I’m almost reluctant to write this article after reading some of the vitriol yesterday directed at China MediaExpress (CCME) skeptics. For a taste of it, just look through some of these comments.
I know this is going to generate a lot of comments, so before I begin I want to mention a few things:
First, I’m not short the stock and I have no plans to go short. I sold out of my long position on Monday afternoon at 2:00 pm when the shares were $20.59. I didn’t follow the market the rest of the afternoon and was surprised to see the dramatic drop. I thought the Citron report (which is here if you haven’t seen it) had already been in the news, since it was released the day before, but looking at the chart it doesn’t look like the market really noticed it until around 2:30. That being said, I don’t think the Citron report had much new information.
The other point I’d like to make is that I’m not calling CCME a fraud. If someone else wants to do that, fine. You can debate that, but don’t accuse me of it. What I do want to do is outline my thought process of buying the stock, my skepticism along the way, and ultimately my decision to sell out.
I came across CCME in April and spent a few weeks doing some research and mulling over the idea. I opened my position on May 10, 2010 at $11.27 and was comforted by some Seeking Alpha articles that answered some open questions for me. Although I was concerned about buying a Chinese small cap, I was comforted by two things: CV Starr’s investment in them, and the Deloitte audit. I respect Hank Greenberg and I know that he knows China very well. I thought that gave CCME a lot of credibility. I also didn’t think it was possible to fool Deloitte. A local Chinese auditor, maybe, but not Deloitte.
The simple fact at the time is that if CCME is not, or was not a fraud, buying in at $11 was an absolute no-brainer. I won’t re-harsh details about their business prospects or financials, but at the time I pegged them to conservatively be worth $30 to $35.
I think it’s important to take the old Charlie Munger approach and invert. The idea is to challenge your opinions by coming at them with different assumptions. During the time that I held CCME I repeatedly tried to kill the idea. So, if I was going to fool CV Starr and the auditors, what would I do? Other investors and I had a lot of conversations about this and we learned a lot about Chinese companies along the way.
Let me give you a few examples of what I considered: In the U.S. you would not think it would be possible to fake the balance sheet in order to fool auditors. In China it’s relatively common. Short-term loans are given in order to prove to auditors that there is “cash” in the bank. If you wanted to commit a fraud, this sounds like something you’d do. What else would you do? You’d continuously announce new contracts. You may hold a somewhat glitzy investor day meeting. You’d probably have a network of brokers creating fake contracts and have loads of self-dealing. You’d get the stock price up and then use it to try to purchase other companies. You’d also try to get good press in the U.S., but not do much about press in China. I’m not accusing CCME of these things, but these are some of the things I considered while trying to disprove my long thesis.
In late summer, I spent a week surfing through Chinese websites trying to find mentions of CCME. The numbers were that they were one of the fastest growing companies in the world with net margins in the stratosphere. Surely, they would be written up throughout China as a company of the future. I don’t know Chinese, but I’m handy with Google Translate, and I didn’t find much. I even commissioned a Chinese friend to do a search as well, and nothing new turned up. The Citron report confirms that I wasn't the only one having trouble finding native language information about them. For a company their size and with their growth, they should have been written up by businesss journals throughout the region, instead I only found a few mentions in local newpapers.
A few other things made me skeptical. How could the airport bus contracts have such high margins? In general, it seemed to me there would be relatively low barriers to entry and the bus owners would have a ton of leverage. I know there may be relationships with government officials, but still. Wouldn’t the bus companies require lower prices? The Charlie Munger in me said the bus owners could be getting kickbacks or some other arrangement like that.
For the Citron report, they make a number of compelling arguments. If you’re long CCME, I would suggest setting your ego aside for a few minutes and reading the report objectively. For example, where is the media attention in China? Why don’t their competitors mention them? How are the margins so high? Why are they so reluctant to part with all the cash they’re making, other than a paltry dividend?
I’ve seen that the Twitter universe has blown up over Citron, and I’m not going to get into that, but you should look at their arguments and see if you can refute them. If you were being objective, the allegations would be tough to disprove. I know, you shouldn’t have to prove that CCME is not a fraud, the burden is on the one who made the allegations, but you should think about them very deeply if you’re long the stock. I don’t know the Citron people, but these were the very same questions that myself and other investors have been having since June so I’m not surprised they came out.
And still, I was long CCME.
Over the last few months I started trimming my position. Until yesterday at 2:00 pm, I still had 2% of my portfolio in CCME. I sold out the rest of it then. I had been trimming the position since October, and if you take into account the entire position, I only ended up making 21%.
I don’t know if CCME is a fraud. What I do know, though, is there are at least half a dozen suspicious things about the company and their reports. Taking that risk at $11 is different than taking it at $18. Even if it were to drop back to my initial entry point, knowing what I do now, I wouldn’t touch it. That being said, can I tell you that Citron’s allegations are true? No. But I also can’t tell you they’re false.
There’s a story about a scam artist giving a sales presentation on a product that will cure baldness. The crowd wants to believe it works, but it’s an outlandish product and usually a tough sell to the crowd. One particular day someone in the audience challenged the salesman. He stood up and said there was no proof that this tonic worked, and urged the others to laugh at this clown selling a ridiculous elixir for an exorbitant price. The salesman slumped on stage. He thought it would be another tough day with no sales.
Astonished, though, one man raised his hand demanding the product. The salesman told him it wasn’t for sale. The man who had challenged him had been right. It didn’t work. Insistent, the customer demanded the salesmen sell him the miracle product that cured baldness. Then another customer made the same demand. And another. It was the best day the salesmen ever had.
Afterwards, he asked the first man why he wanted the product so badly when he knew it didn’t work. The customer said, “You don’t understand. I’ve been bald for 30 years. I need for this to work. It has to work. Hearing that guy stand up and say it can’t work only makes me need it more. It’s my only chance.”
The salesman realized then that what he was selling was hope. The crowd didn’t want to hear logic. In fact, the crowd became angry at the one who presented the facts. Realizing what had happened, in future sales pitches the salesman even planted a challenger in the audience to call the seller a fool. Sales went up and up.
Some people want to believe so badly that when challenged with logic, they respond with emotion. After reading some of the reactions to the Citron report, I’m beginning to think that Citron may be that audience member who yelled “stop!”
Who are you in this story?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.