China MediaExpress (CCME) has its fair share of doubters, but even the hit-piece that came out from Muddy Waters Research (which in my opinion has fictitious and misleading documents designed to immediately overwhelm readers) does little to cast aspersions on CCME's cash balance.
From the "Muddy Waters Research" report:
We add in the cash balance to value the Company. If one assumes that the $169.9 million in cash on the balance sheet is accurate, which is a large assumption considering we do not believe the reported income, one would value CCME at $5.28 per share.
Checking the latest Global Hunter Report:
We reviewed the company's contracts with advertisers and bus operators, rate cards, and we have also reviewed the company's bank statements.
So how do you acknowledge the cash balance, and then go on to ignore how the cash got there? The only way the cash can build up is via operations. The incentives just aren't there for fraud. Why would the CEO or any banking system put additional capital at risk when the CEO's future is tied into the future success of the company, and if fraud were to be committed, both parties would lose everything?
Let's take a look at recent corporate frauds:
Satyam Computer (SAYCY.PK)
For those of you new to this story, Satyam systematically inflated numbers until it had $1B in cash on its books that didn't exist. The auditor didn't independently verify the cash balances with the bank, but instead took the company's word for it. Could this happen with CCME at this point in time with all the fraud accusations?
Global auditing firm Price Waterhouse Coopers ("PWC") audited Satyam's books from June 2000 until the discovery of the fraud. Several commentators criticized PWC harshly for failing to detect the fraud. PWC signed Satyam's financial statements and was responsible for the numbers under Indian law. One particularly troubling item concerned the $1.04 billion that Satyam claimed to have on its balance sheet in non-interest-bearing deposits. According to accounting professionals, a reasonable company would have either invested the money into an interest-bearing account or returned the excess cash to the shareholders. The large amount of cash should have been a red flag for the auditors that further verification and testing was necessary. Furthermore, it appears that the auditors did not independently verify with the banks in which Satyam claimed to have deposits.
Additionally, the fraud went on for a number of years and involved both the manipulation of balance sheets and income statements. Whenever Satyam needed more income to meet analyst estimates, it simply created fictitious sources, and it did so numerous times without the auditors ever discovering the fraud. Suspiciously, Satyam also paid PWC twice what other firms would charge for an audit, which raises questions about whether PWC was complicit in the fraud. Furthermore, PWC audited the company for nearly 9 years and did not uncover the fraud, whereas Merrill Lynch discovered the fraud as part of its due diligence in merely 10 days. Missing these red flags implies either that the auditors were grossly inept, or in collusion with the company in committing the fraud. PWC initially asserted that it performed all of the company's audits in accordance with applicable auditing standards.
All you really need to see is Enron's org chart to understand how easy it would be to put a move on the auditors. It's incredibly complicated. Enron was systematically abusing revenue recognition accounting loopholes, and doing financial engineering to effectively say it was making more money than it actually was.
China Milk Products Group:
More recently, China Milk Products Group announced that it had the cash to repay its bondholders some $146 million after they exercised their early put option to sell back the bonds to the company. The snag was that it hadn't received clearance from China's State Administration of Foreign Exchange to remit $170.6 million in principal and interest payments out of the country.
But in February, after the resignation of its chief financial officer, company secretary and an independent director, China Milk admitted that it did not have enough cash in its bank accounts outside China to repay its bondholders.
In Singapore, Oriental Century requested a suspension of its shares after KPMG contacted the company's chief financial officer on March 9, 2009, saying that it had difficulties seeking the reconfirmation of the bank balance and that there were doubts about the authenticity of a bank confirmation received earlier by KPMG.
- Can CCME be faking cash when you have random accusations coming from all over the world, driving increased scrutiny from the SEC, law firms, and their auditor Deloitte? No.
- Can CCME overstate its numbers and hide its income in various places on the balance sheet that are difficult to verify like Enron did? No. The organizational structure and the balance sheet and income statement are unbelievably clean and simple to audit. If the cash is there, the company that created the cash is there.
- Are company directors and the CFO resigning? No.
- Is the company indicating that it wants to pull its listing? No.
And note that the people making up the accusations may not even have an office that they claim to have.
Bottom Line: If the cash is there, the company is there.
Additional disclosure: I'm also selling puts.