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.

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.

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.

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.

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.

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.

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.

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.

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.