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John Besant-Jones

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  • Natural Gas: The Tricky Craft Of Counting Drilling Rigs - Part I [View article]
    The total US rig count data for both oil and gas has only fallen by some 200 compared to last year, with a big increase in oil rigs compensating for much of the 500 rig fall in natural gas classified rigs. That may support the author's point about reclassification, albeit not conclusive proof. Moreover, natural gas production should still fall even if the rig count fell by some 200.

    If natural gas production has remained constant, then it is peculiar that natural gas prices have slowly risen since last March. However this could be explained by an increase in underground storage, and a large reduction in LNG imports.

    I am sure that other people know more about this than me, but (similar to the reclassification issue) the rig count may also not properly distinguish between a rig for a producing well and a rig for an exploration well-even if it is meant to. It would make sense that natural gas production remains constant for the present (but obviously not on a longer term sustained basis) if producing well rig counts were unchanged, but exploration well rigs fell (which they would do at very low natural gas prices), hence an overall fall in natural gas rigs but natural gas production currently remaining constant.
    Oct 27 05:14 AM | 1 Like Like |Link to Comment
  • Telestone Technologies' R&D Staff Is Underpaid Or Overstated, As Are Its Accounts Receivable [View article]
    An accounting explanation for the mismatch between A/R in TSTC and the A/P in the Big 3 is almost certainly explained by the fact that a proportion of the A/R are unbilled A/R. These may not become the equivalent A/P for the Big 3 until the A/R are billed or invoiced. Instead they may appear as Accrued Expenses for the Big 3. Even though the contract may be completed, the invoicing often only takes place at the time the cash payment is made. This is usually because of tax reasons peculiar to PRC tax law.

    Another explanation is that they may be doing business with companies that are not fully consolidated on to the Big 3's balance sheet, but would be considered as representatives of the Big 3. I am not talking about affiliates.

    Your question about the cash settlement of A/R may be answered by this statement at the bottom of page 33 for the 10K related to the year end Dec 2011:

    "We have experienced a fairly long receivables turnover period due to a rapid growth sales strategy in 2010, especially in the second half of 2010, and most of those sales were not yet settled in 2011."

    So what they are saying is that at least 80% of the contract value obtained in 2010 could not have been paid within 12 months. This does appear to be a contradiction.

    I agree there are a lot of other issues to explain.

    Send me a message.
    Oct 17 10:33 PM | 1 Like Like |Link to Comment
  • Apple Should Take The $199 Chinese Smartphone Seriously [View article]
    People have been saying similar arguments against Apples's iPhone for years, but it has not worked out that way.

    Apple is not seen as a commodity product or brand in China, where Western luxury brands perform extremely well. Its all about the image, the status symbol, the quality and the durability. This is the market segment that Apple aims for, not the lower price segment. So even if the functionality is similar and price is lower, there are many other considerations. For example, in Hong Kong, there are even people standing on the streets with signs saying they will buy your used genuine Apple iPhone; they will offer you much less money for an alternative brand, and many are not interested in lookalikes. that is the strength of Apple brand name. The street markets are full of new iPhone lookalikes or other smartphone brands, even the shops, but still the genuine iPhone dominates. Its the same with mainland China and other Asian countries that I have visited.

    My interpretation of your comment about the Apple iPhone not yet being used for the China Mobile network is that this means there is still another large chunk of market share it can gain.

    What you are saying here appears more like an ongoing threat to phone companies that have been relegated from the top spot by Apple, and is perhaps one of the reasons why these companies are not performing as well as they used to in the past.

    Yes, there may be competitors that could eventually threaten Apple's iPhone dominance, but only when their phones do not fail or fall to pieces after a short period of time, and when young guys start buying them to impress their girlfriends.
    Sep 6 11:23 PM | 1 Like Like |Link to Comment
  • Why The Market Is Missing The Point On Ambow Education, A Strong Buy [View article]
    One of the worst things that could happen to a Chinese company's share price is for the State to become involved if there is serious malpractice. I have an academic study conducted by Chinese professors that support this statement. The effect is that the firm loses both reputation and guanxi with its customers and suppliers, which for this company are its students and teachers respectively. It then becomes much harder for it to do business. There may also be issues with operating licenses.

    If the allegations are true, the company needs to work hard just to assure officials that the problem is limited to the relevant operating unit. If the allegations have been made on State television, then there must have been some official approval, and a reason for this. Somebody does not like them, and this time one cannot accuse a foreign short seller for making false allegations. I will be interested to see how the company deals with this.
    Sep 5 09:07 PM | Likes Like |Link to Comment
  • Arbitrage Opportunity In China's Focus Media [View article]
    I have to agree with other commentators that the downside risk for this stock is huge if the proposed buyout does not materialize. The critical aspect of the deal's wording is that it is "non-binding". Hence the way to interpret the consortium of PE firms involved is that this proposal gives them the opportunity to have a closer look at the books, and if all is fine then they will go ahead with the deal, but they will walk away if they discover if all is not well. With such great headline numbers, there would have to be some serious problems for them to walk away. So you get around $2.50 upside, or $10-$20 plus downside. An arbitrage is meant to be a risk free gain. So is this really an arbitrage? Obviously not.

    At the current inflated share price, comparing PEG ratios and dividend yields to index averages or other stocks is misleading, because it only considers reward and fails to take in to account risk. It is not correct to assume that the risks for this stock are exactly the same as Apple's or the S&P 500 Index. The natural level of PEG and yield value which considers BOTH risk AND reward should be benchmarked against where the stock was trading before the deal was announced, or probably lower if the deal is not successful.

    A bullish mean analyst rating should also be treated with caution. It is well known that overall, analyst recommendations across the stock universe are deeply skewed towards bullish anyway. In other words, a bullish stance is no different than the average typical recommendation. As for the price target average of $37.87, I fully understand how the spreadsheet robots could have got to that number using assumed 20 year projections on their DCF models, but the fact is that a group of even better informed investors have valued this company at only $27 according to their own DCF models, assuming all is good. So $27 should be the highest price target for those with an optimistic outlook.

    To be clear, my comment is about the credibility of this suggested arbitrage trade, and not about the credibility of this company's audited numbers, profitability, or business practice.
    Sep 3 11:21 PM | Likes Like |Link to Comment
  • Why Royal Dutch Shell Is Likely To Bid For InterOil Imminently [View article]
    Is it really a concern that an extended well test could "waste gas" if the commercial viability of the project relies on there being enough gas to last at least 15-20 years, amongst other things? Surely the extra gas used would be insignificant relative to the total volume required for commercial use. Presumably an extended well test could either confirm or change flow rate, quality or volume estimates in either direction.

    Unless a 3D seismic is performed, it seems there is not enough information for Shell to make a sensible bid for the company even if it was allowed in to the data room.

    With Shell recently announcing that it plans to invest $1bn per year in China shale gas plays, there are alternative investment choices. I am unsure what would make Shell invest so much money in PNG if Shell is also investing to make one of project's main potential customers, China, less dependent on LNG imports. Moreover, if China does become more gas independent in years to come, then can this discovery in PNG still compete with other LNG exports in the region if it has high operating costs and demand growth reduces?

    The technical data so far does appear to be promising, but as various commentators have pointed out, it also contains a degree of uncertainty. And with the accompanying economic uncertainty, InterOil needs to reveal more technical certainty for both the project to continue and to bring in partners, or for Shell to go ahead and make a bid without its shareholders being worried.
    Aug 22 06:38 PM | 1 Like Like |Link to Comment
  • China's North American Energy Ambitions [View article]
    When this company originally IPO'd in London, I was in the Oil & Gas team at one of the investment banks that bought this company to market, so I know a bit about this.

    It is very true that the Chinese oil companies gain tremendous technological expertise by making foreign acquisitions.

    I will expand with several points:

    1) Historically, Chinese oil companies have not been at the forefront of exploration in the international arena (for various reasons). Instead their dominant international strategy has been to buy large assets that are already discovered, and either producing or close to producing. Even large mature oil field acquisitions are useful because the experience and technology gain from maintaining mature oil fields in the West can be transferred to mature oil fields in China.

    2) Some of the Western oil assets that have been bought by Chinese oil companies are at prices which some Western oil companies might claim is too high, and consequently the returns from these assets could be relatively low. However, this is more than offset by several important factors, including: A) The cheap funding these companies get from SOE Chinese banks. B) The money they save by buying existing assets instead of exploring for new discoveries (the cost in exploration write-offs can be huge if no big commercial discovery is made). C) For PetroChina and Sinopec, it is cheaper to buy in to existing production rather than buy oil in the market, at current market prices, to compensate for the shortfall in domestic oil required for their refinery operations, which are also price controlled.

    3) Up until a few years ago, North Sea oil went through a revitalization period whereby mature, declining fields were linked up with smaller less commercial fields to produce greater flow rates at an acceptable level of economics. There was also the benefit of horizontal drilling, and various deep sea technologies. All this experience can be transferred to CNOOC's Bohai Bay, for example.

    4) There is no doubt that shale gas technology will be highly valued in China given its huge reserves. It can take at least several attempts to get it right. I believe in November 2009, Obama stated that the US would be willing to share shale gas technology with China. One should also consider the possibilities of China's huge coal bed methane reserves.

    In summary, the Chinese oils have a good international strategy.

    Good article Matt-send me an InMail.
    Aug 16 10:43 PM | 3 Likes Like |Link to Comment
  • Deer Consumer Products Shares Halted After Factories Idled [View article]
    If the company is no longer doing "non-domestic" manufacturing, then it would close or dispose a plant facility outside China, since that defines "non-domestic" manufacturing. This article is about the possibility of a plant being idle or closed in China, not outside China, which in turn is not commensurate with the large increase in domestic sales..

    If however you really mean that it no longer does non-domestic "sales", then it may be more logical to close or idle a China based manufacturing facility that supported this export operation.

    The key issue here is whether there was enough spare capacity at the other facility to the extent that it can also support the increased level of domestic sales. From a cynical point of view, the reported sales increase is so great that this would be unlikely, especially given the fall in staff numbers, but it is possible. Perhaps someone knows if such spare capacity existed, or if there was substantial investment to gain this extra capacity?

    The other explanation may be that some manufacturing was contracted out and the company is playing a larger agency role. This is also consistent with a fall in overall staff, but an increase in sales and marketing. Again, does anyone know if this was explained to shareholders? For various reasons, a greater agency role does create greater risks of financial misstatement, so this explanation should not necessarily be considered a good thing.
    Aug 15 09:51 PM | Likes Like |Link to Comment
  • China Medical: Liquidators Request SEC To Suspend Shares [View article]
    I do not agree with this extreme view, and we will just have to agree to differ. The worst. most spectacular and most infamous cases of fraud that I have read have taken place in other parts of the world.

    My point is that the legal system for liquidation in China is unfamiliar for foreigners, needs careful navigation, and based on the experiences of domestic investors, may not lead to a desired outcome. There is a risk that a wrong approach is used when attempting to recover assets. It could also take a very long time before a settlement is reached.

    In combination to this, it is not clear to me that after liquidation there will be much value left for shareholders, after considering what assets are actually recoverable, what assets exist that have value and what is that value, what are the write offs, and after all this the bond holders may be paid first. Moreover, there are other issues, such as the repayment of tax discounts given in previous years, and payments of extra tax for written off debts (ie account receivables), since debt write offs can be considered as a form of income (this assumes the business no longer operates, which is the worst case scenario).

    It is also unclear if the Chinese courts give higher priority to unsecured bond holders over shareholders, but what we do know that is that the appointed liquidators are acting on behalf of the bond holders, not the shareholders. So who is their first priority? Moreover, since this is a US listed company, even if there is an equal award to both bond holders and share holders made by the Chinese courts, then for the purposes of distribution, the US laws may then step in afterwards and give priority to the bond holders.

    If the bonds are trading at a discount then this suggest the full amount may not be recoverable even for bond holders. If the bond holders cannot get all their money back, and shareholders get paid after the bond holders, then what does this say about the value of the shares....hence the mystery as to why are the shares still trading even at this level.
    Aug 15 03:26 AM | Likes Like |Link to Comment
  • PWC Zhong Tian: A Chinese Auditor With A Flawless Record [View article]
    The problem with waiting until the auditor resigns is that the share price has already crashed, and the investor's loss is made.

    I am not suggesting that every company be considered as a potential auditor resignation; instead I am saying that waiting for an auditor resignation is not a great strategy. A better approach is to look for potential red flags and then decide if an auditor resignation is likely or not.

    In all cases of Chinese companies that I have researched, there were clear red flags before the auditor resigned.
    Aug 11 04:48 PM | Likes Like |Link to Comment
  • China Medical: Liquidators Request SEC To Suspend Shares [View article]
    I refer you to the paper "Civil litigation against China’s listed firms: Much ado about nothing?" written by the Royal Institute of International Affairs at Chatham House for a good summary of the problems related to recovering money via civil litigation against listed firms in China. Although the liquidation laws have been reformed since the paper was written, which have improved the legal process for shareholders, many other problems remain. The list of problems is too long to mention here. To give you an idea of how immature the legal system is in China for this process, the courts only started hearing such cases from 2002 onwards.

    I have looked at over 50 cases of accounting fraud in China (and am looking at more); this being a mixture of overseas listed and domestic listed Chinese companies. Out of this I also looked at a number of cases where the company was taken to court by shareholders, and in none of them was the outcome satisfactory for shareholders. I could look at more cases but my focus is about the accounting irregularities; if I did look at more cases then I am confident it will be the same story. This is also consistent with what Chinese professors of business have told me, and what I have read in research papers on the topic.

    The case you state with Borelli, where the company maintained operations and creditors were paid in full, was a voluntary liquidation for a company called China Central Power. Of course it is in the interest of the Chinese government to keep that essential public utility service going. CMED is an involuntary liquidation, and a very different business. In fact, we do not even know if the company's operations are still running now.

    Moreover, the liquidators are acting on behalf of the bondholders; they are not acting for shareholders. This article is about what the shareholders get. Presumably the shareholders may get something, but they are clearly not the priority.

    I am not sure if you ask all these questions because you have not done your own proper research, or because you genuinely believe that liquidators in China do not find it any harder to recover funds for shareholders than in the US. You are also hanging on to the success of one person in limited situations that do not resemble anything like the egregious position of CMED.

    It is patently obvious there are clear unique difficulties recovering assets for foreign shareholders in China compared to the US. Yet you attempted to generalize my comment about these difficulties by saying that it could be applied to the US; but in the immediately preceding sentences I specifically mention unique issues in China that clearly indicate it was not the generalization that you suggest.

    If you still have difficulty in understanding what is going on, then I suggest that you neutralize your position, wait for the outcome, and learn from the experience.
    Aug 11 04:28 PM | Likes Like |Link to Comment
  • China Medical: Liquidators Request SEC To Suspend Shares [View article]
    I have done a considerable amount of research in to Chinese accounting misstatements, including looking at cases of fraud allegations for Chinese companies actually listed in China. I can tell you now that even Chinese investors under the protection of the CSRC have a hard enough time getting adequate compensation for their lost investment. In many cases, if there is any success, it ends up as an out of court settlement amounting to a sum much lower than the amount originally pursued.

    Foreign investors would probably have an even tougher time recovering their lost investments. Additional problems include locating the company management, not just the assets, as well as assessing their true recoverable value. For example, if CMED has racked up high accounts receivables with local hospitals (the company recently changed its strategy from dealing with distributors to direct business with customers), then one can imagine the difficulties that foreign share holders and bond holders will have recovering that in Chinese courts. One wonders what the other assets are really worth, and what cash really exists or is spent in an unrecoverable way.

    The debate about whether the shares are suspended or relisted is almost academic if there is little in the way of recoverable assets, except for the window of opportunity to adjust holdings.

    I do understand and respect the point of view that the outcome of liquidation is uncertain with regards to compensation or remaining value to shareholders, rather than simply state that it is zero. However this seems to be a mathematical line of thinking that is more suited for Western style liquidation processes, for Western based assets, for Western shareholders, in a familiar Western legal system. For foreign investors in unfamiliar Chinese courts, where there is no certainty about what assets really exist, what the assets are really worth (apart from the fact that its less than book value), what amount can be recovered (almost certainly not 100%), where are the assets, and where are the management, its hard to imagine the liquidators having much success. We do not even know if there are hidden liabilities. Moreover, whatever might be recovered goes to bond holders first, so there may be little or nothing left for share holders. Such uncertainties make me surprised that the share price has maintained even its current level.
    Aug 9 06:07 PM | Likes Like |Link to Comment
  • Chinese Real Estate Market Perspective [View article]
    A housing shortage in general may not be what the Chinese want. However if this prediction is based on the same number of speculative buyers staying in the market (which may not be the case) but a smaller number of speculative builders, then this forecast could be misleading. I wonder if the supply/demand forecast is better balanced on an underlying basis without either of these speculators, which must surely be the objective. There is also the absorption of surplus unoccupied units to consider, bought by these same speculators.

    A fall in unit prices to more affordable levels is certainly a government policy, although not to the extent that it causes mass bankruptcies in the construction industry.

    The PRC land appreciation tax does a good job in removing some of the upside for speculators, so perhaps this is another useful tool for adjusting the market instead of just bank lending.

    For the more established builders, it appears that they still wish to maintain volume growth to keep the headline number looking good. However in the bottom line, their profitability may be considerably lower with more realistic prices. Moreover, sustained volume growth but with lower profitability could present some working capital problems. There is also the potential for asset write downs. Some builders may offset this if they have an existing stock of cheap landbanks,

    The issue then becomes do they scale down their volume targets, which could precipitate some price recovery albeit with lower sales. Or do they continue volume growth with cheap SOE bank loans but on lower profit margins. In either circumstance, it feels like there are still some challenges ahead.
    Aug 8 06:11 PM | Likes Like |Link to Comment
  • Fueling The China Engine: A View From The Top [View article]
    If the company pays a premium to the current spot price when this spot price falls below the prepayment contract price, then this means that the company's profitability may fall. The extent of this profit fall is uncertain unless the exact terms and mechanism of these contracts are known. For example, these price premiums may be small for minor differences in price, or large for bigger price differences.

    In addition to the risk of prices falling below contract prices, a cost of capital on the amount of advance supplier prepayments needs to be incorporated to account for third party supplier risk. This should then be compared against the reduced risk of rising prices obtained from making large, interest free, unsecured advanced prepayments to these suppliers. The balance of this sum, and possibly other factors, is the net value added or destroyed from this strategy.

    Your research does a good job in highlighting the upside. As I mentioned before, I am just pointing out both the risks and rewards of the company's strategy, and how a professional fund manager or analyst may think when assessing it.
    Aug 3 01:09 AM | Likes Like |Link to Comment
  • Fueling The China Engine: A View From The Top [View article]
    The most common reasons given for large supplier prepayments in China are to protect against inflationary price increases, to contractually ensure security of supply, and to pre-order with enough time to take in to account a difficult supply chain. Some companies argue that it is important to make large supplier prepayments in order to do business in China, whilst other companies manage perfectly fine without making such cash payments. There are also instances where a company will make loan guarantees for their suppliers. If product prices fall, the company is less likely to take a hit on inventory values using the "Lower of cost or market value" concept, since supplier prepayments are not technically part of existing inventories. It is, however, possible for a company to take writedown on prepaid contracts. It is a moot point whether to consider this as smart accounting or a fudge.

    The main concerns with supplier prepayments are that large amounts of capital are locked up with third parties with are generally unsecured and earn no interest. They are technically not subsidized loans, but in cases such as Boshiwa there is a risk that the auditor may view them as lacking in commercial substance. At present, there is no suggestion this is the case with LPH. Supplier prepayments are also difficult for the auditor to verify. Although auditors use confirmations from suppliers to verify the pre-paid amounts, they cannot audit the books of the suppliers themselves to know what the money is really being used for.

    Hedging using derivative instruments is likely to be a cheaper alternative to making large supplier prepayments, however the hedging instrument may not exactly track the specific product or inventory prices of the company. Moreover, a hedging ability requires a high degree of sophistication; there have been cases where SOE's have lost a lot of money as a result of such activities. One can also argues that when prices are controlled, the price fluctuations and hence the need for hedging is much less, but this would equally apply for the need for supplier prepayments.

    Take or Pay contracts could also be used. This has the advantage of not locking up huge chunks of capital, but has the disadvantage of penalty payments if the product is not taken. The merits of this option therefore depend on the size of the penalty payments versus the cost of buying product at very high prices in prepayments if the market price is much lower.

    Supplier prepayments can work favorably when the product price is rising and the agreed contract price is fixed at a rate lower than the prevailing market (spot) rate. If the contract price is not fixed, then this diminishes one of the main reasons for making large prepayment in the first place. When product prices fall below the agreed supplier prepayment contract price, a company may drawdown on its stock of existing inventory instead of taking prepaid supplies. However this strategy only works if existing inventories are valued at a lower price (so profitability is less affected), and there are enough existing lower priced inventories in the event of a sustained period of lower market prices. In other words, if product spot market prices fall but inventory costs are higher, then profitability might also fall if inventories are used. Or if low priced inventories are exhausted then the company may have to eventually use higher priced stocks purchased through pre-payments. The ability to purchase cheaper products instead in the spot market at cheaper prices could be limited if too much working capital is locked up with prepayments. A company could be bailed out of uncompetitively priced supplier prepayments if it is able to pass on the higher prices to its customers, subject to government price controls and competitor forces, however it is diffucult to imagine these customers being happy about paying above market prices if they can purchase cheaper elsehwere.

    In any event, such circumstances suggest that supplier prepayments are not a hedge when supply prices fall, and could adversely affect profitability. This is not a miscalculation. Since the terms of the exacts pricing and volume in the prepayment contracts have not been disclosed, one cannot say that this risk is not valid for this company.

    I write this simply to highlight both the risks and rewards of supplier prepayments.
    Aug 2 02:25 PM | 1 Like Like |Link to Comment
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