Folli Follie: The Other Greek Parmalat?

Summary

• The image we received from reviewing FF’s financial statements and official declarations over the year is that of a rapidly-growing multinational fashion company.
• Unfortunately, following an extensive investigative and due diligence work, we find it impossible to reconcile that picture with our findings on the ground.
• The core of the issue seems to be concentrated in FF’s Asian and, particularly, Chinese subsidiaries.

Executive Summary

The image we received from reviewing Folli Follie’s (OTC:FLLIY) financial statements and official declarations over the year is that of a rapidly-growing multinational fashion company led by double-digit growth in its key segment: Asia. Unfortunately, following an extensive investigative and due diligence work, we find it impossible to reconcile that picture with our findings on the ground, which point to an unprofitable, struggling company with materially smaller, and rapidly decreasing revenue, network size, and cash balances. The core of the issue seems to be concentrated in FF’s Asian and, particularly, Chinese subsidiaries. Our conclusions are well substantiated by the following points that will be reviewed in depth in this report:

• A. The network of points of sale (POS) appears materially smaller than expected: We performed an extensive due diligence and checked each individual POS, often in multiples ways: contrary to the 630 POS mentioned in the 2016 annual report for the FF brand, we found evidence of only 289 operating POS. The majority of the remaining ones appear to have ceased operations.
• B. Onsite checks: We personally visited several FF POS in key strategic locations (e.g. New York City and Tokyo, Japan) and can confirm that many critical assets of the company, still appearing on its website (e.g. FF Soho or FF Madison Avenue shops), are indeed closed. We also noticed how a number of POS, including in key locations, appear to be of negligible size (often just a small window) and in the process of liquidation.
• C. Digital presence: We ran an audit on FF presence online, checking website traffic and popularity on social media and benchmarking it against FF competitors. Our findings suggest that FF digital presence, especially in Asia, may be indicative of a far smaller company.
• D. Financial analysis: FF official figures indicate growing revenue and profit, but constantly negative free cash flow, the bulk of which is explained by large and increasing working capital in its Asian subsidiaries. The amount of account receivables and inventory of FF Asian subsidiaries seems clearly disproportionate compared to its peers.
• E. Chinese subsidiaries: FF claims $1bn of revenue originating in Asia, of which China has presumably the lion’s share (70% of the Asian network would be located there). Surprisingly, we found that the only two mainland Chinese subsidiaries of FF, Fu Li Fu Lei, and Binlianyun generate only some $40m of revenue and together count only about 50 POS.
• F. Concerns about auditors: After auditing their accounts for several years through Baker Tilly, a 2nd or 3rd-tier accounting firm, FF recently switched to “Ecovis” a relatively unknown firm. Moreover, the auditors of the entity consolidating FF sales in Asia, totaling approximately $1bn, appear to be an obscure firm with a staff of only two people. According to senior Chinese auditors from Big Four firms, this firm may well be inadequate for an audit of this scope ($1bn of sales; hundreds of POS in multiple countries).

Analyst’s Disclosure: I am/we are short FLLIY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Alexander O. Stahel]

Where are the longs today?

FF Group filed for insolvency. End of story and all the lies.

[Jean-Jacques Rousseau]

I'm not a long/short - no position ever - but they didn't actually file for insolvency, just applied to the court for temporary (max 4 months allowed by greek law) creditor protection... Anyway, they have it temporarily until the court will rule on September the 12th on this, and they might alway reject the FF request...

My take, this is a move to protect the majority shareholder family from criminal fines etc as they have also asked for creditor protection..

All the best.

[phantom_X]

forensic audit shows FF exaggerates Asia revenue by 1000%

[Alexander O. Stahel]

For the doubters: Bloomberg, 07/17/2018 14:03:56: Folli Follie says its statutory auditor, Ecovis VNT, informed the company that they revoked their support to their audit opinion dated April 26 2018 on Folli’s consolidated financial statements for the financial year ended December 31 2017, according to Athens Stock Exchange filings.

Clearly, there is more bad news to come. It does not take a genius to conclude that the $350m cash reported in FF Sourcing Limited Hong Kong for 31/12/2017 are a false representation. In my view, it is likely that the company will struggle to refinance part of all of the currently outstanding 2019 & 2021 bonds once the forensic work and the subsequent E&Y audit is over.

[DeepValuePlay]

Not to say you're wrong, but there are plenty of reasons unrelated to the cash balance for which the auditors would revoke their opinion.

[Arian7]

Fosun position now is 16,37% of the total shares

[8thwonder]

Management also buying shares yesterday

[DeepValuePlay]

Link please

[8thwonder]

Just look at the announcements on their IR page

[DeepValuePlay]

Found it. They announced they MIGHT buyback shares. Any indication on whether they bought or not?

Management response seems very unconvincing considering they have ALL the information. Something definitely smells fishy. Now a big 4 company will reissue the 2017 financials... If they find anything it can send the stock down even further and until they finish their audit we probably won't receive the 2018 quarterly financials. I see downward pressure on the stock in the short run.

In the longer run it depends on the results of the big 4 audit...

In the even longer run retail is dead LOL

I'm waiting this one out for now.

[Dee-Lite]

Yeah good idea let's all buy those shares now, they are so cheap and there's so much hidden value in there

[Arian7]

Fosun bought shares. Fosun position now is 15% of the total shares. Why a chinese company will increase its stake in a campany that doesnt have the shops that is condider to have in China?

[atilacraft]

Im Spanish and live in Spain. I constantly visit big Spanish shopping Malls called El Corte Inglés where I see Folli Follies corners. I have checked the list of POS disclosed by QCM inCorte Inglés stores (26) and compared it with the numer of POS disclosed by the Corte Ingles Webpage (nearly 60). If there is such a difference only in the spanish market I guess the Due Diligence made by QCM doesnt seem very reliable. Attached is the link

http://bit.ly/2rnMISz

[Alexander O. Stahel]

The store network issue is in Asia, not Spain. The main issue is FF Group Sourcing Limited which consolidates 75% of all sales worldwide and which clearly is a black box.

[p.giannakakis]

Share buyback of up to 10% of the outstanding shares just announced.

Let's see if they are really going implement it.

http://bit.ly/2HYbfIj

[8thwonder]

@Arian7 where did you find info that they hired a big-4? Can you provide a link?

[Arian7]

http://bit.ly/2jFnWsD

[Arian7]

http://bit.ly/2JY9GGQ

[Arian7]

Folie folie hired a big-4 audit company. The company is not a fraud. Obviously is not a well managed company but not a fraud. Obviously now is fairly undervalued if you condiser that FF position only on Dufry shares cost 250million.

[Alexander O. Stahel]

They were ordered to hire a big 4 auditor. That is not the same as them hiring. They have to or else the regulator suspends shares from trading. Message: the board is not in charge, it is the regulator. We will now what they are in some months time.

[8thwonder]

They were ordered to hire an independent audit, not a specific firm. Which firm is up to the discretion of the company.

[turkisheye]

I saw the list from FF Group, haven't had loads of time but I went through the top 20 Chinese "closed POS" on QCM's file today and there was no discrepancy between them and what FF Group are claiming (i.e. QCM verified that stores FF Group say don't exist, don't actually exist). For the rest of world I found only 5 discrepancies, the only English language store, called Bella Mia Boutique in Northern Ireland, has a good website that was easy to find and is still accepting orders. This is despite QCM's claims the store is shut and the space available for rent! If anyone finds a fraudulent store in FF Group's up-to-date list would be great if they could post it here...

[8thwonder]

FF Group released a list of all POS today. Very interested to see how this reconciles with what QCM ends up publishing.

[Dee-Lite]

One last point for today:

how come a large group so dependent on Internet-generated traffic and sales can afford a very obsolete POS locator on its core website:?

Can I risk a pun here and say this is pure Foolish Folly!

[Dee-Lite]

I believe QCM have many valid points of major concern:

poor Internet traffic, just as FF Group try to counter-attack invoking a rebalancing from brick-and-mortar into web-based sales. So if they do close POS, why did they not mention that shift in strategy in their disclosures?
Why do they make announcements about significant push in the US while closing their few flagship stores in NYC, but one or 2?

auditing and duty free sales via airlines: how is that auditable through a man-and-a-dog company like Chung & Partners?
how about the huge inventories impairing the FCF? Having massive inventories and aged payables recognized as Creditors is never a good sign of a brand selling well.

Fashion industry is quite volatile especially in a second-tier market like affordable luxury where brand power can erode very fast and that seems to be the case with FF

While the chairman invokes the 35 years of hard work, certainly valid in part, this does not disprove QCM's findings of late at all. Changes of fortune do happen faster than we might think, and the problem here is the cooking of the books in order to try and cover up that change in trends and results.

Interesting points made separately on the bond issues and I hope QCM can answer that though.

[p.giannakakis]

Here is something that could be of interest.

Before and after 2014, the same people audited the consolidated financials.

From the 2014 annual report:

"29.12.2014
EGM Decisions 29.12.2014
The decisions of the Group’s Extra-Ordinary Shareholders’ General Meeting dated December 29th, 2014 adopted the following resolutions:
...
2. The General Assembly re-elected the appointed by the General Meeting of the 20th June 2014 Certified Auditors of the Company, namely Messrs. Chryssoula Tsakalogianni daughter of Georgios (SOEL Reg. No. 23811) as Regular Certified Auditor and Georgios Varthalitis son of Ioannis (SOEL Reg. No. 10251) as Alternate Certified Auditor, who are today members of the audit company under the name “Baker Tilly Greece – VNT S.A.” and elected the latter as audit company. 38,219,382 shares voted in favor, i.e. 83.29% of the total shares there represented. 6,796,717 shares voted against, i.e. 14.81% of the total shares there respresented. 873,527 shares abstained, i.e. 1.9% of the total shares there represented."

From the 2015 annual report:

"More specifically, today the Shareholders General Meeting adopted the following resolutions:
...
4. Election of Mrs. Chryssoula Tsakalogianni, daughter of George, (SOEL no. 23811), as an ordinary Chartered Auditor – Accountant and Mr. George Varthalitis, son of John, (SOEL no. 10251) as a deputy Chartered Auditor – Accountant, both members of the auditing company “V.N.T. AUDITING S.A.” (ELTE no. 045 and SOEL no. 174 under the trade name “VNT S.A. Certified Public Accountants”, for the fiscal year 2015 and definition of their remuneration due for that year. 41,716,399 shares voted in favor, i.e. 84.87% of the total shares there represented. 6,119,943 shares voted against, i.e. a percentage of 12.45% of the total shares there represented. 1,317,412 shares abstained, i.e. a percentage of 2.68% of the total shares there represented."

[George Kesarios]

@Dee-Lite

Sorry I do not have an opinion on the matter. Would take too long for me to formulate an opinion, and I have no intention of doing so.

[p.giannakakis]

STATEMENT OF FF GROUP’S CEO, GEORGE KOUTSOLIOUTSOS

http://bit.ly/2rpi8Hf

Tomorrow is gonna be an interesting day.

[atilacraft]

By the way, Quintessential is a long short Hedge Fund based in Cayman with Bloomberg reported assets under 50 miiilion USD. I wonder why they are using information from 2016 annual report when they have the 2017 annual report published. I also noticed that in the report thay mention tha FF Group has issued a 300MM bond in 2017 when that information is false. FF group only has outstanding a 250MM Convertible Bond maturing in 2019 and a swiss franc 2021 Bond with 125MM Outstanding. In the shareholders general meeting dated in June 2017 the board announced the possibility of issuing a 300MM EUR Bond "the issuance of the mentioned bond will take place as soon as the market conditions are considered to be appropiate". That bond was never issued.

[8thwonder]

Agreed. The google maps/store argument is completely irrelevant. Also doesn’t make sense for a 30% owner + 13% Fosun to commit fraud. The company’s response to the short thesis was strong, albeit the most concerning point is around the Chinese auditor, which the company didn’t address, which is worrisome. Somebody is obviously lying, just hard to tell if it’s QCM or FF Group.

[Alexander O. Stahel]

Quite easy after today and tells u how weak your above assessment was!

[turkisheye]

I will disclose up front I'm long the stock here, but I want to make three quick points.
Firstly, on Google maps you can "search this area" for different stores, and as a quick sense-check across a random selection of Chinese cities (Chengdu, Changsha, Wuhu, Shenzhen and Guangzhou if it's of interest!) you get 14 FF stores, 20 Coach, 17 Pandora and 3 Michael Kors. This doesn't seem too out of step with the reach implied by reported numbers and doesn't back up QCM's suggestion that FF Groups true Asian sales could be <10% of Coach's... Interestingly my nearest FF store, in Geneva, isn't on the store locator despite being open, so while a key part of QCM's thesis is that the store locator is actively fraudulent it is more likely just out of date.
A second point is the confusion between a point-of-sale and a store and the implication this is reflective of deceit from FF. Often (for both them and peers) a point of sale is a few cabinets or shelves in a larger multi-brand store. This also explains why phoning a store which sells multiple brands and asking about FF's opening hours got so many negative responses. Photos are also selective, on Streetview you can compare the Ginza Coach and Ginza Folli Follie that appear in the report and they look the same size to me.
Finally I take comfort from the 10% stake held by Fosun, it sounds like they are happy FF have a good presence in China and I would like to think a company with huge domestic operations would know?

[phantom_X]

If FF truly has inner value, Fosun may want to privatize the company, at current 2 P/E multiple.

[phantom_X]

Fosun is caught in another shithole lol. heard that Guo bought stake just because his wife is fan of the brand