The BCSC / Jon Carnes drama and its implications

A British Columbia Securities Commission (BCSC) panel dismissed fraud allegations against Jon Richard Carnes.

• The Globe and Mail (a Canadian newspaper) has an excellent in-depth article that gives “The full story of Jon Carnes, Silvercorp, and the BCSC“.
• You can read the actual decision at http://www.bcsc.bc.ca/Enforcement/Decisions/PDF/2015_BCSECCOM_187/ .  It’s interesting if you’re into short selling.
• I have tweeted about some of my thoughts on the decision over at @glennchanWordpr.

While Carnes theoretically won, the panel’s written decision was very biased against short sellers.  Firstly, the BCSC failed to realize that they went after the wrong people (this is a pattern that repeats through history with many regulators… it’s nothing new).  However, the panel did not see value in creating an environment where people can expose fraud without fear of repercussions and nasty legal bills from regulators.

More importantly, one of Carnes’ researchers (Huang Kun) was wrongfully imprisoned in a Chinese jail and suffered abuse while detained.  Money is one thing.  Having your human rights violated is another.  I believe that Carnes’ lawyer(s) presented newspaper articles that describe Kun’s story.  Exhibit EX00344 (a BCSC webpage lists the hundreds of exhibits filed) seems to be a Globe and Mail article that describes what happened to Huang Kun in China.  The panel’s written decision does not seem to mention Huang Kun at all.  His name does not appear in the decision anywhere.  I am very disturbed at what appears to be the panel white washing the abuses that have occurred.

Advertisements

Figuring out the skill of mining CEOs

In my opinion, the best method for a CEO to make shareholders richer is to be good at wheeling and dealing.  CEOs like Brian Dalton and Kevin Mcarthur (Tahoe and ex-Goldcorp CEO) are very good at valuing assets and structuring deals.  These CEOs are good at shuffling paper around and making deals in a way that more wealth accrues to their shareholders.  They look for undervalued assets and sell shares/assets when they are overpriced.

Misadventures in reading a financial statement / absorption costing

When reading financial statements, I pay particular attention to costs that have been capitalized.  Capitalizing costs boosts income in the short-term and is often a sign of aggressive accounting.  I often use the shortcut “Crtl + F” to search for instances of capitalized costs in an annual report.  However, it turns out that I don’t understand accounting rules such as absorption costing for inventory.  Under US GAAP, Canadian GAAP, and IFRS… absorption costing is the only method allowed for valuing inventory.  Companies must capitalize fixed manufacturing overhead (e.g. rent) into inventory.  I wrongly assumed that footnotes describing this practice was a sign of unusually aggressive accounting (it isn’t).

On Tuesday, I attended a stock picking competition where 3 teams of MBA students (the finalists) analyzed an obscure and illiquid Canadian company called Buhler Industries (BUI.TO).  It is from skimming through Buhler’s annual report (page 16 of the annual financial statements on SEDAR) that I erroneously thought that Buhler may have been inappropriately capitalizing overhead costs into inventory.  From talking to others, it turns out that I’m not the only person who didn’t understand that Buhler management was simply following the rules.  I suppose the lesson here is that there are so many unintuitive and/or complex accounting rules that most investors are not aware of all of them.

Egregious accounting fraud in retail

I’ve been thinking a lot about how somebody could commit fraud in retail.  In my opinion, accounting fraud in retail is a bad idea.  Fraudsters cannot both (A) avoid jail and (B) inflate earnings by a meaningful amount or otherwise significantly mislead investors.  Smart fraudsters gravitate towards mining, oil & gas, pharma, etc.

While fraud is a bad idea in retail, some fraudsters are crazy enough to commit fraud even if there is significant risk of jail time.  I think some people are biologically wired to steal and cheat even if it doesn’t make sense.

For investors, detecting accounting fraud in a retailer may be extremely difficult.  I have not figured out reliable methods of independently verifying a retailer’s numbers.

Google Trends

Google Trends may be an interesting tool for investors.

1. It allows investors to gather data on a company that’s fresher than the last quarter’s earnings release.  This can be helpful in turnaround situations such as Aeropostale (ARO) and Cafepress (PRSS).
2. Having leading earnings indicators can be helpful for manufacturing companies (e.g. RGR, SWHC) where there is not much data on consumer demand due to fluctuating inventory at the retail and distributor level.
3. In rare cases where fraud is suspected, Google Trends may provide some indications about actual revenues.

Here is an example of Google Trends in action:

Enterprise storage will become more commoditized (EMC, NTAP, VMEM)

History has a pattern of mass-market products eventually decimating low-volume high-end products.  The cost savings from economies of scale overpower the benefits of specialized solutions.  This has happened to word processing (e.g. Wang Labs), mainframes, high-end CPUs (SGI versus Intel), post production systems (ADSK, ADBE, AVID, etc.), film/video cameras, and many other industries.

Back in Dec 2012, I wrote a post on enterprise storage.  Now, I’m starting to be more confident that enterprise storage will indeed become increasingly commoditized.

Data Centers – Part 5 – Accounting + cost of capital

Summary:

• Making overly optimistic projections about the estimated useful lives of computer equipment can be used to inflate profits.
• Data center stocks with a very high cost of capital should be avoided.