Thoughts for Monday open: sell, do nothing, buy?, page-9

Hi Guys,

This is an interesting situation - have the shorters missed the mark here with TFC/ QIN or are they on the money and have they uncovered a significant fraud?

I am a LT investor and have followed the TFC/ QIN story since near inception after a recommendation by a NZ publication, Market Analysis.

TFC/ QIN has certainly weathered a number of storms to get to this point - including the GFC, the demise of the MIS tax schemes, the withdrawal of their major Australian bank funders, issues around mortality rates and oil yields and a Board stoush for control of TFC back in 2014.

Has all of this been a very long run ponzi scheme or is this that nature of building a very difficult business that:

(1) Being forestry relies on a large lead time between capex investment and operational cash flows, and

(2) Is based on a brand new cultivated product that hasn't been done before that presents all sorts of uncertainties before certain milestones are achieved.

TFC/ QIN is certainly a prime target for criticisms and attacks due to 1 & 2 above. Some of them valid, such as a reliance on capital markets to fund the plantation development until operational cash flows, and some less so.

The fact that their financial accounts, due to regulatory requirements, consists of a high % of non-cash profits/ losses from the revaluation of biological assets, makes the company seem opaque.

In regards to the merits of Glaucus's accusations there is some new information for investors (e.g. possible issues with Chinese customers) and some uncertainties that we have known about for some time (oil yield and future pricing for Indian Sandalwood uncertainties).

There are also some blatant falsehoods in Glaucus's report, carefully worded to avoid litigious actions but clearly designed to lead investors to a certain conclusion.

I will leave any factual rebuttal to TFC/ QIN itself, if they so choose.

It is encouraging, however, that the founder, Frank Wilson has such a huge stake in TFC/ QIN (49m shares). It would not be logical for FW to have such a large personal stake in TFC/ QIN if this was a ponzi. Instead you would think he would have minimal exposure to equity.

I have, however, provided two external notes of interest.

The first, is the wikipedia history of Sino-Forests, a Chinese based forestry company that turned out to be a fraud and was called out by Muddy Waters. Sino-Forests eventually went into bankruptcy. It appears that Glaucus is making similar accusations of TFC/ QIN. Are they correct? I don't know. At least we know that the plantations exist and any Australian can drive past them or tour them.

The second piece is an email sent out by Market Analysis over the weekend talking about the short attack by Glaucus on TFC/ QIN. Whilst it doesn't rebut any of the accusations it is a good read for concerned investors. I would recommend Australian investors consider subscribing to Market Analysis as they are a good research house with a long standing track record of outperforming the market.

Cheers
John

Wikipedia - Sino Forests
Fraud allegations[edit]

On June 2, 2011, shares in Sino Forest plummeted following the release of a negative research report ^[10] by Carson Block of Muddy Waters Research, which made allegations that Sino-Forest had been fraudulently inflating its assets and earnings, and that the company's shares were essentially worthless. Muddy Waters claimed that Sino Forest was a "multibillion-dollar Ponzi scheme" that was "accompanied by substantial theft".^[11] Sino Forest rejected the allegations of fraud and launched an independent investigation by PricewaterhouseCoopers.^[11] Shares in Sino Forest fell by 82% following publication of the Muddy Waters report,^[12] with prominent investor John Paulson selling his entire stake in the company at a $720 million loss.^[13]
On June 30, debt rating agency Standard & Poors downgraded Sino-Forest's long-term corporate credit rating from "BB" to "B+". A second downgrade to "B" followed on August 23.^[14]
On August 15, 2011, Sino-Forest announced that the results of the PwC probe into the allegations would be delayed to the end of the year due to difficulties in gathering data from the Chinese companies involved.^[15]
Suspension of Trading of Shares[edit]

On August 26, 2011, the Ontario Securities Commission suspended trading of the shares of Sino-Forest, stating that the company had engaged in practices they "knew or should have known" perpetuated a fraud.^[16] The OSC also initially ordered that five directors of Sino-Forest resign, but rescinded this demand a few hours later as the Ontario Securities Act does not allow the commission to summarily force the resignation of a company director without a hearing.^[17]
Bankruptcy Protection[edit]

On March 30, 2012, Sino-Forest filed for bankruptcy protection in Canada under the framework laid out in the Companies' Creditors Arrangement Act.^[18][19]
On April 4, 2012, Sino-Forest's auditors, Ernst and Young, resigned. ^[20]
Defamation Lawsuit[edit]

On March 29, 2012, one day before filing for bankruptcy protection, Sino-Forest sued Muddy Waters in the Ontario Superior Court of Justice for defamation. Sino-Forest sought damages of $4 billion.^{[21] [22]} In response to the lawsuit, Muddy Waters stated that Sino's bankruptcy protection filing vindicated its accusations since the company would not require bankruptcy protection if it was really generating close to $2 billion in cash flow.^[18]
Settlement of Investors' Lawsuits[edit]

In 2015, the firm's auditors Ernst and Young, a group of financial institutions (Credit Suisse Securities (Canada) Inc., TD Securities Inc., Dundee Securities Corp., Merrill Lynch Canada Inc., RBC Dominion Securities Inc., Scotia Capital Inc., CIBC World Markets Inc., Canaccord Financial Ltd. and Maison Placements Canada Inc.), and former Sino-Forest chief executive David Horsley paid $117 million, $32.5 million and $5.6 million respectively to settle investor's lawsuits. ^[23]


Market Analysis - Weekend email

Quintis Ltd (code QIN), formerly TFS Corporation, has been the subject of a short selling attack by US based Glaucus Research Group (glaucusresearch.com).

Glaucus make numerous serious accusations against Quintis and value the shares at A$0.00 (i.e. nothing, suggesting the company will end in bankruptcy court).

Glaucus is a “short seller”.  It seeks to identify troubled companies, then borrows shares and sells them, hoping to make a profit when the company fails.  

Waiting around for a company to fail is, of course, uncertain and time consuming, so Glaucus seeks to speed up that process by releasing its research reports (some may say “poorly researched and self-serving” reports) to a wide audience.  This can cause the share price of the target company to collapse and Glaucus can buy back shares at that lower price to cover its short position.

Short selling data on Australian companies is released after a delay of about one week.  Our Online Share Selection database shows the short interest in Quintis/TFS Corporation is currently 14.5% [Note that owing to the one week reporting delay, that is the short interest at the start of the last week].  Short interest in the company was between 5.0% and 9.2% since mid-2015, but rose to 10.1% at the end of November 2016, 11.1% in December, 11.5% in January and 12.3% at the end of February.

Only the total short position is reported - and there is no requirement for short sellers to disclose their individual short positions to the market.  So of the current 14.5% short interest (i.e. 56,517,599 shares borrowed and sold short), we do not know what percentage has been sold by Glaucus.

As we said above, Glaucus makes numerous serious accusations against Quintis.  Quintis may or may not choose to respond to any of those allegations.  But before you become too concerned about what may be going on at Quintis, have a look at some of Glaucus' other recent targets: Hong Hong listed CT Environmental Group (attacked on 23/11/16), Nasdaq listed National Beverage (attacked 28/9/16), Hong Kong listed Tech Pro Technology Development (attacked 28/7/16) and Japanese listed Itochu Corporation (attacked 27/7/16).

A sample (in alphabetical order) of Glaucus allegations against its earlier  targets includes “accounting impropriety”, “blatantly violating securities laws”, “den of thieves”, “earnings manipulation”, “fabricated financial performance”, “fabricated financial statements”, “falsifying documents”, “fraud”, “fudged facts” (by a “convicted criminal”), “ludicrous corporate governance”, “manipulation to avoid recognising losses”, “undisclosed related party transactions”, “undisclosed stock gifts” and “questionable one-time gains magically appearing”.

By comparison, the people running Quintis look like choirboys and scouts!

The Glaucus attack on Quintis appears to have been timed to coincide with its change of name and stock code - perhaps to create more uncertainty and confusion in the market?  The shares closed on Tuesday at 141½ cents, then closed down at 131 cents on the day the report was released.  The shares then traded under the new QIN code on Thursday, closing at 113½ cents andon Friday closed at 110 cents (after an earlier low of 97½ cents - down 31%).

So what next for Quintis?  The best answer to that may be to look at Glaucus' previous targets.  If this short seller is genuinely disclosing serious corporate fraud then its target company share prices should fall sharply and head lower as the companies fail.  Here is what actually happened:

Itochu Corporation:
The shares traded at Y1262 before the attack and Glaucus valued them at Y631.  Over the first week the shares dipped to a low of Y1141 (down 10%) and over the next seven months appreciated to a current price of Y1622.  The board members did not have to “resign in disgrace” and presumably profits were not as “manipulated” and “inflated” as Glaucus believed?

Tech Pro Technology Development:
The shares traded at HK$2.27 and Glaucus valued them at zero.  This report came a week after another short seller had targetted the company suggesting its business was deteriorating and it lacked sufficient financing.  These shares quickly fell 94% to HK$0.14 (helped by a large end of day sale under a margin call), bounced to HK$0.23 and now trade at HK$0.16.

National Beverage Corporation:
The shares traded at US$46.48, Glaucus valued them at US$16.15 but this “faddish stockmarket darling du jour”, accused of “fake invoices”, “falsifying documents”, “earnings manipulation”, “ludicrous corporate governance” and numerous “undisclosed related party” transactions appears to be even more popular with the market!
The shares dipped to US$42.67 (down 9%) on the Glaucus report and over the last five months have almost doubled to US$80.29.

CT Environmental Group:
The shares traded at HK$2.14, with Glaucus valuing them at HK$0.38.  The shares of this “Den of Thieves” fell 38% to a low of HK$1.32 in early December 2016 but have since recovered to HK$1.87.

Results of Glaucus Research​

Despite the very serious nature of the Glaucus allegations, two shares fell only about 10% on the Glaucus “exposure”, then rose 30-70% above levels before the report (and up 40-90% on their post-report lows).  One share fell 40%, then recovered to be down just 15% (or up 40% on its post-report low).  Only one company fell to lose over 90% of its value.  That happened virtually instantaneously.

At best that is a 25% success rate . . . but any company whose share price is forced significantly lower for any reason is likely to fail.  If a share price falls 80-90% then the banks will cancel debt facilities and recall loans, creditors will cut off credit and demand payment in advance, customers will seek more financially secure suppliers and important employees will probably look for new jobs.  No business can survive that.

Summary and Recommendation​

Short selling is a very risky business!  An investor who owns a share has limited (i.e. 100%) losses but unlimited potential for gains.  A short seller has limited gains (i.e. 100%) but facesunlimited potential losses!

Glaucus is free to choose targets with serious problems but, even after manipulating the stockmarket to drive down share prices, appears to have little better than a 25% success rate.  An investor buying into a Glaucus short selling target a week or so after the attack would appear to be able to buy near the post-attack low!  In three out of the four most recent cases the share price then appreciated 40-90%!

Perhaps one of the reasons that the share price will recover from this initial sell off is that Glaucus and other short sellers must eventually enter the market and re-purchase all of the shares they have sold short.  In the case of Quintis this is 52,517,599 shares or 14.5% of the issued capital.  Trading volumes were 9-13 million shares per day since the attack, but are usually around 0.5-1.5 million shares per day.

Publishing a very negative research report can generate a selling panic and push the share price lower.  Trying to buy-back fifty million shares to cover short positions could potentially trigger a buying panic and push the share price higher!