November 27, 2012 1:17 pm

Muddy Waters issues critical Olam report

Carson Block, founder of short-selling research firm Muddy Waters©Reuters

'Speaking truth to power': Carson Block, founder of Muddy Waters

Muddy Waters Research, the short selling firm, on Tuesday warned that Olam, the Asian commodity business, runs a high risk of failure amid possible accounting “malfeasance” and “significant misconduct” over its handling of a string of acquisitions.

In a highly anticipated report, Muddy Waters – founded by prominent shortseller Carson Block (pictured) – drew repeated parallels with failed US energy company Enron in an analysis of Olam accounting practices.

The move against Olam marks the most ambitious attack by the US analyst who shot to prominence last year following his research into alleged accounting irregularities at Sino-Forest, a Toronto-listed Chinese timber concern which collapsed in the wake of the claims.

“Olam is now riding the tiger. We think the only way off at this point is to fall,” Muddy Waters said.

The attack is the biggest crisis that Olam has faced in the 22 years since it was founded. The Singapore-listed group has grown into one of a new generation of fast-growing Asian commodity powerhouses, including Wilmar and Noble Group.

In an initial response, Olam said there was “no substance” to the allegations made by Muddy Waters, adding that its “accounting practices are fully compliant with international accounting standards”.

“We will clear our name and hold Muddy Waters accountable for their damaging actions,” Olam said.

Prices to buy Olam’s benchmark corporate bonds slipped about 5 per cent on Tuesday – a considerable move for such debt. Its five-year notes, due 2017, closed at 87.5 per cent of their face value and 10 points below their price before Mr Block’s presentation last week. Shares in Olam closed down 6 per cent at S$1.56.

Central to Mr Block’s case is an allegation that Olam frequently books non-cash accounting gains – negative goodwill and so-called biological gains – to inflate earnings.

“Both Enron and Olam have made significant use of non-cash accounting gains that turn theoretical future profits into gains today, but incentivised the companies to make questionable investments that generate accounting profits,” the report said.

Muddy Waters accused Olam of committing “a shocking number of accounting gaffes”. It argued that Olam’s reported S$1.1bn in cash by the end of the 2012 full year was “misleading”. The report said over half of that figure appeared to come from Olam withdrawing “significant margin from its brokerage accounts”.

It said the accounting record might be due to incompetence or “there could be malfeasance”.

Olam said it would “assess the report and respond appropriately in due course”. The company has already signalled its determination to contest such allegations vigorously. Last week Olam filed a defamation claim against Muddy Waters and Mr Block in the Singapore high court over statements made at a recent London conference.

To back up its claims Muddy Waters revealed that it had hired “investigators” to research Olam’s operations in “numerous countries across four continents”. It said it had also hired experts in forensic accounting, law and international trade and finance.

Some of its investigators had taken photographs of what Muddy Waters alleged were failed acquisitions in Nigeria. Investigators had also visited a tomato paste factory in California acquired out of bankruptcy by Olam in 2009, interviewing workers who spoke of large amounts of inventory put “on hold”.

“Management talks about the ‘gestation’ of these projects, but our research makes clear that they are marred by incompetence and perhaps significant misconduct,” the report said.

“The vast majority of the acquisitions we have researched are of low quality assets that appear to bring little more than cosmetic benefits to Olam,” the report said. “In short, these projects are ‘pie in the sky’ that we strongly believe are destroying substantial amounts of capital.”

Olam says it has made 35 acquisitions since 2009 when it embarked on a new strategy to acquire plantation, dairy and other commodity assets, seeking higher margins as it reduces its exposure to commodity trading.

Sunny Verghese, Olam chief executive, defended the company’s use of biological gains in an interview with the Financial Times last week, saying that investors were well aware of the practice which is common among Olam’s peers.

Muddy Waters said that Olam had often bought companies “on life support”. It said Olam had a record of announcing having paid an amount for a company that turned out to be “well in excess” of what it actually paid in cash.

“While the cash Olam spends and debt Olam assumes are real, we believe that its NCAGs [non-cash accounting gains] are misleading accounting line items that can fool investors into believing the company is more profitable than it really is,” the report said.

Muddy Waters said Olam appeared to have spent S$571m less on acquisitions than announced, but that the company had spent S$996m on unattributed non-acquisition capital expenditure, mostly since its 2011 full year.

“One possible interpretation is that Olam is doing far more greenfield projects than realised, which greatly increases its risk profile. Another possible interpretation is that Olam has problems with internal controls and significant cash leakage,” Muddy Waters said.

Mr Verghese said in the FT interview that only three of the 35 acquisitions were “underperforming”.

“Three out of 35 is a fantastic record, name me any private equity investor which would have a similar record,” he said.

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