Tag Archives: China

KPMG on Luxury Market in China (2010)

30 Jul

This is the most recent version of an older version of this report I read recently.  Implications are huge here for many firms, think Tiffany, Coach, LVMH, Ralph Lauren, and the list goes on and on.  Worth a read for anyone who covers luxury retail names and wants to know whats really going on in China.


Scribd sucks (as I’ve said since it started), so I’m just uploading the pdf directly here. Sorry for the confusion


The Best Laid Plans of Mice & Men: YOKU Summary Thesis Update

28 Jul

A friend sent me an email about YOKU because he’d read my previous work, and I set out to respond quickly and concisely.  However long and about 1,200 words later, I realized I’d inadvertently (basically) summarized my outlook on YOKU in a kind of stream-of-consciousness style.  With the caveat that this is neither my full nor formal analysis, I’ve decided to publish my response to that email for those of you interested in my take on YOKU.

With all that being said, here goes:

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A Chinese Reverse Merger “Fraud” CEO Speaks

13 Jul

Among the almost countless reasons investors should be wary of investing in taste of the moment or “hot” Chinese stocks, we may now have solid confirmation of a new one: a complete and utter lack of personal responsibility/accountability of/by those running these firms.  This flies in the face of the many critics and short sellers who loudly proclaim the majority of these firms are merely examples of management getting rich while the shareholders get poor.

In an article translated into English, “The president of a delisted high-tech firm in northern China, who prefers to remain anonymous, has shared his views of the whole process of being listed and delisted.  The president claims his company was dragged into the listing process and naively trusted a host of exploitative government officials, bankers, and auditors, only to be torn apart later.”

As far as I can tell, the anonymous executive is none other than Mr. Zou Dejun, CEO of alleged fraud Rino International, at least from similarities mentioned in the article to RINO’s regulatory filings.
Remember, this is the firm whose auditors (questionable firm, Fraser Frost) resigned for lack of reliance in mangement’s representations, and whose stock was de-listed by the NASDAQ in April.

I have not followed RINO’s plight in enough detail to comment on the fraud allegations and/or “proof” offered-up by the likes of Muddy Waters, however, from this executive’s account, there is a far more fundamental concern.  The executive assigns blame for his firm’s misfortunes to literally everyone except himself: auditors, investor relations firms, China and US-based “capital markets” firms, Chinese politicians, his own employees, really everyone EXCEPT himself.

To be sure, a reluctant CEO unprepared and uneducated in matters that come with the title is an unenviable position in which to find one’s self, but there are numerous and extraordinarily simple ways of dealing, for instance, resigning, or better, doing your job and putting your foot down when outsiders try to tell you how to run your firm.  I don’t buy for a second that cultural issues such as pride and honor are acceptable reasons for failure to do so.  This is true in every country – sure to varying degrees – but no CEO anywhere on the planet wants to admit he needs help or can’t handle the task with which he is faced.  Nor do I buy that this executive was so painfully naive and so disconnected from the circles of professional businessmen that he lacked the wherewithal to see what was happening, nay, to see what he was signing-off on.  His sole tangential admission of blame is in saying “if I had to do it all over again, I would have done it differently.”  Great, I’m sure all the shareholders who relied on you to look out for their best interests feel much better now.

This is the job of  CEO, to be able to politely dismiss the interests of others which are not necessarily in the interest of the firm and its stakeholders.  To say to the politician, we absolutely plan on going public, but only when we are ready to show the World how great our firm and our Country are, to say to the lawyers, bankers, and brokers and high-priced auditors thanks, but no thanks.  To allow all of these people to dictate to you – the CEO – what the company is going to do is cowardice.  Man up and do your god damn job.  And if you don’t feel like stepping up, don’t run your mouth and complain about it when the only person you really have to blame is yourself.

The experiences of this executive are hardly unique to China (how many failed executives in the U.S. blame “the markets” or some other outside force for their shortcomings?), however especially in the reverse merger space, I would not be surprised if they are relatively wide-spread and shared by a great many of his peers.  Again, in this executives defense (assuming he is who I believe he is), the risk factors were largely stated in regulatory filings.  I doubt anyone except the lawyers who drafted them actually read that far, though.

As I’ve said dozens if not hundreds of times at this point:


A Sign of the Times, Perhaps, Buried in the WSJ?

30 Jun

Buried at the bottom of an article in this past Tuesday’s WSJ about due diligence firms sprouting up to investigate Chinese companies for hedge funds and other Western investors was a little tidbit it seems everyone either didn’t read, or felt comfortable ignoring regardless. The WSJ – investigating Deloitte’s resignation as Longtop Financial’s auditor – seems to have encountered a not-unsubstantial speed bump which I’m afraid may be indicative of far larger and more troubling problems:

A spokeswoman for Deloitte’s global network referred questions to its Chinese affiliate. Efforts to reach the Chinese firm were unsuccessful.

There are two largely distinct possibilities here: First, the WSJ reporters are not very good/diligent investigators/researchers, or second, Deloitte’s Chinese JV is in more trouble than we thought, in the wake of its involvement in frauds like CCME and Longtop.  Ordinarily, I’d simply put a call into Deloitte’s offices in Shanghai myself (it took me about 90 seconds to find a phone number), but its now ~3am local time, and I have no desire to leave a voicemail and wait for a callback that very well may never come.  Giving the reporters at the WSJ the benefit of the doubt that they – having been given the contact information for Deloitte’s China office by Deloitte global – would be able to figure out how to get at least a “no comment” out of someone there, leads me to believe there may be something amiss.*  Seeing as I have no other information upon which to base this concern, I’m not putting too much credence in it, but it is something upon which I’ll be keeping an eye going forward.  Nothing really surprises me in China anymore.


*Of course it is entirely possible “efforts to reach the Chinese firm were unsuccessful” means the reporters gave up, or otherwise mangled the effort.

Project YOKU-zuna: Downgrading to Conviction Sell (Again)

20 Jun

Last week Goldman Sachs (Asia) LLC (YouKu.com’s lead cheerleader underwriter) upgraded YOKU to a buy with a $55 12-month target price.  I’ve read the report, and I think the GS analysts are even more bullish than some of the silliest blind China bulls I’ve encountered.  The report is also riddled with non sequitur, stating, for example, that smaller competitors must be profitable in order to continue operating and that firms are under U.S. sort of obligations to pay for content (like TV shows and movies).  Such naivete aside, I’ve re-worked much of my model and assumptions, in many cases giving the company significant benefit of the doubt, but I still can’t rationalize the current stock price (~$29).  My analysis suggests the stock is STILL significantly over-valued, even after declining ~45% since my initial report.

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Project YOKU-zuna: Failure to Execute

15 Jun

While his legacy is still being written, YouKu CEO Victor Koo has achieved success seen only by a very select group of revered business leaders, visionary CEOs with an ability to not just dream it, but do it.  His previous effort, Sohu, is one of the most successful internet firms in China, and if the past few years are any indication, he’s well on the road to a repeat performance with YOKU.

I’ve been analyzing this company (stock) for the past two weeks or so trying desperately to essentially over- value the firm.  When I started, the stock was trading around $43/share, and even with aggressive assumptions for revenue growth, margin expansion, and other measures of management effectiveness, I couldn’t figure out how the company could be worth more than mid $20’s/share (for whatever its worth, the stock closed yesterday at $29).  Investors should make no mistake: Just because a firm operates in a major growth sector in a major growth market, profits are far from guaranteed.  Running a several billion dollar company is NOT an easy task, and while some have been able to handle it (and then some), the path to sustainable success is littered with the carcases of corporate failure.  Many and myriad are the chances to slip-up, while those to achieve lasting prosperity are fewer and farther between.

That being the case (like it or not), this week I’m playing around with my original assumptions to see how the valuation changes if the company – led by Victor Koo – fails to attain the lofty goals I set with my assumptions.  I’ve made some relatively small changes/fixes/improvements to my model and its assumptions too nuanced and numerous to mention here (those with financial modeling experience should understand, model is now more consistent/accurate/flexible, formulas less clunky, etc), but the cumulative result is that the DCF value is now higher –  17% higher in fact or $27.77 – than the $23.76 from my initial effort.  Using this new, higher value and the assumptions driving it, let’s see what happens when we make some changes.

Here is the income statement along with growth rates and margins:

As you can see, that $27.77 valuation is predicated on some serious revenue growth – 58.1% CAGR – and gross margin expansion – 75.5% CAGR –  over the next decade.  It is these two assumptions that I want to address today, to see what happens if YOKU fails to grow as fast as projected.  We should be publishing more in-depth report on YOKU’s operating costs soon.

I use comps (SOHU, Tudou, etc) and industry reports (e.g. the iResearch data cited by both YOKU & Tudou) to help generate my assumptions for revenue growth and gross margin expansion/contraction, which is what I’ve done here (see my last post on revenue growth assumptions).  I then use a multi-step approach – to reflect the business (growth) cycle – et voila, an oversimplified explanation of where these numbers come from.  For YOKU’s top-line growth and gross margins, though, I focused primarily on the rates for the next year or two and assumed those rates degrade constantly over time, i.e. for 2011, I assumed a 110% growth rate, which decreases 10% each year, and cost of goods (services) of 75%, which similarly declines 10%/year.  While this is not very likely to reflect the firm’s actual performance over time, it makes it far easier to sensitize the valuation to changes in growth rates.

I think using 10% decay for both of these figures is fairly generous; I’d be surprised if YOKU management can get costs in line that well, even as the business scales and matures, considering significant wage growth and inflation in China.  If we adjust the decay rate for cogs to -7.5%/year from -10%/year, all else being equal, the valuation drops from $27.77 all the way down to $19.37!

If we assume cost of goods decreases 10%/year, but that revenue growth will come up a little short of my initial estimates, say this year will still be 110% growth, but that will decay by 12.5%/year thereafter, the value drops all the way down to $19.02!

If we assume that both revenue growth and gross margins will be strong this year, but will be increasingly less so going forward, lower than my initial assumptions (of -10% sequential decay), say -12.5% for revenue growth and -7.5% for cost of goods, the value goes all the way down to $13.14!

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Project YOKU-zuna: Deconstructing Questionable Revenue Growth Assumptions

6 Jun

I don’t like stating the obvious, except when it seems many if not most are seemingly oblivious to it.  Such, I believe, is the case with the stock price of Youku.com (YOKU).  As I shared last week, I believe the firm is grossly over-valued even when assuming amazing revenue growth and margin expansion over the next decade.  We’re talking 70% average revenue growth for the next 10 years.  Off the top of my head, I’m not sure any firm of this size has achieved a decade-long run that impressive in the history of the corporation!

This should be obvious, but firms can only grow so much, so fast.  YOKU makes substantially all of its money from online advertising, which means its revenue growth is bounded by two factors: the growth rate of the Chinese internet advertising market, and its share of said market.  The very-same “independent” research firm YOKU cites in its regulatory filings – iResearch – says the market only (yes, only) grew 54% last year, yet YOKU’s revenues grow three times as fast (152%)!

The only way for this to happen (and continue to happen) is for the market to grow faster than estimated, the sub-market in which YOKU operates – online video advertising – grew (and will continue to grow) faster than the broader internet advertising market as a whole, and/or YOKU made (and will continue to make) HUGE market share gains last year.  (YOKU could also expand into new markets, but for our purposes, we’ll assume the company invests most of its capital in the internet video space.)  Of course there is another way – falsifying revenue – but as I have done in my financial analysis, I’m working on the (very possibly unrealistic) assumption that YOKU’s financials are fraud-free.

In order to rationalize YOKU’s current (at the time of my analysis last week, around $42/share) price, not only did YOKU’s revenue growth rate have to significantly outpace that of the industry rate, but going forward, it will have to continue to do so for years to come!  Even if Victor Koo is the most brilliant CEO the World has ever seen, he is still (using our no fraud assumption) faces real-world constraints in how fast he can grow the company.

If we take a deeper look at the industry and YOKU’s position within it, I think it will become even more crystal clear that YOKU’s share price – driven largely by unrealistic revenue growth assumptions – is grossly over-valued.

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