Note: this article is the continuation of the series The Case for Short Selling: Muddy Waters LLC
20th November 2012: The equity of Olam International had already taken a huge hit and on the 20th it was the day for the bond to plummet as well. Olam’s dollar denominated bonds which ended their term in 2017 saw a record fall following the sale on the equity markets. Even though top officials at Olam had come out to contend the claims made by Muddy Waters but it seemed that the market was much more comfortable betting on the short seller rather than the company.
The reason was rooted in scandals of the past like Enron ,where not only was the strategy the same, stating revenue faster and greater than it should be , but also the fact that the company was showing a rosier picture than the one that existed. Investors were must comfortable taking their money out rather than risk it further on uncertainty. The fall of the bond price was from 97 cents to 91.5 cents on the dollar after the announcement which is a fall of over 6% in a day. Considering that the bond is safer than equity and guarantees a return, it magnifies the loss in investment value. The failure to raise enough revenue would mean that the company might not be able to maintain its payments or service its debt which can raise uncertainty for the investors.
The response from Olam had been strong till now where CEO Sunny Verghese had supported the fact that the company is growing and is looking to external and internal sources to grow its earning power. This is after knowing that the company is heavily indebted and has borrowed against many of its new ventures looking into the future. This does raise questions that as it is already heavily leveraged and would be looking for more financing, the company might have an incentive to overstate its revenue either to appease its creditors or to raise more funds in the future based on exaggerated figures. It has been done in the past so it’s not a wild theory either. This is why short sellers are important to keep a company true to itself and not to misrepresent facts that can be seen through by the observant participants.
It was time now that the bleeding had to be stopped. The best way to do that was to go on the counteroffensive and to hit back at the claims made against it. The firm accused Muddy Waters of taking a short position in the company and then spreading wrong rumours in order to take advantage of its position and to make a gain at the cost of other investors. Trade data shows that the position was taken on the 15th of November by Muddy Waters while the comments came out on the 19th which does give some credibility to these claims. A lawsuit soon followed to quell most of the concerns that existed in the markets
21st November 2012: The trick seemed to have worked as the shares started rebounding in Singapore. Investors were coming back and the shares were regaining confidence. It was Muddy Waters turn and they turned up the heat by increasing their criticism of the Olam saying that they had never seen a more disproportionate response. In a letter to Olam they stated “Companies that attack criticism the way Olam does fail to understand that raising money from the public is a privilege.” The rise in confidence was seen as no substantial report had been issued by Muddy Waters which detailed their rationale and could be critiqued by Olam and its officials.
22nd November 2012: Olam was getting successful in its attack and the best was yet to come as it stated that they had enough liquidity to withstand a market shock. This was counter to what many believed was the root of the problem based on its high levels of debt. In addition to that, Ernst and Young, the auditors for Olam came out in its defence saying that Olam had done nothing wrong and was in line and in accordance to the accounting standards.
26th November 2012: The saga was reaching the length of a week and things were becoming more and more ambiguous by the day. Within the war of words between the two parties, the rule that caused it all also came into light. The standard state that the biological assets that Olam traded in were supposed to be restated in every three months. The rule is subjective to such an extent that many people feel there is a grey area to the application of the rule. Due to the subjectivity, the estimates will lead to different valuations and depending on the person looking in; he will deduce his own conclusion in the end.
Many feel the disparity in assumptions is the reason why Muddy Waters and Olam are at odds with each other. Just when things could not have gotten more convoluted, Block backed away from his position and said that he was not assured about Olam as he was afraid Chinese government was perpetuating the fraud within its own companies. Till now, Block had shorted many Chinese companies but now felt that in case of bankruptcy or accounting fraud at its own companies, the government would look to protect them in order to sustain itself on a larger scale. On the stock exchange, the short interest won out as the trading restriction was lifted and the share fell more when trading resumed.
27th November 2012: The story was becoming like a full blown slug out between Olam and Muddy Waters. The two heavyweights were taking shots and it was time for Muddy Waters to have another blow. Block likened the company to Enron in terms of its inflated and exaggerated balance sheet and said there was a lack of funds and cash flows for the company to be able to react to a change in market conditions. The short seller said that the company had been burning its cash flow fast ever since it went public and that based on its acquisitions and expansion, the company would run dry soon due to lack of funds to grow any more.
In addition to that, the inflated revenues would also come back down to their actual value which will be shock to the market just like Enron’s revelations saw the share value fall to nothing. As a third party investor, the market advised people to keep an eye on the company themselves, carry out their own research and find a middle ground that was being drawn up by both sides. The result would probably be in the grey area in the middle where the investor can reconcile the high growth and high manipulation that is seen on the two extremes and find his own assumptions realized on the spectrum. Muddy Waters was also taking a swing at Chinese companies by claiming that Chinese government was supporting fraud which pushed down prices for these companies and there were suggestions of delisting from the American exchanges.
29th November 2012: The response from Olam was again fast and strong and their upper cut to Muddy Waters was in the form of added business that they were signing amidst the media hoopla. They also showed their liquidity of $10 billion for its investors to see to assure them that things were not as bad as some might make them think. They contended that their balance sheet was stronger than ever and the acquisition strategy of being asset heavy is expected to yield high returns to its investors. They were also boosted by its shareholders who rallied the shares on the day and the backing by some of its bigger shareholders like Temasek holdings was assuring in the turbulent times.