Thursday, October 27, 2011

Kikukawa Quits - Olympus soars (but why?) or Covering Up The Cover-up

Farewell then, Kikukawa. Bloomberg reported his departure today. Does it change anything at all? Has the uncertainty gone? No. Amongst other things, in his parting statement he said

“I apologize for causing concerns due to the share decline triggered by the replacement of the previous president,” “There is no corruption” [in past acquisitions]....

His choice of words  is precise and no accident. Like Tarantino in his own Pulp Fiction's "Bonnie Situation", one has to laugh at Kikukawa. In the Bonnie Situation, Tarantino is upset NOT because Travolta and Jackson have brought a dead body to his house, but because his wife will be home soon and mind find out. Kikukawa, was NOT apologizing for anything apart from the disrepute to the company and fall in the share price. To his credit, there likely was NOT (in Clinton-esque truthiness) corruption in the scrutinized acquisitions. They were likely made in good faith and at toughly negotiated prices. The actual advisors (who conducted the M&A work) were probably paid appropriately and thus the actual advisors received nowhere near the amounts claimed, and a follow-up of the money-trail would likely confirm this. No funds were criminally siphoned to Switzerland (or Cyprus or Malta) to pay Yakuza or to prevent blackmail in one form or another, nor did they find their way to Hawaii  to fund villas for the board. I just wish to reiterate, one more time, I think this is really about hiding and disposing two-decade-old Zaitech losses, which have been cloaked and/or re-punted in hope of repair, but due to market evolutions, remain financially gangrenous. Embedding these still-unrepaired losses into "advisors fees" were seemingly (at the time, when not under scrutiny) a plausible way to try to finally put them behind the company without having to lose face over their origin, or the subsequent bumbled face-saving attempts to hide them. Kikukawa may have architected, or merely approved this final ill-fated stab at exorcising them, but I think when revealed it will be that he was, more importantly, running protection to cover up the covering-up of mistakes made long-ago. Kikukawa's fault (apart from the cultural baggage preventing him from coming clean) was the arrogance to assume Woodford would let the proverbial sleeping dogs lie when told to not to worry about it. Woodford's sacking was due to the honorable mistake of not going "All-in" with Kikukawa and his Board of Subs (sic?). He probably didn't know (if I am right) of the losses origin, for at the time, he was a likely an endoscope salesman.  I do wonder however, what Woodford would have done if Kikukawa had taken him in confidence and revealed all history, explaining the reasons for historical subterfuge. Would he have reluctantly supported the somewhat better inentions of the Board of Subs?

Coming clean, where a cover-up of the cover-up has been made, is an all or nothing affair. Of course, if I am right, historical accounts will have be restated, though since these will be one-time charges, far back in time, they should have no bearing on the present operations, thus lifting of uncertainty thus allowing  the business - once again - be valued on the basis of a world-class high-margin medical instruments company with a rather significant though problematic legacy camera unit. Now, back to Greece's haircut.. 

PS - The Bonnie Situation clip above really is apt for the description of Olympus' situation, and should be watched if only to start the day with a laugh....

Tuesday, October 18, 2011

Throwing Good Money [or Honor] After Bad

When shit hits the proverbial fan of a corporate leader (or inexperienced trader) in the west, they might, in the panic of the moment, be more inclined to respond by "throwing good money after bad" in a desperate Hail-Mary attempt to miraculuously snatch victory from the seemingly inevitable jaws of defeat. Some Reg-D "Death Spiral" deals undoubtedly fall into this category as does Nick Leeson and other trading losses martingaled directly to prison. In Japan, the S.O.P. seems to be concoct some other half-baked quarter-truth or non-truth (i.e. outright fabrication) in a desperate attempt to avoid the dreaded shame, embarrassment (even the unlikely jail!) and subsequent ritual skewering that inevitably follows being caught in whatever indecently illegal act one was undertaking or had undertaken.

I am intrigued by the Olympus Corporation's and former President and Chairman Tsuyoshi Kikukawa's behaviour. I am not in the least surprised. Nor am I shocked (for I am not though I soon will be) long. Not because I shouldn't be but because one could almost predict it. Not of course specifically Olympus's corporate trousers being precisely caught around their ankles, but rather the general class of corporate response to a potentially shame-inducing crisis, that at some point would reveal the series of decisions that lead to the point of being in so deep, one has no choice but to continue the charade (or at least one FEELS there is no choice).

I have been reminded by different folk on various occasions of the old adage: "never lie to your doctor, your lawyer, or your accountant". I cannot help but wonder whether this holds true for The Olympus Corporations Japanese managers and directors in regards to their new Chief Executive, Mr Woodford. I wonder whether they would even consider NOT disclosing the full truth a blood-relative of a lie. One would guess however that his response, might be different to those with soiled hands, or those fearing the resulting stigmata of FD, with its sordid details.

The facts as revealed by Mr Kikuwa and the Olympus Corporation just do not make logical sense. There is a story here, not yet disclosed. I think it is related to the legacy Zaitech losses. Rather than come clean and have to bow very low in admitting one-and-a-half decades of more or less continuous deceitful accounting to hide and cover them up, they tried an alternative exit. Perhaps they thought that exit could be written down more easily without embarrassing questions to the WA of Olympus. Perhaps they thought Plan B was that if brought to the spotlight, a person rather than the organization might fall on his sword claiming "good intentions" but "bad investment". Uncompliant auditors however, who might force greater disclosure and footnoting placing a new (foreign) CEO in a potentially compromising position, was probably not under the meat of their distribution of probable outcomes (howver much it should have been).

The next few weeks will be fascinating. For what its worth, I like Olympus. For what its worth, I like buying into fundamentally-sound enterprises, with good assets, brands, and/or technological leaders in their fields, that have large one-time writedowns (however mischievously generated). Hanover Compressor (HC), OMG, El Paso (EP), Yakult (2267) are such examples, to name a few. It is something I can, at the very least, understand, without having to judge or condone it, however morbidly fascinated I might be in the personal details enroute to the perditious act(s). I reckon Olympus will fit this pattern, though cannot wait for the truth to come out.

Monday, October 17, 2011

Long-Term Memory?

I worked with a guy who in the mid-nineties once claimed hush-hushedly to have structured a big series of "repair bonds" for the Olympus Corporation. He was not boasting, but trying to help. For this was interesting to me for no other reason than I was managing a reasonably-sized long-short book primarily in Japan, and such information hitherto was (except for precious few) completely unknown to the market. It was concurrent to the exposition that many Japanese companies had such liabilities, yet the analysts I queried about the possibility of such liabilities at Olympus laughed it off with incredulity, as they cheered the stock higher with estimate upgrades and near-ubiquitous buy recommendations.

For those wondering what a "repair-bond" is, it is a financial transaction - typically structured [unsurprisingly] by foreign bankers, primarily (but not exclusively - Hello O.P.L.- U.P.S.!!) in Japan which for an example might replace an existing trading position or security deep under water (with a large typically undisclosed mark-to-market loss) with a long-duration security that they can mark to par, but which really isn't worth par if not held to maturity. There are many flavors of such shenanigans. Many Japanese companies (and Refco!!) used a variation of "pass-the-parcel" to move undeclared liabilities between their multitudes of subsidiaries with differing fiscal year-ends in order to elude the auditors. Others, tried to shuttle the remainder of a position into something more aggressive (like Martin Armstrong's PEI) to try and win-back what they'd lost which is/was almost universally a lousy idea.

The Japanese seem more susceptible to such schemes since losing face is decidedly of great importance - above and beyond the financial loss. So crucial is it, that counterparties devised convoluted pathways to reimburse a financial to avoid embarrassment and culpability on all accounts for all concerned.

Olympus' gargantuan black hole recently disclosed allegedly caused by bizarre transactions with brass-plate offshore entities is of a magnitude not dissimilar to that which was purported to have existed 15 years ago. Yield or investment opportunities for repair have been few and far between. Anything non-yen denominated has imploded, has anything Japanese stock-market related. One must wonder whether the hole is in someway related to these now ancient legacy losses - stuck to Olympus' shoe like a piece bubble-gum. Perhaps the foreign CEO came to understand, whatever his personal inclination to come clean and "Do a Bill Clinton", that this was not, in Japan, as easy as it seemed. Of course, this may not be related to the Zaitech fiddling and diddling clean-up. But, then again, perhaps it might....

Wednesday, October 05, 2011

When Around the Bend the Yen Descends...

In May of 2007, when almost everything seemed Hunky-Dory, the sober-minded BCA forecast EURJPY of >180. In a note of reply to this extrapolation of this prevailing trend into the future, I took a stab as to which side of the distribution the fat-tail might be hiding. With certainty, we now know where it was (Cass-1, BCA-Nil). Since The Reckoning began in earnest [and risk-off] pushed USDJPY below par, many have tried their hand shorting JPY. Armageddonist Kyle Bass (somewhat wrongly one might point out) forecast its demise several years ago in a lengthy piece arguing that JPY is essentially guano (my word not his though upon reflection I realize I've erred in my wordchoice as guano IS extremely valauble). And swaggering big-picture dudes talking their books at Drobny's pow-wows, have featured short JPY trades more or less continuously since 2009, with each episode leading to the formation of a nascent trend, though each subsequently ending with a head-on into the electronic herd and other mysterious flow.

JPY now sits at 76 and some bits versus USD, and circa 103 basis the European unit. This is NOT a post forecasting the imminent demise of the Yen. My hide too lies besides Friends of Drobny, reckoning that the end of Q1 was the denoument, though I still think it will pay sufficiently in the next 12mo, despite being egg-faced on the timing. But that is not the point of this post.

What I encourage you to do is put your imagination caps on for a few minutes. Not that you need them to inspect the collateral damage of a currency appreciating up towards 50% vs. the worlds other two largest units. Of course during the past two decades Japan has followed the US and Europe in hollowing its base, setting up shop first abroad in its largest market, then all over southeast asia and subsequently in China and beyond. The global manufacturing enterprises thus created can absorb some of the shock. And they do hedge their FX too, providing additional triage. But as in the mid-1990s squeeze, Japanese enterprises' product prices abroad have not moved with the currency, as manufacturers have chosen to stomach lower margins in order to retain markets, customers and volumes rather than cede them to competitors. This is one of the primary reasons trade gaps are sticky. And it is not necessarily irrational, particularly if one believes the curse of an over-valued exchange rate to be temporary.

Investors have observed the carnage and voted with their feet. Many large exporters have dived beneath their 2008 crisis-lows, plumbing price and valuation depths not seen for a deacde (or more). Their brethren that haven't sunk so low are chasing their coat-tails. It is, to use a technical term, ugly. And as usual, there is circularity since banks remain large shareholders, and despite their clean-er balance sheets (clean meaning not laden with US Housing, and peripheral Euro sovereign exposure), experience stress upon capital ratios with each new lurch down in the broader indices.

The pessimist (and the quant, and the fundamental screener) looks and sees uncompetitive enterprises, and all the red flags associated with declining sales and margin erosion. Five-year histo sales growth of MINUS 15 to 20%. Same in operating profits (or worse). Some reflects reality for zombie co's remain and continue to produce in comical Shaun Of The Dead fashion. However, under the circumstances, the numbers of these JPY-sensitives actually demonstrate some superhuman adaptive skills. They have managed (so far) to avoid being fatally torpedoed by the currency, and in the main, keeping the declines in operating profits to almost-tenable levels. Their income statements, when viewed in dollars or Euros, of course tell another picture. In this imaginary land, historical top-line growth for companies this size and breadth have been respectable - even ignoring The New Normal. One must imagine the sensitivity of their OPs to fanatasize about what lies below, though any of the brokers will share their forecasts as will the companies themselves (if you chance the latter). But a USDJPY at par would unarguably bring a polished lustre (and apparent top-line revenue growth) to what are presently tarnished in diminished local currency value translations. The circularity works through the system. Bank capital re-inflates, reducing stress, and encouraging an expansion of lending. The Government's balance sheet, too smartens as currency losses on the trillion or so of their US T-Bonds diminish and their USD coupon receipts contributes to government coffers. Worker bonuses rise, consumption edges higher and consequentially, suicides drop. Maybe even whaling might finally be abandoned!! (I exaggerate on this last point.)

Rose-tinted glasses...yes, perhaps. But the grimmest view of JPY-sensitives by investors are also seeing a distorted view of the world (Stevie Wonder's Sunglasses?!!?) since the JPY is no SGD CHF NOK SEK or CAD. It is JPY and it is, irresepctive of its levitation, Bat-Shit. The current prevailing view is one that myopically assumes the status quo remains, and makes no judgement upon where the fat-tail is NOW, and what those impacts (whenever the fat-tail shows itself) will be.

Japanese companies are already some of the cheapest in the world. Admittedly, sometimes for good reason (hostile to shareholders, poor governance, truly dismal prospects). When regressed against peers along value and growth axes, they are the cheapest, but also with the lowest growth. It is, I submit, worth more closely examining the idea that the apparent lame-duck growth (shrinkage, more accurately, in local JPY terms) has more to do with the extemes of the JPY rather than the ossification one encounters in the type of value traps enroute to ignominy. In precisely the same way fair-weather friends make themselves scarce at the first signs of trouble, or the young, beautiful gold-digger abandons her balding sugar-daddy when SEC investigation bankruptcy is on the horizon, so have investors fled from otherwise sound (and cheap!!) enterprises, in the process driving them to multiples of diminished cash-flow expectations or, even better, free cash-flow expectations that would have made Graham or Dodd or both salivate. And these enterprises are not shells of their former selves, hollowed-out by predators and asset-strippers, but companies that continue to invest robust proportions of revenues in R&D, and remain on the leading-edge of their respective markets.

It is true that many Japanese companies remain hostile to foreign investors, pay hommage to a wider constituency than that narrow-defined by shareholders, and are undoubtedly poor communicators. To their credit, their corporate GINI's would make American executive management blush; they can, and are willing and able to make longer-run ivnestment decisions that American mgmt can only dream of; and they have spent the last two decades relentlessly (and deftly) avoided being cast upon the Scylla of vaulting energy prices and the Charybdis of an elephantizing exchange rate. What doesn't kill you makes you stronger - not in the proverbial sense, but, as my youngest too-often exclaims "For Real!". One needn't recount here, after two deacdes of being squeezed vise-like, the output unit of GDP per input barrel of oil and labour which by comparison will only conjure images of profligate lard-ass Yanks driving Lincoln Continentals, and Cadillacs of the type that causes Jeremy Clarkson to spit venom and derision. Yes, maybe the Japanese don't do finance like GS or MS, nor do they do activism like Warren Lichtenstein or Nelson Peltz, having had their near-death brush with Zaitech. But then again, maybe NOT emulating US IBs and their financial shenannigans is not such a bad thing, all considered. At the corporate level, they are, at this stage, more likely to be financially STD-free, despite their less-than-salubrious past.

I find myself getting bulled-up as I write this, but THAT is not the point, nor my conclusion. The allure may merely be in relation to the rest of the trolls, who are not as far along in their metastases. The point is that when the world is driving by looking out the rear window and extrapolating the recent past ad infinitum into the future, discounting or ignoring causes, at the expense of reasonably weighing the probabilities of alternate future realities, one can ascertain on which side of the distribution the fat-tail resides. And that, to me, seems where we are at the moment. And I have put my imagination-hat on and think the visions neither far-fetched, nor even that far off.

Tuesday, October 04, 2011

Rolling Stocks

Guns, ammo, foodstuffs, palladium, rare old photographs, P&G, cheap utilities, signed first-edition books, proficient food retailers with scale, a farm, water companies, TIPs, Norwegian Kronor, CRESY, RYN, Southern Queensland cotton farms, lowly-levered prime REITs in Paris, cheap big pharma, BDX, Gazprom, Lukoil, Total etc. I can think of many reasonable and liquid stores of value that may suffice over polarised outcomes. But Japanese private railways (outside JR East and West and maybe Keisei) fail to enter into the realm of (at least my own) imagination.

Perhaps, they are, through a certain lens "low risk" if one employs a myopic definition that includes beta, volatility, and market cap (but ignores debt, constantly depreciating assets, capex requirements, future demographic challenges, and the fact that they are denominated in a currency at the likely pinnacle of relative performance). But they ARE at least assets versus the alternative of a promise by a politically dysfunctional system (ignoring the premium one is paying for many given their bloated accumulated liabilities). But by this measure, prime Class-A real estate, arguably longer-lasting assets, or the cabled monopoly telecommunication backbone of Japan, can be had with much more attractive present (and potentially future) earnings yields, granting greater upside potential other things the same. Yes rents can (and do) fall, but so (one might posit) does passenger traffic in the advent of depression.

Nonetheless, Japanese private rails, particularly the least-attractive turds, have been vaulting ahead inverse-step-for-inverse-step to meaty riskier assets, irrespective of growth, earnings momentum, or prevailing value. Yes the Japanese rails are emblematic of global markets in general during the past two months of unraveling undoing the best-laid trading plans, or fastidious reasearch. For their rise is (IMHO) unlikely to represent a search for truly obscure alternative stores of value, but rather signifiy the deleveraging process itself. What was bought (if it can) must be sold. And what has been sold (short) evidently must be bought. And make no mistake: fundamental value, momentum, growth long vs. short investors have been short the rails. No need to be clever, or conjure improbable theories of how Tobu or Nagoya will (finally) extract value from its real estate holdings which in any event are on offer elsewhere at half of book. But just as every proverbial dog has its day, rest assured that once the scramble through exit subsides, there will be numerous days that will have their dog.