and first to show both day and date. All movements were practical and yet with displays of ingenuity. Needless to say though, they were also made in-house, a trait that serious watchmakers took serious pride in having. Sadly, its innovations ended when Hans died in 1960.

But what's more fascinating about Rolex is its participation in significant events of human triumph. Such as being the watch that was wore on the first conquest of Mt Everest or the watch that went to the deepest dive in Mariana Trench some 10,000 metres deep. Still working, of course at the extremes of our beloved planet. (Well... Omega went to the moon, hence this blogger recommends Swatch which owns Omega :) It was also the preferred watch for soldiers and pilots during the WWII which were, unfortunately, confiscated by the Nazis.

Its enduring effort to help others with innovation and pure simple generosity is another hallmark of its legacy. For the POWs who lost their watches to the Nazis, Hans made sure that the soldiers received a free watch as long as they wrote a letter to Rolex. Then in the 1950s, when pilots needed to fly transcontinental, Rolex developed the GMT watch for PanAm so as to help the pilots and crew cope with jet lag and communications back home.

For workers working in environments that caused interference with mechanical watches (engineers in power plants, doctors using MRI etc), Rolex developed the Milgauss that is anti-magnetic. As for sea-farers, mountain climbers, racers, trekkers and explorers, Rolex have dedicated models to them and some of these are also the best selling and are the best retainers of value.

The Rolex Milgauss

It is hard for us to fathom today, but during those times some 50 years ago, an accurate watch was very important not just for professionals but also for normal folks. There were stories of train crashes because the operator's watch wasn't working well. Hans understood this need for accurate timekeeping for everyone, especially for some who cannot afford Rolex. So he created a second line called Tudor, which uses ETA/Swatch movements so that others can afford them. Today Tudor is seen as 2nd class and hence almost fading into oblivion, but I see the decision back then as a noble one of empowering the working class. One that is close to the heart of Hans and Rolex's legacy.

With all these strong powerful emotive stories behind Rolex, is it a wonder it grew to become the most well-loved watch brand globally? Of course, most aunties and uncles probably don't know the stories of trials and tribulations behind the Rolex brand. They just buy to show off, or they buy it as a store of value, knowing that it will be worth at least 70-80% of their purchase price should they need to pawn it some day. Actually most Rolex watches if held long enough (like more than 10 years) sells for more than its purchase price.

For aspiring watch lovers who bothered and researched about the world of watchmaking, they would usually go full circle with this love-hate Rolex relationship, just like many others before them. We hate it for its conspicuous ubiquitousity but grow to love it for what it stands for and what it is worth.

That's the story of Rolex.