Monthly Archives: September 2013

An unexpected catalyst for Consciencefood

My timing in selling my position in Consciencefood has been unfortunate because a day after selling my shares the company announced that the CEO intents to take the company private: offering exiting shareholders $0.184 per share. So I guess that my concerns about the company were probably for a large part unfounded, but at the same time it also illustrates one of the bigger risks you face as a value investor. The value might have been there, but if the company can be bought at a 23.5% premium you still miss most of the upside, and everybody who didn’t buy recently gets a break-even result at best.

Obviously it’s not a done deal yet, so it will be interesting to see how this is going to unfold. It wouldn’t surprise me if shareholders are happy to be able to exit a poorly performing investment at a small premium, but at the same time the offer price is below the recent IPO price which will make it tougher sell. I’m not a shareholder anymore, but in my opinion the CEO is trying to steal the company with a low-ball offer here.


No position in Consciencefood

Diving deeper in the Consciencefood numbers

After publishing my write-up on Consciencefood it seems that concerns about fraud are the biggest issue. While I didn’t see a coherent fraud story when I invested in the company I have been thinking what makes sense and what doesn’t. Possible red flags that I see are:

  • High revenue growth, high return-on-equity before the IPO: good/lucky timing from management, or the results of manipulating the accounts?
  • High capex after the IPO: (potential) growth, or a way to transfer cash to related parties?
  • High debt position while having simultaneous a large cash position: why is the debt needed? Is the cash real?

There aren’t a lot of other possible things to worry about as far as I can see. There is no acquisition activity, there is no goodwill on the balance sheet, their are no questionable loans on the balance sheet to suppliers or receivables from subsidiaries. Most of it seems pretty basic and straightforward.

IPO: timing or fraud?

I think this is a really good question to ask because as a shady manager the prime time to commit accounting fraud is the period before an IPO. You want numbers to look good, and you want to get as much cash as possible from outside investors. And if you can spot fraud back then you know that you can’t trust the company today.

One thing that had already attracted my attention is how receivables as a percentage of revenue and assets exploded in the pre-IPO period.

Consciencefood DSO

What is good to see is that the days of sales outstanding has remained reasonable stable after 2007. The trade receivables don’t balloon past the maximum credit period of 90 days that the company is giving their customers so based on this it does appear that nothing is wrong with the reported revenue, and the company gives the following explanation for the increase versus 2007 in the IPO prospectus:

The increase in the average trade receivables’ turnover days was mainly due to us granting longer credit terms due to the competitive nature of the instant noodles industry. In addition, we have decreased sales to our distributors and increased our sales to direct customers which tend to request for a longer credit period compared to sales through distributors. However, the average trade receivables’ turnover days during the periods under review were within our maximum credit period of 90 days.

This sounds logical, but it doesn’t match what we see in their credit risk profile. Receivables allocated to the in-house sales team dropped from 87% in 2007 to 72% in 2009. So I don’t see how the explanation above can explain anything:

Consciencefood receivables based on channel sector profile

Somehow we don’t find this distributor or business partner on their list of major customers:

Consciencefood major customers

I have no idea who those customers are. I can’t find anything tangible on Google, and also tried looking at some Indonesian registries of businesses, but I either get zero results or tons of results because the name is very generic: odds are that there is a “Toko Indah” in your city even if you are living at the other side of the world.

What’s behind the low overhead?

There are more ways to make accounts look good, and the good numbers in the earlier years are a bit suspicious. Indofood is the biggest player in the market with a 72% share of the noodle market. The company has similar gross margins as Consciencefood (around 26%), but as a percentage of revenue their spending on marketing, distribution and administrative expenses is a lot higher. Consciencefood spent just an average of 5.5% of revenue between 2007 and 2009, while the average for 2010 to 2012 is 7.2% and climbing (TTM is at 9.5%). Part of the thesis was of course that this is just temporary because the company is trying to grow, but you have to wonder why a significantly bigger company spends on average between 13 and 14 percent of revenue on SG&A. I would have expected that a bigger company could enjoy some economics of scale if there would be any difference.

A possible explanation is that SG&A costs were hidden through related party transactions, but that these costs are now coming back. How this could have worked is that Consciencefood sold their noodles through distributors (an undisclosed related party) that asked artificial low prices for transport and marketing. Now that the company is public these related parties get back their money by being able to ask higher prices.

It sounds like a plausible scenario, but the big question is of course why Consciencefood is, even at these elevated levels, still spending just 9.5% of revenue on SG&A while Indofood has been spending significantly more every year. Maybe this hypothesis explains part of the increasing SG&A expenses, but it can never be a full explanation. The costs simply aren’t high enough after the IPO.

Transportation costs

There is one cost that should be similar for both companies: transportation. Getting things from A to B is a commodity business, and the cost of fuel and trucks are the same for both parties. So how much of their revenue is Consciencefood spending on transportation versus Indofood? Consciencefood doesn’t disclose this in their annual report, but between 2007 and 2009 it was approximately 1% of sales while Indofood spends 3% of sales on transportation.

Indofood does a lot more things than making noodles. Their consumer branded products division generates 43% of sales and is good for 42% of EBIT. So it seems unlikely to me that the high transportation costs are the results of lower margin business divisions, and when we look at the segment results we see that the consumer branded products division does have SG&A expenses in line with the >13% average.

What’s also not helping the Consciencefood case is that North-Sumatra doesn’t have a very high population density compared to Java. This shouldn’t be positive for transportation costs, and the same is true for the fact that Consciencefood is pricing their noodles at a slightly lower price point than Indofood. If you move cargo that’s worth less you generate less revenue while you still need the same amount of fuel to move it from A to B.

Population density Indonesia

Can this be explained?

So what could explain the low transportation costs? With a lower population density it’s unlikely that they have to drive significantly smaller distances. Trucks and fuel are priced the same for both parties, and while I haven’t found a good data source it’s nearly impossible that different wage levels are the explanation. The minimum wage in North Sumatra is actually higher than in the Java provinces and so is GRP per capita.

I don’t know what’s left as an explanation. I can see how you can for example spend less money on advertising if you have a better or cheaper product. You might have lower corporate overhead because you are running a leaner organisation, but having a competitive advantage in moving your products from A to B using trucks seems nearly impossible. In fact the company writes the following in the IPO prospectus:

We deploy our own trucks to deliver goods from our factory to our customers that have been secured by our own marketing team. For sales made through our distributors, either Olagafood or our distributors will arrange for the delivery of goods by third party operators. We do not enter into long term transport contracts with third party transport operators as there are many such operators.

High capex after the IPO

The higher level of capital expenditures after the IPO could be a way to move cash from investors to insiders, but at the same time there is also a very valid and logical explanation available since the IPO was done to raise cash for expansion. But I still wonder what’s exactly going on. The company did almost 500 billion rupiah in revenue in 2009 with just 23 billion in PP&E while they did 800 billion in revenue the TTM with 280 billion in PP&E. Part of the explanation is that they have a large amount of unused assets related to their entry in the beverages market and that the Jakarta factory wasn’t running at full capacity, but still… why is there so much more PP&E required? Are they planning a huge expansion, or was the size of the business in the past maybe overstated? That would match with the low SG&A costs.

What’s by the way interesting about their PP&E is the low amount of depreciation of motor vehicles in the years before the IPO. In 2009 depreciation for motor vehicles was just 264 million rupiah or ~20,000 USD. That’s extremely low for a company that at the time was supposedly producing 660 million packs of noodles and doing most of the related transport. You can read that they do their own transport when the noodles are sold through their own sales team in the quote a few paragraphs up, and in 2009 that was >70% of revenue.

A positive is the factory fire in Jakarta. That might sound weird, but it’s a good check that their new equipment is in fact real. If write down 27 billion rupiah of equipment and inventory the insurance isn’t going to pay you 31 billion afterwards if it wasn’t real. And as a scheme to transfer cash from the balance sheet this obviously doesn’t work either.

High debt and cash position

I think this is the item that got most people worried, but I don’t think it’s is a huge problem even though I have to admit that I can’t really provide an explanation of why the debt is used. The reason of why I don’t think there is a (big) problem here is because I do trust that auditors can do their job, and verifying that the cash is in the bank is one of the easiest things to do. A lot of investors got burned in China where they learned that cash doesn’t have to be real, but in those cases branches of the banks were in on the fraud. I’m not saying that this is impossible, but at the same time I don’t think it’s very probable.

I actually think that the large amount of cash on the balance sheet is a positive sign, because if we trust that it is real insiders are doing a poor job of transferring the money from the company to related parties. But the fact remains that there isn’t a really good explanation of why the company is borrowing money…


I still think that so far there isn’t a coherent story that explains how investors are being defrauded, but at the same time there are a bunch of questions that I can’t answer. I don’t think you have to know everything about a company when you invest – if that would even be possible – but when the answers to your questions are both potentially material to the investment, and potentially knowable for local investors I’m not comfortable with the unknown. Because of this I decided to sell my position in Consciencefood (my broker must be happy…). It was a though decision because I also see the potential for a lot of value here, but in the end I think it’s more important that I buy businesses that I can fully understand, and for now Consciencefood isn’t one of them.


Sold the majority of my position in Consciencefood, and will sell the remainder soon.

A review of stocks profiled, but not bought

As an investor you spend most of the time researching and evaluating the stocks you own or want to buy. Less time, or even no time, is spent analyzing the stocks you didn’t buy, or the stocks you have sold. This is also for me the case. To rectify the situation a bit I decided to look back at the stocks I researched and wrote up on this blog, but didn’t buy for various reasons. I haven’t included returns from dividends in the table below because I’m lazy, but I don’t think that would materially alter the picture. Only the stocks profiled in 2012 and earlier are included to the give market some time to deliver a judgement.

Overview of the return of the stocks profiled but not bought


Most of the stocks in this list got on my research list because they looked cheap so it shouldn’t be a surprise that the performance of the group is on average pretty good. But results are just one part of the equation, what really matters are the reasons why I didn’t buy. Not buying a stock because it’s just to complicated to understand the value is in my opinion always a good reason no matter how it performs afterwards. GKK falls in this category: I thought it looked cheap, but I simply didn’t understand the CDO assets.

Some other names on this list, IMOS for example, were also put in my “too hard” basket, although I feel like I maybe should have been able to see the value. RSE was my first encounter with a commercial property company. Knowing what I know now I think I would have bought it, but if you are for example unsure about how much leverage is prudent I don’t think it’s a bad decision to walk away. But maybe I should have worked harder at figuring out how much it’s worth.

For some stocks it’s even with hindsight hard to know if you made a mistake by not buying it. CMMCY was a sketchy Chinese stock, but also one with a lot of hints that it could be real. I knew that if it would be real the return would be great and I even anticipated how likely it was that the CEO would take it private. I honestly have no idea if this was a mistake or not. It could have gone to zero in an alternative universe, but I might also have been a pussy. 

More sketchy companies

I’m very glad that every single stock that performed terrible is in this list, and not in my portfolio. DSM.V and AAB.TO are resource companies, and I didn’t buy these because I thought management couldn’t be trusted despite the big discount to NAV. Obviously the decline in precious metal prices didn’t help these businesses, but it seems that some sketchy transactions didn’t help either. SND.V is another name in the resource sector were I saw at best and average company with a very promotional management while others thought it could be the next big thing.

LFI.L has done pretty well to my surprise. Didn’t really think this was a viable company, but I was probably wrong. Haven’t followed it, so not sure if anything has changed the past year, but it’s certainly up a decent amount. CTLE was never a serious idea. It is/was an obvious pump-and-dump and predicting that it would go to zero didn’t take much, if any, skill.

Biggest mistake

I think my biggest mistake was probably not buying AAA.AS. This was a private equity fund trading at a big discount that was liquidating and buying back large amounts of cheap shares. I thought I would be able to pick it up at a 50% discount because it often had traded in that range in the past, but it never became that cheap again. I guess that in a sense it’s positive that one of the stocks on this list that I wanted to own the most is also one of the best performers, but that’s not going to buy me anything… It would have been a great deal at a 40% discount too, but I was anchored too much at the higher historical discount.


This list is obviously a very limited sample, but I do think it’s encouraging that the average performance of these stocks is lower than my portfolio while the variance in the results is a lot higher. A lot of names on this list didn’t make it in my portfolio because of concerns about leverage or the quality of the business, and that’s reflected in the results. And the big question is how this group would have performed if we would have had another 2008 instead of gradually rising markets: that would have been the real test.

It also shows that sometimes the best returns can be found when the stock is so ugly that even for me it’s too hard to buy, and that’s a though balancing act. As a value investor you often buy ugly companies, but you also have to be able to sleep at night. I know there has been some research in net-nets that suggest that buying companies that are actually losing money generates higher long-term results than buying profitable net-nets. MEAD might be a good example. I thought it was a melting ice-cube, and it seemed that this was true, until multiple bidders emerged to take it over. It would have been a roller-coaster ride though.

I think that one of the most important things in investing is having the conviction to stay with your strategy when things go bad, and that’s why having a certain level of quality in your portfolio is a good idea. I know that things will probably turn out alright if I buy something cheap with a long track record of profitability, and I don’t know if I will be able to do that if I’m basically just buying the biggest pile of crap I can find.


Not long anything mentioned in this post

China Energy Corp. completes reverse split

I entered my position in China Energy almost exactly 6 months ago, and yesterday the reverse split was executed which can only mean the money is finally on it’s way to my account. I have mixed feelings about this outcome. I will realize an absolute return of roughly 7.5% which isn’t a whole lot given how long it took, and the fact that it certainly wasn’t a risk-free transaction. My thesis that the initiation of the going private process would only make sense if they indeed wanted to go through with it proved to be correct, but at the same time China Energy must be by far the most sketchy company I have ever invested in.

I doubt that any real alpha was created by participating in this transaction, and I think the easy money has mostly been made in the game of Chinese going private transactions. The majority of the companies that were real (or at least had some value) and had the capability to go private have done so by now. I’m still long WSP Holdings; this position luckily offers way more return potential, but it’s also a hairy situation. Wouldn’t call it easy money.


Technically still long China Energy Corp. until the cash hits my account

Why I’m looking outside the US in two graphs

I haven’t invested in a US stock since I bought AIG more than a year ago, at least if we exclude ALJJ which was mostly a merger arbitrage play. It’s not a conscious decision, but I simply didn’t find a whole lot of US stocks that screamed value to me. Recently a lot of names in Singapore and Hong Kong came to my attention, and when I look at the return of the various indexes for the past year that doesn’t seem to be a coincidence:

The S&P 500 versus emerging markets (VWO) and the MSCI Singapore Index (EWS)

The GMO 7-Year asset class forecast is in my opinion a good sanity check for overall valuation levels. The expectations for emerging markets are a lot better than those for the developed world, although this graph doesn’t account for possible different risk levels.GMO 7-Year Asset Class Real Return Forecasts (August 2013)

The expected average negative real return in the US certainly doesn’t mean that I don’t want to invest there: I believe that there is always a bargain somewhere. The odds of finding one are going down though, and I think that correlates with my experience so far this year. Fishing is easier when there are more fish in the pond.