Model Portfolio mkoza:TGF

The news coming out of CCME is disturbing. Although I have become somewhat toughened as a result of my experiences in the market and am comfortable taking large losses on occasion to achieve a superior long-term return, I am very unhappy with this situation.

The news: CCME has just reported that Deloitte uncovered irregularities with respect to confirmations of the bank accounts in CCME's subsidiaries. Dorothy Dong, the director representing major investor CV Starr on the Board, has resigned, in light of the CEO's apparent unwillingness to respond to this issue. As a result of these revelations, there is a substantial likelihood of significant fraud within the company, and I currently plan to sell my holdings of the stock unless the proper cash amounts are confirmed prior to the reopening of trading. Please bear in mind that the situation is still fluid, and my views can change at any time based upon new information.

I am just amazed that Starr, Global Hunter and Deloitte (until now) all missed these problems, especially given the amount of prior due diligence that they must have conducted.

A note on diversification: I would never recommend that anyone put much more than 10% of their stock portfolio into any one stock. In my Marketocracy portfolio, I started out with a high single-digit (percentage) position in CCME in early January 2010, and only increased to low teens after the revelations of the Starr investment and DD. This position did balloon to high teens when the stock peaked, but such a concentration should not be taken as recommended allocation. In fact, when asked on a recent webinar whether I would be adding to my CCME holdings at the current depressed price (similar to the current price), I stated that I had plenty enough already (low teens percentage of Marketocracy portfolio) and that there were a number of equally undervalued stocks available in the market, although many of these had much less vetting than CCME.

Posted by Marketocracy at 2:23 PM | Permalink

CFO and auditor have resigned; auditor stated issues related to management's representations. What the issues are should be at least partially revealed in the auditor's resignation letter, which will hopefully be filed with the SEC soon. Apparently the access to CCME's books/contracts that Starr and the analyst had was not sufficient to uncover all potential problems, at least to the auditor's satisfaction. I can no longer recommend this stock; whether I sell or not depends on the contents of the auditor's resignation letter, and on what exchange and at what price the stock opens at. This unfortunate event will be a big hit to my personal portfolio, my Marketocracy portfolio, and my development path.

Posted by Marketocracy at 2:20 PM | Permalink

Upon a cursory review, I believe that the info in the Muddy Waters report is insufficient to make an investment case against the company. The timing of the report release is suspicious, and today's trading volume is suspiciously high at twice the float.

I have neither bought nor sold any CCME shares this week. I do not trade around news events that mention my name in conjunction with the company. CCME remains a very large holding for me, as has been the case since January 2010 when I made my initial investment.

I do not believe that rebuttals from the company are the most effective course of action. I believe that a tender offer for a large number of shares would be the most effective course of action, although I understand that foreign exchange controls may delay the implementation of such an offer.

Posted by Marketocracy at 5:06 PM | Permalink

My definition of intrinsic value ranges from relatively simple to complex, depending on the stock. For most of the Chinese small company stocks, it is simply free cash plus about 10 times earnings for a good grower, 6-7 times earnings for a non-grower. This is based on the current environment, and stellar growers like CCME deserve a higher multiple in line with large peers such as SINA, FMCN, or even BIDU if you think they will grow at >50% for a long time (perhaps too optimistic).

If there is debt, subtract from cash to get the free cash. If there is construction in progress or recently purchased land, I may choose to add that to cash, since this was just recently cash and is not contributing to earnings yet. Some cash is needed to run the business, and must not be counted as part of free cash. If current ratio is at least 2x after removing all cash from assets and all debt from liabilities, no more cash is needed to run the business since it is assumed that receivables/inventory can be borrowed against. If DSOs are >90 days, maybe those receivables cannot be borrowed against, and many small Chinese companies cannot borrow at all. So the calculation must be flexible.

It is more tricky to estimate the sustainable growth rate. I prefer organic growth, but if a company can prove they can grow accretively through acquisitions, they may get some credit for this. Sometimes EPS does not go up because cash was raised by selling stock, so this must be adjusted somehow, by perhaps backing the cash out by undiluting the shares. UTA is somewhat exposed to this logic. Also, companies grow by spending, which can depress earnings temporarily. For a lot of Chinese industrial type companies, I am using 6-7x because, even though there may be organic growth, it may require heavy spending, and I am not comfortable with sustainability of margins; this has kept me out of DYP, ONP, etc. I think this last comment also applies to avoiding value traps. One way to avoid value traps is to buy companies that are growing - such companies cannot be ignored forever.

In China, of course, cash flows are important - I often deduct all sales associated with high receivables to get true EPS. If inventory is immediately resalable, I only deduct the gross profit of the sales associated with excessive receivables, from the pretax income. But if the company sells industrial equipment, esp. equipment constructed on the customer's site (work in progress, unbilled revenues), I may deduct the entire amount of excess receivables from operating income, which often makes the valuation look too poor for investment. This would probably help prevent one from investing in or losing too much on RINO; although their big surge in receivables came late. Also, I discount for companies that are trading way below book value, but are currently losing money/breaking even; half of book value may be fair value for a money loser, maybe even less than that if the path to profitability is long - this prevented me from investing too much in RDN too early, like Mr. Whitman did. Although, oftentimes, I do buy (and sell) too soon.

Posted by Marketocracy at 3:54 PM | Permalink

CCME's business is going strong. A material increase in buses under long term contract to carry their advertisements was announced. A prominent newsletter writer jumped on the "bus". As I have surmised, it is becoming more and more clear that CCME ($17) has a mandate to oversee the placement of clean ads as part of its partnership with the government, and such mandate could mean that the partnership is more likely than not to be renewed before it expires in 2012. Those betting the high margins and torrid growth are not for real are being proven wrong. The forward PE is still a small fraction of what it should be, although you can say that for many Chinese stocks right now.

CELM ($5) - electric motor manufacturer, new buy - 2011 EPS estimates are being increased, forward PE now about 4. Not a reverse merger, but carries a similar discount, perhaps due to pre-IPO transactions that would have been meaningless pre-Sarbox, and are meaningless going forward. There were substantial stock awards to employees in recent quarter, but there was no stock comp previously, so the shock should fade.

HRBN ($16) - CELM's big brother - this linear and rotary motor maker trades at a 33% discount to a credible buyout offer from the CEO. We will hold for the 50% gain, which I expect in the next six months. Forward PE is five, and GS is lined up to provide financing, so I expect this one to happen, and the stock should be much higher in 12 months anyway if it doesn't.

UTA ($6) - travel agency - keeps chugging along, cash is piling up, disclosures are improving. CEO took more of an active role on recent earnings call. More of the allegations from the Bronte and Blodget crowd were discredited. Hotel biz was flat, risk avoidance cited amidst scramble for rooms during Shanghai Expo. They need Priceline's help and should get it, after the learning curve in their partnership is scaled over the next few quarters. New auditor is a small US-based firm with no apparent blemishes for shorts to bash. UTA still has internal financial control issues, mostly related to lack of expertise. The new auditor may help, and a higher profile CFO is supposedly in the works and is sorely needed.

JKS ($25) - solar panel manufacturer, new buy - this one is growing fast, and only a crash in the euro can stop it. Margins are expanding rapidly, as are 2011 EPS estimates. Under an ideal scenario, JKS could earn up to $10 per share in 2011.

SUTR ($2) - steel processor - disappointing quarter, still very undervalued, but better options exist. Selling well below liquidation value, so we won't sell very much here.

XIN ($2.4) - homebuilder, new buy - EPS estimates for 2011 are being increased, stock sells at a forward PE just over 2. Valuation offers downside protection if 2nd and 3rd-tier Chinese residential real estate markets (XIN's markets) go bust - but a heavy-handed Chinese gov't will probably not let this happen. A number of promising projects are about to open for XIN, and market prices are increasing even for its troubled Kunshan project that is experiencing mass mortgage cancellations, so no writedowns appear to be in the offing. The psychology of the Chinese homebuyer is unique and misunderstood by many. That said, lower-priced homes do appear to be selling better in this environment, and XIN's business model of not overinvesting in land should pay off in this regard.

Posted by Marketocracy at 11:21 PM | Permalink

Share offering has resulted in discount to peer multiple; SOLF could post EPS in the $1.50-$2.50 range in 2011 yet trades at only $9. SOLF has a reasonable level of vertical integration (less than TSL, more than JASO). I will sell all remaining JASO and some UTA to raise funds to buy SOLF. UTA has not reported yet and is over 12% of portfolio after recent runup; 10% or less may be more appropriate at this point.

Posted by Marketocracy at 12:31 PM | Permalink

UTA's announcement Tuesday night that its recently (Sept 1) appointed auditor, GKM, has resigned, is disappointing, but not totally unexpected given the negative publicity surrounding controversial reverse merger stocks such as UTA, and the pressure on UTA in particular. Interestingly, GKM did not even wait for the company's conference call, on which many accusations were answered, to resign - hence I believe the resignation was a "fait accompli" dictated by sentiment. UTA was forced (IMO) to seek out a virtually unknown auditor, who they disclosed Tuesday night. Like many other small Chinese companies, UTA has internal control deficiencies, and thus the move to a high-profile auditor such as those in the Big 4 (GKM is affiliated with a Top 10 auditor) may take some time. However, unlike another Chinese company that recently had its attempt to upgrade auditors result in failure, internal control deficiencies were not cited as a reason for GKM's resignation - in fact, no reason was given by GKM, which, given SEC disclosure requirements, leads me to believe that GKM had no material issues with UTA.

UTA may see more weakness here as various short sellers and third-tier commentators such as Henry Blodget make ridiculous challenges to the company. It is also possible that delays in financial filings may occur, or that restatements will be required by the new auditor, but the new auditor's current client list indicates that the new auditor may be somewhat flexible with UTA's accounting procedures, which involve booking a full quarter of revenues and income for acquisitions that close just before the end of the quarter. In any event, I believe that UTA's financial statements give the proper picture of UTA's pro forma cash flows, and that UTA has a sound balance sheet. I will continue to hold UTA, and may seek to buy on weakness.

Posted by Marketocracy at 12:32 PM | Permalink

An investor conference call was held Wednesday to answer numerous questions that had been submitted as a result of allegations by short sellers. All questions were answered and backed up with facts in the positive.

UTA has a thriving online business, trips are 99% booked by Chinese living within China;
thus an English-speaking outsider may see problems where there are none in terms of customer usage of the website. Hotel website is no longer used much; web traffic has been diverted to main (cnutg.com) website. Alexa web traffic statistics back this up; China Rank data is not relevant for specified reasons. UTA utilizes E-ticketing, which eliminates the need for a physical ticket.

All this being said, UTA's online business only accounts for about 70-80% of airline and
hotel booking revenues - most biz is conducted through call centers or done through
wholesale or franchisee channels.

Employee compensation and staffing levels were discussed in detail. Most employees were hired in the 4th quarter of 2009 and are paid mostly on commission, hence the low salary component of cost of sales for the year.

Why is interest income so low? Low interest paid on cash balances was explained: 19MM secondary offering proceeds not earning interest, 25MM bank deposits in HK and US, money market interest rates there are effectively zero. I have seen that some Chinese companies are earning 1% interest, but this is for term deposits (cash not targeted for near-term uses). UTA has acquisition plans for its cash.

According to the company, the former CFO left because his contract was up and he wanted to leave Shenzhen. This may be true, but I also think he just wasn't skilled enough for the position, so he wasn't invited to stick around. I am optimistic that UTA will soon find a better CFO. The new auditor is a step up that had been planned ever since the company moved up to the NYSE.

Financial guidance of $1.35 - $1.40 EPS for the year was reiterated. Cash balance was $2.20 per share as of June 30 and could balloon to $3.50/share by yearend as a result of strong operating cash flows, sale/leaseback of kiosks, and return of acquisition advances.

UTA's annual shareholders meeting is coming up on October 11, and a three-tier staggered board has been proposed. This proposal is probably in reaction to the possibility of takeover attempts. A staggered board is not beneficial to shareholders and must be voted down, in my opinion.

Gencorp (GY)

Gencorp is an aerospace/defense company based here in Sacramento. Gencorp and I go back a long way. My dad worked there in the 50's and 60's. My brother, who currently works there as an electrical engineer, says business is picking up, and he is being assigned a lot of overtime. In addition, a cost cutting program is ongoing. EBITDA is at a $120MM annual run rate, before pension charges. Net debt is about $200MM, and market cap is about $300MM, for a 4x EBITDA multiple. EPS is currently being suppressed by nonrecurring pension charges, which have at least one more quarter to go, based on guidance. The business requires very little capex, maybe 10% of EBITDA. I feel that this business deserves an EBITDA multiple of at least 6 or 7, which would result in an enterprise value of $800MM and a doubling of the
share price.

But Gencorp also has a real estate division, which is in charge of monetizing Gencorp's 12,000 acres of land within a growing residential corridor. Some of this land is already zoned for residential construction. Recent deals in nearby Roseville went off at about $27K per acre. Using this figure, we can value Gencorp's land at $320MM. Thus, Gencorp may be worth as much as $1.1 billion or more, and the share price could triple. In the next decade, the value of this land could increase substantially - during the recent bubble, raw land zoned for development sold for as much as $250K per acre for small parcels, and much more for choice larger parcels. Gencorp sold for $20 a share in 2006, and I think it could get there again.

Posted by Marketocracy at 7:06 AM | Permalink

UTA is one of my top stock picks, trading at a cash-adjusted PE of 1.3.

Recently, problems with the English language version of UTA's main online airline/hotel booking website, cnutg.com, have been exposed. However, it should be understood that, although UTA advertises the availability of tickets to international destinations, UTA primarily serves domestic Chinese travelers. There are no questions regarding the ability to book Chinese domestic travel on the Chinese language version of the website, as long as one realizes that final trip confirmation and payment requires a phone conversation with an agent (unlike Ctrip, which allows complete web-based booking).

The english language version of the cnutg.com website looks like this:

http://en.cnutg.com/

The Chinese language version is here:

http://www.cnutg.com/

As you can see, the Chinese language version has significantly more functionality.

Website cnutg.com's web traffic is about 5-6% of market leader ctrip.com, according to worldwide online web traffic monitor
alexa.com:

http://www.alexa.com/siteinfo/cnutg.com

http://www.alexa.com/siteinfo/ctrip.com

Adjusting for bounces (single page views that do not usually result in a transaction), cnutg.com has about 7-8% of the traffic of ctrip.com.

Per SEC filings, UTA's trip ticketing revenues of $30MM for 2009 are about 11% of Ctrip's $270MM; thus, UTA's revenues appear to be supported by web traffic metrics, given that a greater portion of UTA's transaction time occurs on the phone. Hence, UTA's business is not fictional or overstated, as detractors claim.

Next up - UTA's employee compensation

Comments on Universal Travel Group (UTA) compensation per employee:

Detractors of the stock have stated that UTA's total staff compensation was only about $500,000 in 2009, which translates to only about $700 for each of UTA's 780 employees. This faulty conclusion was used to inspire skepticism of UTA's stated financials and business scale. The detractors only considered staff salaries reported within cost of sales to arrive at their $500K total. UTA's full-time staff consists of 80 administrative employees, 200 marketing employees and approximately 500 call center employees. One would expect that the bulk of the compensation for these employees would appear under Selling, General and Administrative expense line (SG&A). In fact, this is the case. in 2009, UTA reported $3.3 million of "Salary and commission paid" in SG&A. Thus total employee compensation is $3.8 million, not $500 thousand - but we're not done yet. There is another $3.5 million in "Franchise commission paid" reported in cost of sales. Thus total employee compensation expense for 2009 is $7.3 million, or approx. $10K per employee, slightly higher than the detractor's estimate of the average salary in Shenzhen. Thus the claim by detractors that "they don't have the staff or they are very lowly paid or the accounts are wrong" is incorrect, based on the numbers reported to the SEC.

Posted by Marketocracy at 1:02 AM | Permalink

UTA is under attack by Bronte Capital, a prolific short seller. Bronte claims that the UTA online travel-booking website doesn't work and therefore there may be no online travel business as claimed, although there is a phone-based business. Not being Chinese or even web-prolific, I have no way of verifying their claims at this time. Bronte also questions the accounting, although most of the claims result from their problems with the website, and may not be substantiated after further review. Bronte may not understand how UTA accounts for costs, and may be picking and choosing numbers to make their case - this is a common approach by short sellers. However, their claims should be investigated, although this appears to be a quick-hit type of short attack - there has been massive put buying in the last few days. The current market valuation of the stock has already priced in the strong likelihood of massive fraud, so I would not advocate selling at this point, especially since the company has not yet had any time to mount a response.

Posted by Marketocracy at 7:27 AM | Permalink

CCME operates in an ideal environment for advertising - its audience is captive for an average of several hours on its partners' inter-city bus network. A large percentage of passengers are business travelers and the upwardly mobile, ideal targets of advertisers like Coca-Cola, KFC, Siemens, Hitachi, China Telecom, China Mobile, Nokia, Procter & Gamble, and China Pacific Life Insurance, all of whom are direct or indirect customers of CCME.

CCME is first mover in its space. They are not a serial acquirer like VISN (commuter bus display operator), and did not have to buy out all distributors prior to going public like FMCN (elevator display operator). This allows CCME to maintain gross margins similar to FMCN's LCD display advertising segment and also allows CCME to keep SG&A very low as a percentage of sales. Yet, SG&A is still at a believable level. SG&A is about a third of COGS, similar to VISN, AMCN, and IDI.

Deloitte as auditor - best auditor in China, audits one-third of companies trading in Hong Kong, handled biggest IPO in history (China Ag Bank).

An investor with an impressive Asian track record owns all $30MM of CCME's non-dividend paying convertible preferred. Starr International owns this preferred stock and is controlled by Hank Greenberg, who built AIG from Asian roots.

The company is very transparent and shareholder friendly - CCME had Investor Day on September 7: http://www.ccme.tv/en/vedio.aspx?id=9

Strong cash flows - Despite 160% revenue increase in first half YOY, and 10 million LT prepayment, operating cash flow was only slightly less than net income in the first half.

Large competitive moat - Government regulator has given CCME exclusive rights to new business on inter-city buses until 2012. Most inter-city bus operators (which are essentially suppliers to CCME) are small and state owned and have little bargaining power. Contracts with these operators are long - 5 to 8 year terms. CCME controls over half of its market.

Risks: Other newly public Chinese advertising companies have faltered due to lack of sustainable moats, late entry into markets, and management focused on the short term. CCME stock has been heavily shorted. There is also the potential for insider selling as lockups expire. There are still some low-priced warrants outstanding. CCME came public via a SPAC (Special Purpose Acquisition Company), which generally gets just as much scrutiny as an IPO. However, a SPAC is still a form of reverse merger, and reverse mergers have been the subject of numerous negative articles. Some small reverse-merged companies have accounting problems, which is not a surprise due to onerous US accounting rules and Sarbanes-Oxley. In some isolated cases, financial results of reverse-merged Chinese companies (FUQI, CSKI) may have been intentionally overstated. However, the problem companies usually give telltale signs (such as unusually high margin businesses that appear out of nowhere and are out of line with peers, inability to get a registration statement declared effective by the SEC, etc.), and these signs are not present for CCME.

Despite the large near-term pressure on CCME's sector, I believe that the long-term outlook for this stock is very good.

Posted by Marketocracy at 9:56 PM | Permalink

EXXI (NASDAQ) Energy XXI

I am still high on this company, but, contrary to the party line, the drilling permits are still not flowing for shallow drillers such as EXXI, and I am afraid that this environment may persist beyond the short term, and possibly through the remainder of Obama's presidency. Only two permits have been issued since the early June release of new rules for shallow water drillers. This is a tiny fraction of normal permitting levels. I am cutting my price objective by $10, to $30-$40. As the lower end of this range is less than double the current share price, I may reduce my holdings to 5% of my portfolio.

Posted by Marketocracy at 10:16 AM | Permalink

UTA (NYSE) Universal Travel Group

This is a Chinese roll-up of travel agencies and online ticket reservation companies. Effective net cash is $2.50/share, and I expect the company to earn $1.50 EPS in the next twelve months. Stock price is $5, so cash-adjusted PE is 1.7. The company recently had difficulty explaining a decrease in gross margins, leading to an analyst downgrade and CFO resignation (CFO was unable to accurately portray results of UTA's complex array of businesses, IMO). UTA is not as steady a grower as CTRP, but UTA's more diversified business model may hold up better long term, especially if the roll-up strategy pays off (it can be difficult to execute consolidation in fragmented industries in China). UTA recently partnered with a subsidiary of Priceline. With a no-name auditor, virtually no analyst coverage (price target cancelled), CFO resignation, and China bubble syndrome, this stock would be regarded by most as very risky, but I believe that the weakness of the bubble argument, the Priceline partnership, co's believable strategy and margins, co's willingness to use cash to grow the business rather than sitting on it or buying real estate, CFO quitting explained by poor performance and flighty track record, and extremely low market valuation, reduce the risk level and make this stock very attractive on a risk/reward basis. Price target $15 near term, $50 in 3 years.

Posted by Marketocracy at 10:13 AM | Permalink