Mortal Combat: Olam Versus the Muddy Short Seller

Talk about chutzpah.
“We hereby make a bona fide offer to pay for Olam to have one of its public debt issues rated by S&P,” US maverick short-seller Muddy Waters announced on 30 November. “Olam may accept our offer at any time before December 5, 2012 at 17:00 Singapore time by emailing: [email protected], or by issuing a press release stating that it accepts our offer.”
Olam International Limited, the Singapore-based integrated supply chain manager and processor of agricultural products and food ingredients whose shares Muddy Waters is shorting, ignored the taunting offer.
Instead, on 3 December, the company announced a proposed US$750-million US dollar denominated bond-and-warrants issue due in 2018. The Singapore government’s investment company, Temasek Holdings, which owns 16% of Olam, has pledged to purchase all of its entitlement and to buy the bonds and warrants other shareholders will pass up, if any.
“The clear action on the part of Temasek to sub-underwrite an issuance of securities by the Company is a resounding message of the support and confidence a discerning and sophisticated investors places in our Company, our strategy and the integrity of our management team,” crowed Olam Group Managing Director and CEO Sunny Verghese.
To which Muddy Waters retorted on 4 December: “We theorize that Olam’s banks told Temasek they would turn off the taps unless Temasek provided additional funding to the Company . . .  If we are correct, this financing is anything but an expression of confidence.” Muddy Waters founder Carson Block then told The Wall Street Journal that Muddy Waters was still shorting Olam’s shares. “This thing has a lot more downside,” he said.
Could have been worse
It’s barely three weeks since the Olam vs. Muddy Waters firefight erupted, and already we’ve seen a libel suit (by Olam) and threat of a countersuit (by Muddy Waters), a 133-page research report (by Muddy Waters), a 45-page rebuttal (by Olam), and the aforementioned free credit-rating offer (by Muddy Waters) and proposed debt sale (by Olam).
Asia’s companies and CFOs should take note. The Muddy Waters of the world – others like it include and Anonymous Analytics – are getting bolder and targeting large global companies like Olam, which reported net profit of US$404 million on revenue of US$17.1 billion in the fiscal year to June 2012. Muddy Waters had previously shorted the stock of much smaller Toronto-listed Sino-Forest, which had 2010 revenues of only US$1.9 billion.
On 19 November, Olam’s stock closed at S$1.74 in Singapore. After Block said in London that Olam would collapse under the weight of its debts, the share price fell 7% to S$1.61 the next day. On 7 December, Olam closed the trading day at S$1.46 – down 16% pre-Muddy Waters. Compared with the year-to-date peak of S$2.76 on 8 February 2012, the stock has now lost 47% of its value. Olam’s ADRs have similarly fallen, closing at US$23.99 on 7 December, down 16% before the Muddy Waters attack and 45% from the year-to-date peak of US$43.30 on 8 February.
It could have been far worse. When Muddy Waters released a negative report on Sino-Forest in June 2011, the stock price plunged 64% from C$14.46 to C$5.23 and never recovered. The company filed for bankruptcy and was delisted from the Toronto Stock Exchange in May this year. It’s too early to say whether Olam can survive the short-seller’s attacks. But so far, the company’s swift and aggressive response appears to be providing a floor at least to the stock price.
And as of 4 December, most of the 21 analysts that follow Olam remained supportive. Nine, including Patrick Yau of Citi, Chuanyao Lu of CLSA, Kevin Chong of Deutsche Bank and Patrick Tiah of Goldman Sachs, maintained a ‘buy’ on the stock. HSBC’s Thilan Wickramasinghe, Macquarie’s Conrad Werner, Morgan Stanley’s Divya Gangahar and Standard Chartered’s Adrian Foulger even have an ‘overweight’ or ‘outperform’ rating.
“I don’t think [Block] is right where [he says] the assets are going to be worth cents on the debt’s dollar,” Dwight Anderson, founder of US$1-billion commodity and industry hedge fund Ospraie Management, told Bloomberg TV on 5 December. “They have been aggressive in accounting but fraudulent, to the extent [Block has] talked about, I think is more exaggerated than reality.”  
Tit for tat
Muddy Waters, which initiated coverage of Olam on 27 November, is definitely on the ‘sell’ track, along with three other analysts (Jeffrey Ng of BoA Merrill Lynch, James Koh of Maybank Kim Eng, and Vincent Fernando of Religare). “The vast majority of acquisitions we have researched are of low quality assets that appear to bring little more than cosmetic benefits to Olam,” Muddy Waters charged in its 133-page report. (Read it here).
“Olam has spent S$571.0 million less on acquisitions than announced,” Muddy Waters alleged, while spending “S$996.2 million on unattributed non-acquisition CapEx.” Over the years, “Olam has committed a shocking number of accounting gaffes,” Muddy Waters continued, which compared Olam to Enron in the “material similarities in the way their business developed, and their action.”
The bottom line: Muddy Waters believes that Olam is “likely to fail.” If it does, the present value of its unsecured bonds – there are 11 bonds and senior papers outstanding with a combined face value equivalent to nearly US$3 billion – would be “14 to 33 cents on the dollar,” Muddy Waters maintained. “The equity would likely be wiped out, or given ‘nuisance value’ at best,” it asserted.
Unlike Sino-Forest, though, which had dithered under the Muddy Waters attack, Olam came out swinging. As soon as the report came out, it branded the “broad allegations” in it as having “no substance,” and then the very next day, released a 45-page rebuttal.  “Everyone is entitled to their own opinions,” Olam quoted the late US Senator Patrick Moynihan in its own report, “but they are not entitled to their own facts.”
“Olam faces no risk of insolvency,” the company insisted. “We have proactively planned for an appropriate capital structure and raised the requisite equity and debt to meet our investment plans. We have sufficient liquidity to pursue our current business as well as future investment plans.”
On the claim that Olam has spent S$571 million less on acquisitions than announced, the company schooled Muddy Waters on the “timing difference that exists between the announcement of a transaction and the subsequent cash outflow that occurs at the time of closing.” One example: the S$163.7-million acquisition of Brazil’s UAP sugar mill, announced on 30 June 2012. “Since the transaction had not closed on that date,” said Olam, “the cash outflow had not taken place.”
Muddy Waters had listed 20 acquisitions from fiscal 2009 to 2012 and compared the cash outflow according to the annual report and “company press releases and analyst perception of the cash outflow on acquisitions.” Olam reproduced the same list and explained the discrepancies, citing such reasons as foreign exchange differences and discharge of payment via assumption of the debt, not cash. “NONE of the capex is missing as alluded to in the MW report,” said Olam.
The company also rebutted Muddy Waters’ allegation that there is a cumulative S$996.2 million in booked but unattributed capex. “Olam has been explicit not only on its capex strategy, but has also notified the markets on every material investment,” Olam claimed. It then provided “the detailed breakup of the incremental capex spend of S$875 million in FY2012, which should dismiss this unwarranted assertion.”
The list included 13 projects in as many countries, by spending on palm and fertilizer assets in Gabon (S$339.2 million) and flour, cashew, tomato and rice farming in Nigeria (S$89.9 million). However, Olam did not address what Muddy Waters claims are unattributed capex in previous years – that amount totaled S$121.2 million.   
Benefit of the doubt
So who is right? Based on the response so far of major shareholder Temasek, the stock markets and research analysts, Olam is apparently being given the benefit of the doubt. “While no business is without risks, we remain comfortable with Olam’s credit position and longer term prospects , and are pleased to have another opportunity to invest in the company, alongside other shareholders,” Olam quotes David Heng as saying. He is Temasek’s Senior Managing Director, Investments.
Not that Muddy Waters is conceding defeat. “The US$750 million that Olam is raising merely postpones the collapse that we feel is almost inevitable,” it said in response to the company’s proposed bond-and-warrants issue. “Given that our model forecasted Olam would have to raise or refinance up to US$4.6 billion in the next 12 months to stay afloat, this raise is likely only a portion of what it needs to make it one more year.”
Muddy Waters added in a footnote that it would reconsider its view “if Olam were to raise at least S$3 billion of equity.”  The proposed debt offering will raise US$1.2 billion or S$1.5 billion if the warrants are converted into equity. Regardless, said Muddy Waters, “Olam’s fundamental problem remains unchanged: The Company has borrowed substantial amounts of money to fund capital projects that we believe are incapable of repaying the debt.”
The short-seller also took a potshot at Ernst & Young, Olam’s external auditor. In its rebuttal, the company had quoted from a 22 November letter by E&Y to Olam’s Board of Directors, in which the auditor noted that its opinion on Olam’s consolidated financial statements for the period to 30 June 2012 and previous fiscal years were “not qualified or otherwise modified.” Said E&Y: “We stand by our audit opinion on the consolidated financial statements of Olam.”
“E&Y is irrelevant to the issues,” said Muddy Waters in responding to Olam’s rebuttal. “Many corporate collapses and frauds had top-tier auditors, including Sino-Forest, which was also audited by E&Y.” In a 4 December media release, it pointedly reported “in other Muddy Waters news” that E&Y has been charged by the Ontario Securities Commission  with securities violations for failing to audit of Sino-Forest with proper diligence. The accounting firm will pay C$117 million to settle investor lawsuits.
Lessons to learn
Asia’s companies can pick up helpful lessons from Olam’s response to the Muddy Waters attack. An early and robust defense – Olam’s Verghese was on investor, analyst and media calls hours after Block’s London remarks – is obviously a big plus. Actually suing (as opposed to threatening to file a lawsuit, which is what Muddy Waters has done) further signaled the company’s resolve and confidence in its position, although it could arguably have given the impression of an overly defensive company that had a siege-like mentality.
But issuing a point-by-point rebuttal a day after the negative report’s release was a no-brainer for Olam. Sino-Forest had made a general denial, and then formed an independent committee to look into the allegations. The panel issued a report based on investigatory work by PwC – five months after Muddy Waters released its report. That delay allowed all sorts of stories and innuendos to circulate and further muddy the issues.
Above all, Temasek’s support is a clear positive for Olam. That the quasi-sovereign wealth fund (assets under management: US$161 billion) will not only subscribe to its full allotment in the bond offering, but will also buy unbought units is a strong vote of confidence in Olam. Muddy Waters’ “theory” that Olam’s creditor banks threatened to “turn off the taps” if the government firm would not put in more equity is not very convincing.
Remember, though, that Sino-Forest initially had a Temasek in its corner in hedge fund manager John Paulson. But barely two weeks after the Muddy Waters attack, Paulson’s various funds sold all of their combined 24% holding in the company. “We believe significant uncertainties exist,” Paulson told his investors in a letter. “Even if Sino-Forest’s special committee investigation clears management and supports the public disclosures and financial statements, the stock may remain depressed for an extended period of time.” 
Temasek is entitled to subscribe to the five-year bond for up to US$122 million in face value (the price is 95% of face value) and get paid 6.75% in annual interest. The free warrants grants the right to buy new Olam shares after three years at US$1.291 per share or S$1.576 at the current exchange rate (8% higher than the closing price of S$1.46 on 7 December).
Olam obtained shareholder approval to issue warrants and new shares in October, so the offering is expected to be launched fairly soon. The take-up by minority shareholders will be closely watched as an indication of the damage Olam has sustained, and whether it can cleanse itself of the mud.
Whatever the outcome, though, it is safe to say that short-sellers like Muddy Waters will continue to target what they see as ruinous business models and practices. Companies laden with debt and those with complex models may be especially vulnerable. They should include a Muddy Waters-like attack into their risk management stress-testing and scenario-setting.
Every company should be ready to explain and fight back – and make sure their finances and everything else are ship-shape and defensible, to begin with. 
About the Author

Cesar Bacani is Editor-in-Chief of CFO Innovation.  

Photo credit: Shutterstock


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