Friday, September 7, 2012

Focus Media: calculating losses on disposal


I have been thinking a little about the last post - where I quoted Focus Media's accounts. They purchased several business for very precise dollar consideration. For example they purchased WonderAd for $14,926,003 and they disposed of it (to the original owner) later for  a loss of $14,926,003.

This was after the the businesses had operating losses in aggregate larger than original consideration paid.

I interpreted this as WonderAd being given back to the original owner.

Now I am not quite sure. My concern is best seen by example:
Suppose I buy a business for $10 million. 
Moreover suppose it has $3 million in property plant and equipment (subject to depreciation) and $7 million in goodwill. 
Then a year later it loses $12 million in operating losses. $11 million of that was "cash losses". The other million dollars was depreciation. [Obviously I will need to inject some cash to cover the cash losses...] 
Now I give it back to the original owner for no consideration. What is my final loss on disposal? 
The  $7 million of goodwill has never been written off (so that is a loss on disposal). 
Also there remains $2 million of property, plant and equipment. ($1 million has already been expensed through the operating losses). 
This gives a loss on disposal of $9 million not $10 million,
My loss on disposal does not equal the purchase price. It is sort of logical it shouldn't. After a year of running the business the assets and liabilities of the business will not be the same as when I purchased the business - and hence the loss on disposal should not equal the acquisition price of the business.
Except by luck. A lot of luck...
I thought at first it might be possible if the business had no depreciable assets. Then the depreciation adjustment as per this example would not be there.
But the business would also not have to have variance in receiveables, payables etc. Otherwise all these would go into calculating the loss on disposal.
If the loss on disposal equals the purchase price an awful lot of luck would need to be involved.  
Now lets get back to the disclosures in the last post.

WonderAd was purchased for $14,926,003 and disposed of with a loss of precisely $14,926,003.

Either the accounting is wrong or there is luck to six significant figures.

And Jinhua was purchased for $7,659,158 and disposed of with a loss of precisely $7,659,158.

Either the accounting is wrong or there is luck to five significant figures.

And Wangmai was purchased for $2,749,158 and disposed of with a loss of precisely $2,749,158.

Either the accounting is wrong or there is luck to five significant figures.

I could go on - but in order to make this work I need either no depreciable assets or luck to maybe 25 significant figures.

I figure the accounting is probably wrong.

And it is not as if these are small businesses. These subsidiaries declared over $127 million in revenue and over $170 million of costs during 2009.

A business with that much revenue and that much has receiveables and payables that change all the time. It has depreciable assets such as computers, and furniture. It has obligations.

I have struggled for another explanation - but as far as I can see the accounts need to be restated. Does anyone else have an explanation?

Whatever - this company has restated the accounts many times and so far these have not dampened the ardour of longs. One more restatement won't hurt.

Hop-to-it Deloitte.




John

There is an alternative explanation for this mistake. They just made up the losses - because they needed fake losses to offset fake profits as explained in this post. Because they made up the losses they missed the subtlety that loss on disposal does not equal acquisition price.

This is a key issue for the due-diligence.

I would prefer think they just got the accounting wrong as they have before (and with no real impact on the stock). However if they have made up these losses it is extremely bad for the take-private transaction. If they are fake (that is made up) losses they are there to balance fake (as in made-up) profits. When the fake losses go away the real (lack of) profitability will be exposed and the company will not be able to service the debt that the PE firms load it with.

13 comments:

local.god said...

Maybe they purchased 100% goodwill to simplify the accounting.

John Hempton said...

Even if they did purchase 100 percent goodwill they would have accumulated assets and liabilities in the time that they ran the business. They ran most of these for over a year.

Paul Gillis said...

FAS 141R allows retroactive adjustments to purchase accounting for up to a year after acquisition. That might explain some of these situations, but not likely all.

Anonymous said...

You might be able to resolve this by getting in touch with the disposed companies directly. A few are pretty easy to find with a web search.

Anonymous said...

Just speaking theoretically, could there be a Credit Mobilier type thing going on, where the directors have unstated relationships with allegedly arms-length subsiduaries ?

I mean, company buys company X, and then sells it a bit later to insiders ?

Anonymous said...

Shouldn't the changes in asset and liabilities during the course of operation flow through the income statement already?

JM said...

John, How do you explain AllianceBerstein increasing their stake to 14.7%? They're not in the merger arb business and i don't they're particularly knowledgeable about China. They're also not the type of investors to step in here and pound the table asking for more than $27 / share. How can they justify to their clients to come in here, play for $2.5 and risk losing it all?

Anonymous said...

"An editorial in the official Xinhua newspaper accused foreign short-sellers of a “malicious act” in targeting Chinese companies listed in the US. It called on the SEC to investigate short sellers. Negotiations between US accounting securities regulators and their Chinese counterparts have still not reached a solution to allow American inspections of audit firms or access to their paper work."

Anonymous said...

Funny thing - from your latest series of posts, it sounds like being a bad accountant is a really good thing. Can blame 'em if they can't get the rules straight!

JM said...

Nevermind. AllianceBernstein filed another 13D and is now at 3.1% holding / 4mm shares.

Anonymous said...

Has anyone looked into the irony of Xinhua posting an attack on short sellers when the Chairman, Jiang Nanchung, has a father (Jiang Weiqiang) who runs the international office of the state information council? Basically a guy who runs one branch of the China media control borg has asked his mates to attack people who are trying to stop his son's company getting taken out.

Additionally, how did Jiang Weiqiang, a lowly public servant on a Chinese public servants salary get the cash to make his son's company a $2.5mm loan in 2006 when the company allegedly had a lot of cash? Its just bizzare.

Donald Shekels said...

John,

Not sure if you got my previous email but just reading your latest write up on focus media consider this theory.

Those BVI entities were SPV's holding paper issued from certain CDO's related to housing bets (other side of micheal burry's trades).  Not all those housing CDO's went to zero, hence why some of the original sellers purchased them back at close to nothing...or in 2 cases at nothing.

The housing loses went somewhere and I believe they would up on the balance sheets of certain publicly listed corporations.

I've touched on this briefly on my blog and in the near future will provide an example of one of the housing studs and his undertakings in a corporate bonds...a publicly listed company who was invested in 6 different limited partnerships which I believe were invested in toxic paper issued from certain CDO's tied to housing.

Donald Shekels
CycleofStructuredNonsense.blogspot.com

Anonymous said...

john,
i did some searching.
it seems the ceo's dad is not the suspected officer.
this is the picture of the officer:
http://www.hudong.com/wiki/江伟强

this is the picture of his dad from his wedding:
(third picture)
http://big5.ifeng.com/gate/big5/blog.ifeng.com/article/2980550.html

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.