Author's Note: This story was held until the completion of the Chinese New Year celebration afforded management and its PR firm a chance to prepare comment on FI's extensive list of questions. Management never responded and the PR firm quit. Because of the strength of my thesis - the company is a rank fraud - and based on weeks of reporting, I decided to travel to China and knock on management's door (literally). The story below is what followed from this investigation.
In the maze of thronged and narrow streets that makes up Fujian province's capital city of Fuzhou, a deft driver, if he's willing - as all Chinese drivers apparently are - to nearly kill or injure vast numbers of his countrymen can take you to the foot of Dongjie street. There was little reason to be there save for its having the headquarters of a company called China MediaExpress Holdings (OTCPK:CCME), an enterprise that seems to be able to weather allegations about its business that would have forced the share price collapse of a company five times its size. The attention of bulls and bears is not misplaced: In a mere four years as a public company, it has apparently come to dominate the ad placement market for leading multinational consumer products companies on a network of what it claims is more than 27,000 buses on Chinese airport and intercity routes.
Also, and this cannot be understated, hanging out on a sidewalk in Fujian - the sidewalks double as parking spots when the streets, which appeared to have been designed in the Han Dynasty, fill up - was not a viable option. There was also the matter of the world-class headache the Financial Investigator was developing from Fuzhou's diabolical smell, an epic conflation of poor sewage treatment, air pollution and the smell of kimchi that made getting the hell off Dongjie street a matter of vital importance.
The Financial Investigator and his traveling companion for the trip, an American investor with extensive experience in China, decided to head upstairs despite our interview with the CFO having been cancelled at the last minute (with no explanation given.) We thought a quick tour of the offices and meeting a few other executives might open our eyes to a few things.
Though the language barrier was a little steep with the young receptionist - when we asked for writing paper, she provided Kleenex - we were in short order shown to their conference room and told to wait. It did not escape notice that pride of place in the conference room belonged to a framed certificate of participation from the Fall 2010 Rodman & Renshaw conference, the World Cup for reverse merger companies and the pumpers and touts who peddle them.
Eventually chief operating officer James Yu came down and after spending 30 minutes trying to understand who we were, concluded that giving us a tour wouldn't hurt. Soon enough, his colleague, Vinne Ye - the chairman's assistant - came out and took us around.
It was most eye-opening.
Of China MediaExpress and its employees, this much can be said: They have a good time.
The feel of the office took the Financial Investigator back to his college years, an enjoyable if violently unproductive time in the late 80s. Like the common rooms of a dormitory, workers at China MediaExpress hung out and shot the breeze, took naps, played cards and crammed for night school tests; with the advent of technology, they also did things that weren't available back then, like instant messaging friends and playing online games. It was like a younger, hipper nursing home, replete with an absence of heat and the odor of lingering fart coming from the streets below. If you didn't know better, you might think it was the sort of company, Google springs to mind, that jumpstarts employee productivity via an anything goes culture.
The thing is, Google has the food and the games and the exercise facilities because there is a spine-crushing expectation of performance. It doesn't just expect its employees to do well, but to excel. This is where a midday weightlifting session or midmorning sushi run comes in handy. China MediaExpress employees goof off because the phone didn't ring once in the more than an hour that the Financial Investigator was there.
There were nothing: no impromptu hall meetings, no one was at a copier, no huddles of twos and threes in the corner, no one was working the phones. No one was pounding a keyboard or studying a spreadsheet. No one, as far as could be seen, did anything for the entire time we were there. It was like B-roll footage for a documentary about office life: people looked the part, but there was nothing going on.
Asked if it was a "special" day, or a holiday, Vinne appeared puzzled at the question. No, it was a normal day at China MediaExpress she assured us, a company that in less than four years of full time focus on the business of placing ads on various bus lines, was poised to post nearly a nine figure net income.
The next stop on our tour was the programming room, or the "nerve center" of China MediaExpress, where we were told much important work went on in grafting the ads from the likes of China Mobile and Coca-Cola into the television shows that have made China MediaExpress so successful. Vinne emphasized her hesitation to even peek in the room because interrupting these hardworking and creative people could really screw up their train of thought.
With the earnest intention of taking a brief glance into this vital operation, we cracked the door and, well, clearly her worries were misplaced.
Four people sat around the table and appeared to have been involved in some fantasy role-playing type card game. Two people were napping - one of whom refused to stir despite our presence - and one who woke up, laughed and started texting someone on her cellphone. A seventh smiled happily as she instant messaged her friends. The centerpiece of the room was a 2005 or so vintage laptop covered in dust with some masking tape on its screen. It was this, our guide assured us - she had backed off the "brain center" routine at this point and everyone was back to screwing around anyhow, except for the guy who was still asleep - where the really important work of editing went on.
Stopping in to the larger offices of the chief operating officer and chief financial officer - Jackie Lam was in the Hong Kong office, it turned out, but despite being the number two executive in the company and its liaison to Wall Street, was not able to be hailed for over 90 minutes; the CEO was also out - was educational. Outside of a series of teapots and cups, there was little there. Oddly enough, the CFO, a man who has to negotiate the financial and regulatory regimes of two large and complex nations on a regular basis, appeared to have few (if any) books in his office.
There is an element of Sherlock Holmes' "The Dog That Didn't Bark" to all of this.
James Yu, the senior executive at headquarters that day, was with us on much of this little tour. No one grinned or acted sheepishly when he walked in on them IM'ing, studying for a night school test or doing absolutely nothing; it was seemingly unremarkable to him or his colleague that in the rooms we were in, during the middle of work hours, no one was working. Recall that this was a surprise visit: our meeting had been cancelled. This was China MediaExpress as it really was. It was a Potemkin company, a headquarters with the trappings of modern business but whose workers did nothing because their was nothing much to do.
Which is strange when you think about it.
Life at China MediaExpress should be just this side of frantic. Its net income has more than doubled since the end of the fourth quarter of 2009, to over $31 million from $14 million; its most recent net income margin was almost 55%, an utterly astounding figure. A company can only report these numbers through four paths: The first three involve having some combination of an ahistorical competitive advantage, a commanding position in a market that is undergoing an explosion in size, and a workforce where personal productivity is fetishized and handsomely rewarded. Those are hard arguments to make in China MediaExpress's case. It sells ads on buses ridden by the lower economic strata in a marketplace that its competitors willingly abandoned. Its workforce, notwithstanding their amiability, plays cards and sleeps in the middle of the day.
The fourth is that in the main, China MediaExpress is a big fraud.
If China MediaExpresses operations appear unimpressive, their reported financials certainly are. Through the first three quarters of 2010, their $155 million in revenues make them the second largest advertiser in the "out-of-home" category in China, behind only long-established Focus Media and its $500 million in revenues. Falling into third place must surely rankle Air Media, another veteran competitor, despite having many more product lines.
More impressively, this was accomplished with no real relationships with Chinese advertising agencies. That is, the people who living is to buy and sell advertising space for high-profile corporations in China say they have never heard of or dealt with China MediaExpress. This point bears fleshing out: A global consumer products company doesn't call up China MediaExpress (or anyone else) and write a check or wire money in return for advertising. They use a wide-ranging network of large and small ad shops that specialize in placing ads to reach targeted audiences. Executives at both Vision Media, another competitor, and Air Media, had never heard of China MediaExpress before the past month, when Wall Street investors and the Financial Investigator began making repeated phone calls to the company's erstwhile rivals asking them about the magic margin machine from Fuzhou.
That no one had heard of the company is an important data point.
Companies in a hotly contested, gossip-heavy industry like advertising keep close tabs on each other, so a new entrant going from a standing start to second place will get noticed; a company that can do that in airport and intercity bus advertising, a business line that was abandoned by both Air- and Vision Media and is widely perceived to be a sub-Greyhound demographic (a fair assessment based on several hours observing airport buses in and around Beijing and Fuzhou) would force a wholesale reconsideration of their business model. After all if you can make 50% net margins selling to China's working class, why should their own companies continue to fight for 2% margins putting LCD displays above urinals?
The answer, naturally, is that they don't make anything remotely close to those margins because they don't do anything approaching the business they claim. China MediaExpress is no outlier as this chart shows; it exists in a universe of one.
It is also a universe of its own making. As with many Chinese reverse merger companies whose Chinese filings show a profound difference in revenues and profits from their SEC filings, China Media Express also has a chasm. In this case, its advertising agency subsidiary Fujian Focus - the similarity of names in Chinese infuriates Focus Media executives - reported 2009 revenues of about 5.18 million RMB, or a little over $761,000 at the blended 2009 exchange rate. Expenses were sharply greater however, so the net loss was 6.29 million RMB, or $925,000.
Unlike many companies who claim that these discrepancies are routine or a matter of sloppiness and don't contradict their SEC filings, China MediaExpress can't say that. Chinese media veterans are adamant: Advertising agencies will not make payment without a legal receipt being issued. In turn, these are immediately reported to the local tax authorities electronically. These numbers in turn form the basis for their SAIC filing.
The massive gap CCME has between its SEC numbers and its Chinese numbers is no accident but rather a reality they have been able to avoid for several years.
Also existing in some parallel dimension are the majority of China MediaExpresses customers. To be certain, the company does have buses and they do show ads, just not ads sourced directly from the rich, name brand corporations that they claim as customers.
The Financial Investigator contacted Coca Cola (NYSE:KO), Toyota (NYSE:TM), Mars (the company claims Wrigley's chewing gum, which Mars acquired in 2008, advertises with them), Hitachi, Adidas and numerous other companies and none said that they had records of corporate marketing programs involving China Media Express. Here is Coca-Cola's response, which is a fair example of the type of response these questions elicited. In fairness, like Coke, most companies said local distributors might advertise and use their names to generate sales. Still, a local Coca-Cola bottler is obviously going to have an ad budget orders of magnitude less than its corporate parent.
The question of Apple (NASDAQ:AAPL) puts this issue into relief. The company itself said it does not directly advertise with CCME but any one of its hundreds of distributors in China could. In a rebuttal to critics, China MediaExpress said its Apple ads came through a distributor called Eading Group, but a check of Apple's list of authorized resellers shows it's not among them.
The story was the same for purported Chinese advertisers: The Bank of China, Supor and Industrial Bank said they had no records of business placed with the company but that a local branch or affiliate may have placed an ad. China Telecom's marketing manager for Fujian province said he approves all expenditures above 100,000 RMB and he had not heard of any contracts involving China MediaExpress.
A much discussed contract with the Ministry of Transport is similar. There is a sliver of a relationship, but some investigative footwork reveals the company has entirely oversold its importance.
Beijing Transport Video (the shorthand name of the company on formal documents) is a company owned by the Ministry of Transportation's newspaper in a joint venture with a road construction company from Henan. Part of the newspaper's mission - in reality it is more of a publicly circulated employee newsletter - is to provide public service announcements in bus stations. To broaden the impact of its PSAs, it was decided to install TV monitors in the stations, and to support the cost of doing this, the Transport News established a small subsidiary, Beijing Transport Video, tasked with installing terminals. To offset costs, a modest amount of advertising was sold. Beijing Transport Video (which has no regulatory power and no ability to require buses to carry screens) lacks industry connections or ability to sell advertising. Enter China MediaExpress. To a Chinese speaking investigator, the few employees of this nonprofit organization say that on their own they could only coax some modest ads from construction companies that build bridges and tunnels. But the company apparently convinced them that there were broader opportunities available, if China MediaExpress was in turn recommended as a partner to bus companies.
Whatever the goals or purpose of the program may have been, Beijing Transport Video's financials bely any claims of success. In its 2009 report, the Beijing Transport Video has 187,000 RMB of gross revenues, so about $28,400 for the whole year.
The ad agency issue is another place where the company's claims aren't supportable. China MediaExpress has taken the unusual step of not disclosing the agencies they do business with, though they have provided to investors - in Chinese - the names of several shops they claim to have worked with. In conjunction with a China based and Mandarin speaking research analyst, a public records search of a number of these advertising firms reveals they are all very small and have never, per their state filings, earned anything like the revenue they would receive if they were doing this level of business with the company. See here for a chart listing several of them.
Then there is the problem with China Media Expresses numbers.
Since wide swaths of the income statement are simply not believable, the cash flow statement and balance sheets are probably lost causes. That's okay though, because the real fun is to be had in taking a look at the company's CPM, the most commonly used yardstick in the advertising industry. In a nutshell, CPM measures the cost for the advertiser to reach 1000 viewers.
In its 2009 10-K, it touts an attractively low CPM of 2.68 RMB but that doesn't take into account its airport bus routes. A look at CPM using revenue earned, the reported number of buses in the network and ads seen by passengers reveals a very different figure. Using their own numbers as laid out here, you get a CPM of $22.98. The Super Bowl, in contrast, had a CPM of $27.02. China MediaExpress's own numbers, in other words, indicate that a ride on an airport bus costs an advertiser about what one of the globe's most expensive sporting events cost.
There are other incongruities.
China MediaExpress's filings indicate that no workforce in the Chinese media landscape is remotely as productive as its. Its 65 or so sales staff, using third quarter numbers, produced about $907,000 (or 5.96 million RMB at an exchange rate of 6.57) each in revenue; Vision China's was a little over $106,700. No one in the publicly traded advertising space in China has more than $168,000 per employee. A company whose headquarters suggests an adult daycare center is beating its competition by a factor of five. The sales to marketing expense ratio issue is similarly skewed: for CCME it is 3.7%, for Vision China it is 20.4%. Put bluntly, they are stating that CCME has virtually no costs in generating sales, while a large and established competitor has to spend 20 cents in sales costs alone to generate one dollar of revenue.
ChinaMedia Express's actions in emerging from its corporate shell baffle. At the very least, they are not the actions of a company whose earnings and cash flow generation capabilities put it in a league with Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Merck (NYSE:MRK). They are the actions of a management that is desperate to bring in cash.
How its management treated the exercise of its warrants is illustrative. After forcing conversion and taking in $46 million, $30 million went right back out the door to the founders ($20 million "consideration" and $10 million repayment of a loan) leaving the company with $16 million. Shortly after this, China MediaExpress struck a deal with Hank Greenberg's C.V Starr & Co. Inc. to invest $30 million at prices below the then market value. The January 2010 deal gave Starr almost 4.6 million shares upon conversion and a nearly $8.1 million embedded profit. It's obvious why Starr did the deal; it's much less clear why management did.
[In a request to Starr for comment, the only answer the Financial Investigator received was to be sent a copy of a report from Global Hunter Securities analyst Ping Luo. The report is a wildly bullish validation of management's assertions and claims to be based on access to its internal financial filings. The report is now password protected on the firm's website.]
At this juncture China MediaExpress, per its filings, was a Graham and Dodd value investors fantasy: It was cash flow positive and reporting rapidly expanding net income. Its share price was a mere 2.5 times net income (minus cash) and, having generated $46 million free cash flow in the prior 12 months it was entirely self-funding. It would seem reasonable to conclude that management would have sought to take advantage of their stock's historically cheap value - and their excess capital - to buy in as much stock as possible. Instead they sold millions of shares of stock at a discount to market value.
It then gets more confusing: Less than nine months later a stock buyback was announced at a price close to Starr's blended average cost. This announcement occurred within weeks of a founders sale of 1.8 million shares, in spite of the company's disclosure that the insider had not intended to sell. No sooner had the ink dried on the 1.8 million share sale when Rodman and Renshaw began shopping a block of 2.5 million shares (at a discount) by a related party. Investors have also heard recently that the company - apparently prodded by Starr - would like to raise $100 million through a registered offering, an odd prospect since the company is poised to generate over $100 million in free cash flow alone over the next four quarters with $169.9 million in actual cash on hand as of September 30. Precisely what this capital is for is not clear: they have yet to spend $3.6 million on capital expenditures in the preceding nine months.
Starting in late February, the Financial Investigator began a multi-week process of calling and E-mailing the management and representatives of China MediaExpress to obtain comment. The questions sent are here. E-mail's were sent to Jackie Lam and repated phone calls were made and E-mails sent to public relations advisor The Equity Group's Lena Cati and Linda Lattman but they were never returned. The firm no longer represents China MediaExpress. A message board posting recently said that the Fleishman Hillard firm now represents the company but a woman answering the phone at its St. Louis headquarters said that they do not represent China MediaExpress.
On Friday March 11 at a little after 10 am EST, Nasdaq halted trading in the shares of China MediaExpress pending a statement by the company. As of the following day, none had been released. Like the assurance that its financials were fine and soon to be signed off on by Deloitte, a statement addressing anything of substance may be another dream that this management spun to greedy investors and lazy analysts.
Because all fiction, no matter how long-running or well-crafted, must end some time.
Disclosure: Author has no position in CCME.