What Is The Short Attack On Noble Group Limited All About? Part 3

Singapore’s stock market seems to be an attractive place for a “short attack” these past few years.

The term “short attack” is basically used to describe the act of funds or researchers publicly announcing that a company’s shares are worth a lot less than its current market price due to issues such as fraud, poor management of the business, or a simple case of over-valuation.

The next one in the firing line

The latest target for a short attack is none other than commodities supply chain manager Noble Group Limited (SGX: N21).

On 15 February 2015, a critical report surfaced online, claiming that Noble Group employs extremely aggressive accounting techniques that have a similarity to what Enron, the infamous fraudulent U.S.-based energy trading company, did. Amazingly, the report was written and prepared by an anonymous blogger (or a group of people) called Iceberg Research.

I had taken a look at the report and you can read more about my analysis of it in here and here.

For me, this episode symbolizes the rise of the internet community as a watchdog on big corporations. It also showed how much damage a random person armed with a laptop and internet access can do to a multi-billion dollar company – Noble’s market cap had shrunk from S$8.087 billion on 15 February 2015 to ‘just’ S$7.144 billion today.

A new round’s fired

Earlier today, Iceberg Research fired another salvo by releasing its second report on Noble Group.

This time, the report had focused on an analysis of Noble Group’s calculations of the fair values of its financial derivatives and the way the company accounts for its operating cash flow. As the report is quite lengthy, I’d break down Iceberg Research’s main accusations. The summary of the second report is as follows:

  • There is a large discrepancy between Noble Group’s accounting profits and its operating cash flow, which is due largely to financial engineering.
  • Noble Group uses mark-to-market accounting to book profits from long term contracts on the day of signing (similar to Enron), instead of using more conservative accounting methods such as percentage-to-completion.
  • Noble Group might be overstating the valuation of its commodities contracts.
  • Without all these financial engineering, Noble Group’s balance sheet and business performance would actually be way worse than the reported numbers.

I’d like to specifically take a look at Iceberg Research’s stance on Noble Group’s use of mark-to-market accounting.

Essentially, Iceberg Research had accused Noble Group of generating paper profits mainly through the use of net fair value gains from its trading contracts.

The mark-to-market accounting method is quite a common practice for commodity trading companies. However, most trading contracts are short term in nature, so even if the company does book its profit in advance, it will most likely convert that profit into cash within a year or so.

What Noble Group has done, according to Iceberg Research at least, is that it had booked massive mark-to-market profits on much longer term contracts which are (1) more prone to manipulation, and (2) have fair values that are a lot harder to estimate.

An example given in Iceberg Research’s report is that 59% of Nobel Group’s fair value gains in FY2013 had a maturity beyond a year.

More disturbingly, Iceberg Research claims that all of Noble Group’s fair value gains amounted to roughly US$5.8 billion. For some perspective, Noble Group’s reported shareholder’s equity at end-FY2013 was US$5.16 billion.

Noble’s response

Noble Group had asked for a trading halt earlier this morning (partly to “allow time for consulting the auditors and Management” about the allegations made by Iceberg Research, “given that the [firm’s] annual results are due to be published this evening”) and issued a rebuttal to the latest report.

Noble Group indicated that it believes that all its physical contracts are fairly priced based on market prices. The company also stressed that it has been engaged in conservative accounting practices and that it has a strong balance sheet; to that effect, Noble Group stated that it “has no plan, nor needs, to raise capital.”

In one of Noble Group’s announcements today, the company also pointed out that its auditor, Ernst & Young, has decided to sign off on its year end accounts.

Foolish Summary

Iceberg Research’s accusations are not light. However, the blogger did acknowledge that much of its analysis had been based on its own assumptions. All the claims are also presented with phrases like “we believe,” “we suspect,” and “we think,”  meaning that there could be a lack of real evidence behind Iceberg Research’s logical deductions.

Iceberg Research has stated that there will be a third report coming out soon. I’d be taking a look at it (if it comes) and will come back with my thoughts if there’s anything noteworthy to share.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.