RH has some weird loans

The latest Restoration Hardware 10-Q discloses 2 unusual loans.  The first loan is a $14M promissory note “secured by the Company’s aircraft”.

1. The collateralization of the loan is unusual.  I could not find FAA registration records that would suggest that there are any airplanes currently backing this loan.
2. Secondly, it’s unclear if the interest rate is attractive for the lender.  The statement of cash flows and contractual obligations in the Q2 2017 10-Q imply that the lender will receive $14.0M back ($0.117M plus $13.883M) by 2022 or later.  On the face of it, it seems that this loan has a term of over 4 years and a cash interest rate of 0% (!!).  Now perhaps I am wrong about the terms of this loan as the 10-Q does not disclose many details on the note (e.g. effective interest rate, non-cash components, etc.).
3. Similarly, there is a $20M “equipment security” note that also seems to have a cash interest rate of 0%.

It is a little weird that RH was able to find a party willing to lend money in such an unusual manner.

Unfortunately, I actually don’t know what’s going on… perhaps my readers can figure this one out.

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Defense contractors- a world full of politics, corruption, and incompetence

Arms manufacturers are capable of making weapons that help win wars- but surprisingly enough, their customers don’t care about that.  The root of the problem is with political leaders- their interests tend to lie in buying votes.  As well, the skillset of getting elected does not overlap with the skillset of choosing competent military leaders.

As a result, the world’s richest nations often purchase weapons without any realistic testing and later discover that they do not work.  The Patriot missile defence system likely did not shoot down any Scud missiles from Iraq.  Worse still, they likely increased overall casualties as stray Patriot interceptor missiles hit civilian apartments (see page 9 of “Evaluating Weapons: Sorting the Good from the Bad“).

From an investing perspective, the history of corruption is interesting as it stretches back for decades.  During the Vietnam war, the US Army’s ordinance bureau intentionally sabotaged the M16 rifle with ammunition that would cause the rifle to jam more frequently (see page 3).  Since then, abuses have continued despite exposure in mainstream media.  Chuck Spinney was on the cover of a 1983 TIME magazine; the 1998 TV movie Pentagon Wars explained issues with the Bradley Fighting Vehicle (clip).  This suggests to me that the corruption in the US is fairly resilient, entrenched, and will likely continue to grow at a slow pace.

The China hustle lives on

There are reasons as to why Chinese stocks on non-Chinese exchanges have been a problem in the past:

1. The VIE structure used for many China stocks is dubious.
2. China is an easily-marketable theme that attracted the pump and dump industry.
3. No repercussions for egregious accounting fraud.

Have investors learned their lesson?  Apparently not!  More Chinese stocks with VIE structures are being IPOed.  This is despite the VIE structure becoming even more dubious.  China Law Blog has an excellent post explaining why the VIE (should have) died on January 19, 2015.  Go read it.

Draft makes clear that the State Council understands how VIEs work and that their sole function is to evade the requirements of Chinese law. The Draft makes clear that such evasion is illegal and will be prohibited upon the effective date of the new investment law.

I hope that the investors who buy into the newly-minted Chinese VIEs lend their shares out.

Equifax: a quick accounting note on capitalizing expenses

It’s possible that Equifax is pulling on accounting levers to juice its earnings and the Adjusted EBITDA that it reports.  Capitalizing expenses (e.g. software development costs) creates profits now and losses later- it changes the timing of when expenses are recognized.

1. On the balance sheets, capitalized internal-use software grew from 212.5M to 307.0M (an increase of 44% per year, or 94.5M).  This area of accounting is subjective- should software development costs be amortized over 3 years, 10 years, or somewhere in between?  What expenses should be considered capex?  Should these expenses even be capitalized?- some software companies don’t capitalize software development costs at all.  The answers are not clearcut.  However, accounting distortions can occur if a company were to suddenly aggressively capitalize expenses that it previously expensed.
2. While capitalized internal-use software grew 94.5M, consolidated income before income taxes grew 91.6M in the same timeframe.  So it’s possible that Equifax’s growth is not as fast as it seems.

Pretium: the feasibility study is not playing out

(This is a follow-up to the post about Pretium’s disappointing grades.)

Pretium’s current production should exceed 13.1g/t, yet it has been 4.660g/t 5.1g/t so far.  (EDIT 11/22/2017: fixed the calculation, which came from this post.)

According to the latest feasibility study (filed June 30, 2014), Pretium should have a stockpile of 81kt of material grading 13.6g/t gold.  The feasibility study anticipated that this stockpile would be processed in years 2 and 3 of the mine’s production phase while higher grade material would be processed first.  This is because conventional mine engineering calls for maximizing the Net Present Value of the project by mining and processing the most profitable ores first (where possible).  So, current production should exceed the stockpile head grades of 13.6g/t.  If we assume recoveries of 96.6% on 13.6g/t gold, then we would expect a hypothetical 81kt stockpile of 13.6g/t gold to yield 13.1g/t.  Production results so far indicate grades of 4.660g/t 5.1g/t for June and July (after processing losses), well below the 13.1g/t level.

It seems inappropriate for Pretium to continue to cite its feasibility study in its investor presentations (they are all most of them are on Slideshare) when current production differs so materially from what the feasibility study anticipated.

Pretium: the additional underground exploration program management doesn’t like talking about

(To get up to speed on Pretium, you can refer to previous posts such as this and then this.)

In July 2013, Strathcona began voicing its concerns about Snowden’s resource model.  Sometime in the months after (likely as a reaction to Strathcona’s concerns), Pretium changed its underground exploration program to excavate additional material from the Cleopatra and 615L lateral veins (among other changes).  While there were press releases that mentioned the additional exploration in passing, those press releases did not disclose the reasoning behind the additional exploration.

Callidus Capital (CBL.TO) – Why is the borrow expensive?

(*Disclosure: I have no position in Callidus Capital.)

Callidus is currently suing West Face Capital (a hedge fund) and Veritas Investment Research (an independent research firm) for defamation… and I want no part in being sued.  So I will try to be neutral as I talk about my speculation as to why the borrow is expensive.  The first thing that comes to mind is the defamation lawsuit against Veritas, a firm that does not do activist shorting.  Some short sellers really pay attention when companies sue their critics- more so when the criticism was private rather than public.  I’m not saying that short sellers are necessarily right or wrong to bet against such companies- the counterexample would be Fairfax Financial (Fairfax’s stock has done quite well since launching its lawsuits).  But it is certainly something that (in my opinion) attracts short sellers.