John Hempton had a great run-through of China Fire & Security’s 10-k, after they announced an MBO led by Bain Capital. I think he highlighted a number of dubious numbers in the firm’s accounts, but I had some comments which neither he nor other commentors appeared to explicitly mention, so I thought it was worth posting here. To summarize, it appears as if Bain has announced a buyout of a firm whose accounts raise several unpleasant questions for any investor. You should read the article (1st link above) before continuing, otherwise this will all sound like total jibberish.
1. I was also curious about the seemingly ridiculous allowance for doubtful accounts as a % of AR. I can think of a number of reasons this should raise eyebrows, to put it nicely. At worst, some portion of these credit sales may be entirely made-up. At best, the firm is either doing ineffective credit profiling of its customers, or simply doesn’t care. Both scenarios and everything in between are deeply troubling.
2. I haven’t dug through their filings in much depth at all, but perhaps the company isn’t actually a manufacturer – in the traditional sense of the word – at all. Rather, they’re more of what we’d call a systems integrator; they buy individual components from a variety of actual manufacturers (or worse, wholesalers) and assemble them into the fire detection/suppression systems the filings describe. I think this would partially explain the unbelievably small PP&E/machinery balance in the accounts, as with cheap labor mentioned in another comment, the only expensive equipment they’d really need would be for testing. I can’t prove this is the case, of course, and even if it is, the company’s business description is really pushing the envelope in terms of accuracy and truth…
3. Revenue growth rates seem a bit odd, even for a (quasi-)industrial company, no, especially relative to ballooning SG&A expenses?
4. How come no one has mentioned (explicitly) the possibility that management isn’t interested in selling their shares to Bain because they’ve enriched themselves in other ways? Is it not possible that management has falsified bank statements and other audit documents, with or without their questionable auditor’s blessing? Not saying its happened (slash is happening), but given the other questions raised, it doesn’t seem like a major leap to believe their accounts are intentionally inaccurate.
I’m not sure the degree of his sarcasm, but as far as I can tell its certainly present in some non-zero quantity when he says that Bain, Barcap, BoA, and the rest of the lawyers/financiers working on the deal surely must know many things he (and I) clearly do not if they’re closing this deal given these myriad questions relating to the firm’s accounts. Perhaps they do, and they will be handsomely rewarded when they improve the firm’s operations and cash-out a few years down the road. On the other hand, perhaps the extent of their due diligence was pre-announced site visits and meetings with management, and they’re about to be the next big name investor to be made a fool of by scumbag Chinese “businessmen.” In the grand scheme of things, Bain’s downside is probably no more than mid 8 figures at most, a relatively small amount of their China fund which will hopefully be offset several times over by other investments. The reputational damage may be worse, but it does not yet seem any large investors have had any trouble raising/retaining assets after losses from mangled Chinese investments, so the jury is still out on that front.