Focus Media Conference Call Offers Clarity; Has Muddy Waters Lost Its Mojo?

Nov.24.11 | About: Focus Media (FMCN)

Focus Media’s (NASDAQ:FMCN) management hosted a conference call in response to Muddy Waters’ allegations and addressed the key issues in Muddy Waters’ report surrounding the number of LCD screens and the impairment of past acquisitions.

Muddy Waters used the number from Focus Media’s investors’ kit (112,298) and the number from Q3 results (178,382) to allege that Focus Media overstated the number of LCD screens. However, Muddy Waters’ allegation also potentially highlighted that it failed to fully understand Focus Media’s business.

Focus Media has three different types of LCD screens: Basic LCD screens, LCD 2.0 digital picture screens, and LCD 1.0 picture frames. According to the management, Muddy Waters failed to count the LCD 2.0 and LCD 1.0 screens, thereby understating the actual figure by ~66K units. (See table below)

Basic LCD screen

LCD 2.0 digital screens

LCD 1.0 picture frames


% of total

Tier 1 cities





Tier 2 cities






Tier 3 cities











Click to enlarge

Source: company press release

During the Q&A session, Analyst Dick Wei from JP Morgan asked CEO Jason Jiang whether there were any concerns from the advertiser and Mr. Jiang answered “there’s not much confusion in terms of what the number of screens are out there” because Focus Media provides the advertiser with a comprehensive list that contains the total number, the type, and the location of the screens.

The list that is given to the advertiser is the most critical evidence that Muddy Waters failed to obtain when conducting its due diligence. During its analysis on China MediaExpress (OTCPK:CCME), Muddy Waters cited the discrepancy between the number of buses reported by the company and the number provided to the advertiser, which ultimately resulted in CCME’s demise. Muddy Waters’ failure to verify the LCD figures that were provided to the advertiser shows an inconsistent approach in its due diligence process.

To regain investor confidence, Focus Media will engage a third-party firm to conduct an independent survey of its outdoor advertising network and to confirm the company’s figure. When asked about the steps and the time frame of the survey, Mr. Jiang pointed out that the company will engage in a “well-known third party firm” to conduct a comprehensive check and the entire process is “likely to take about two weeks to complete”.

Focus Media offered a good explanation in regards to the impairment of its past acquisitions, in my view. For the entire press release, please see: here.

As I pointed out in my critique of Muddy Waters’ allegations, Focus Media’s strategy of gaining market dominance through M&A had both merits and flaws. The acquisition of Frame Media and Target Media allowed the company to solidify its industry position and competitiveness in the outdoor advertising space. Most importantly, both acquisitions were accretive to Focus Media because they aligned with its core competencies.

However, the expansion into non-core advertising space, such as mobile, online, and in-store ads, backfired when its mobile subsidiaries engaged in SMS spamming which resulted in a massive public outrage and when the online advertising unit failed to recover from the 2008-2009 global slowdown. Furthermore, the acquisition of in-store competitor seemed to be accretive in theory, but underperformed in practice as LCD screens failed to capture advertising budgets in the super markets where off-the-shelf advertising is preferred.

Poor managerial execution was a crude awakening for Mr. Jiang when he returned to Focus Media in 2009. The company subsequently began to restructure its non-core units (in-store, mobile, and online) to focus on its core business of outdoor LCD advertising. Since then, Focus Media has exhibited strong top and bottom line growth from its core unit, as indicated in the most recent earnings announcement.

Needless to say, Muddy Waters’ research quality is slowly deteriorating ever since it took down Sino Forest (OTC:SNOFF). The open letter against Spreadtrum Communication (NASDAQ:SPRD), which my fellow contributor at Seeking Alpha thoroughly analyzed, in June never materialized to an in-depth report that many investors hoped to see from Muddy Waters, which likely profited from the 60% drop that Spreadtrum experienced at the publication of the report. The current report on Focus Media, while lengthy in terms of page numbers, lacks substance as the research team failed to conduct a thorough due diligence to support its allegations.

Looking back, the most amusing part about Muddy Waters’ Research against Focus Media is its claim that Focus Media over-impaired the acquisition. Anyone with an undergraduate business degree can point out that impairment charges are recognized in a separate line item that ultimately decreases the company’s earnings per share, which it certainly did when Focus Media reported the impairments on the acquisitions. Had Focus Media not impair the asset to 0, its earnings would have been higher.

Focus Media’s impairment loss that resulted in lower earnings is very different from a company that commits fraud by reporting higher than actual earnings. Unless Muddy Waters provides investors with concrete information to support its thesis, Mr. Carson Block is likely to lose his credibility in the investment community.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.