Carson Block Goes Short Unafraid as Chinese Gangsters Chase

Muddy Waters LLC. Carson Block
Carson Block, research director and founder of Muddy Waters LLC. Photographer: David Paul Morris/Bloomberg

At a benefit for pediatric cancer care in London three weeks ago, Carson Block, the 36-year-old short seller whose research helped erase almost $7 billion of market value in China since 2010, unveiled his latest theory.

Olam International Ltd., the government-backed commodity merchant in Singapore responsible for 90 percent of the world’s peanut trade, is a sham in the image of Enron Corp. and doomed to fail, Block said. Within minutes, its U.S.-traded shares began a plunge of more than 20 percent. Two days later, Olam filed suit, calling the statements slanderous.

None of it is new for the founder of Los Angeles-based Muddy Waters LLC, who said he stopped trying to bet against Chinese companies this year after government agents hindered his analysts and harassed workers at a storage company he owns in Shanghai. “Tattooed gangsters” came looking for him, he wrote in an e-mail to Bloomberg on Dec. 4, retaliation for his success uncovering financial sleight of hand at companies such as Sino-Forest Corp., which is now bankrupt.

“Block has been the most vocal and public about the accounting problems with U.S.-listed Chinese companies,” said Timothy Ghriskey, chief investment officer at New York-based Solaris Group LLC, which manages about $2 billion and sold positions in China last year. “To give him credit, it is certainly providing a service to investors by highlighting this issue and saying it is something that needs to be dealt with.”

SEC Enforcement

A lawyer who grew up in Summit, New Jersey, Block co-wrote “Doing Business in China for Dummies” in 2007, telling readers “you may face some of the most brutal negotiations you’ve ever seen” and “it’ll likely be very rewarding in the end.”

Now he’s switching his focus from the world’s most-populous country just as the U.S. Securities and Exchange Commission steps up scrutiny of companies there. In a Dec. 3 enforcement action, the commission accused affiliates of the four biggest accounting firms of refusing to produce documents for investigations into client financial disclosures.

While the SEC has been raising questions about Chinese companies with listings on American exchanges for at least seven years, it wasn’t until Muddy Waters started publicizing its research that investors began to understand the risks. Block has been likened to a “shock-jock” by Allen Chan, the co-founder and former chief executive officer of tree-plantation operator Sino-Forest, and Olam CEO Sunny Verghese said his goal is to “create panic.” To his clients and peers, Block is a hero.

‘Important Function’

“Short sellers perform an important function in the marketplace, especially those who share their views with the public,” said David Rocker, former general managing partner of hedge fund Rocker Partners LP, which averaged an 11 percent annual return between 1985 and 2006 with bearish bets. “I applaud Block’s courage in presenting his views in the face of considerable hostility.”

Critical reports by Muddy Waters LLC drove down the shares of eight companies by an average of 60 percent, according to data compiled by Bloomberg. Now it’s pressing the case against Olam, whose second-biggest holder is state-owned investment company Temasek Holdings Pte. and has a market capitalization of S$3.49 billion ($2.86 billion).

Olam’s Singapore-traded shares lost 16 percent since Nov. 19, the day Block first made his allegations at the Ira Sohn Investment Conference, through the end of last week. The commodity trader brought its rebuttal to court. The stock rose 1.4 percent to S$1.48 today.

Short Lehman

At the annual gathering, the same one where hedge-fund manager David Einhorn said in 2008 he was short Lehman Brothers Holdings Inc. before it filed the largest bankruptcy in U.S. history, Block presented his bearish thesis on the commodity trader using an Enron logo with letters replaced to say Olam.

Enron, once the world’s largest energy trader, sought chapter 11 protection in December 2001 after revelations that the Houston-based company used off-balance-sheet vehicles to hide billions of dollars in losses and inflate the company’s stock price. More than 5,000 jobs and about $1 billion in employee retirement funds were wiped out.

“Comparisons to Enron are overused, but in the case of Olam, the similarities really are uncanny,” Block wrote a week after the conference. “We believe that the single biggest factor in Enron’s collapse was its use of accounting techniques similar to Olam’s value gains.”

‘Burning Cash’

Muddy Waters says Olam should be considered on a “liquidation basis because our opinion is that it is likely to fail,” the Nov. 26 report said. The company uses non-cash accounting gains to boost earnings, has been “burning cash” and will need to raise or refinance as much as S$4.6 billion of debt over the next year to remain solvent, Block’s firm said. CEO Verghese dismisses the claim, pointing to more than S$10 billion of balance-sheet liquidity.

Hung Hoeng Chow, Olam’s associate general manager of investor relations, declined to comment for this story.

Block said he doesn’t expect his work on Olam to elicit the same hostility he was subject to in China.

“We do not believe that Singapore is a thugocracy,” he wrote to Bloomberg News last week. “If Singapore did use heavy-handed retaliatory tactics against us, that would certainly be a surprise.”

Block, a self-described gangster rap enthusiast who usually declines to say where he’s calling from, grew up in the equity research business, working as an analyst in college and passing his broker’s license exam at 19. His interest in Asia started when he spent a summer in Japan during high school. He first went to Beijing in 1997 and moved to Shanghai after graduating from the University of Southern California in Los Angeles with a degree in business administration in 1998.

Law Degree

His plan to do equity research in China fizzled in 1998. In 2005, with a law degree from Chicago-Kent College of Law, he returned to Shanghai to work on foreign direct investment and merger deals at the law firm Jones Day. He quit in 2006, planning to start a private banking business in Singapore, and ended up founding Love Box Self Storage instead.

Pressure is mounting for Muddy Waters to repeat its early success after its most recent targets failed to turn a profit. Beijing-based Fushi Copperweld Inc., a maker of copper-clad metal wire that Block said in April may be committing fraud, has gained 25 percent in New York this year after China Development Bank Corp. offered funding for the company to buy back its shares.

Focus Media

Focus Media Holding Ltd., the Shanghai-based advertising firm that Block claims overstated its network, posted a 24 percent gain in its American depositary receipts this year. The company is the subject of a $3.5 billion buyout offer by a group of private equity firms including Carlyle Group LP. The deal, if completed, would be China’s largest leveraged buyout.

“His research is extremely poor,” said Louis Hsieh, president of New Oriental Education & Technology Group Inc., another Block short. “His latest contention is that he’s backing away from Chinese companies because the Chinese government is in conspiracy with Chinese companies to commit accounting fraud against U.S. investors. What’s the basis for that? It’s ludicrous.”

The American depositary receipts of the Beijing-based company are up 20 percent since Block’s report, the only stock among his eight sell ratings to have a positive performance since he began publishing on them.

‘Somewhat Painful’

Block says the government is protecting frauds by making it difficult to research short sale candidates, as he did with his biggest target to date, Sino-Forest. The shares slumped 74 percent before Sino-Forest eventually filed for bankruptcy.

The Chinese government has used intelligence and police agencies, including the Ministry of State Security and the Public Security Bureau, to deter Muddy Waters from continuing to do research in China, Block told Bloomberg News last week.

“The security service intervention in China has been somewhat painful on a personal level for Muddy Waters’ team members, our family members, and myself,” he wrote.

Calls to the Ministry of Public Security’s listed phone number weren’t answered, and it did not immediately respond to an inquiry sent by fax. A staff member answering the Ministry of State Security’s listed number said the ministry did not have a phone or fax number to handle media queries, and that all inquiries are to be sent by post.

Deloitte Touche Tohmatsu CPA Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian CPAs Ltd. have refused to cooperate with accounting investigations into nine companies whose securities are publicly traded in the U.S., the SEC said in an administrative order on Dec. 3. BDO China Dahua Co. was also named in the action.

Orient Paper

Block hunted smaller game when he started. His first short was Baoding, Hebei-based Orient Paper Inc. with a market value of about $160 million. Block visited the company with a friend, Sean Regan, observed dilapidated machinery and a factory full of steam, according to a Bloomberg News interview in September. When the CEO couldn’t answer questions about production, they realized the company was ripe to bet against.

“The Carson Block model of very detailed reports has set a new standard,” Sahm Adrangi, who manages $125 million at New York-based hedge fund Kerrisdale Capital Management LLC., said in a phone interview. “His original piece on Orient Paper was breathtaking and unprecedented with respect to anything short sellers had done in terms of writing and sharing research.”

Orient Paper fell 40 percent in the four days after Block on June 28, 2010, described its purpose as being “to raise and misappropriate tens of millions of dollars” and accused it of overstating 2009 revenue by 40 times. The company said in 2011 that a four-month investigation found no evidence to support Block’s allegations. The stock has retained its listing on the New York Stock Exchange, where it has lost 78 percent since the Muddy Waters report.

Regulatory Scrutiny

“Prior to the first report I had no idea that anybody would care,” Block said in a June 2011 interview with Bloomberg News. “Every single report from then on was with the expectation and the hope that I would be talking to regulators to help them figure this out. I’m confident that my actions stand up to regulatory scrutiny.”

Rino International Corp. was next. In a November 2010 report Muddy Waters said that the Chinese designer of wastewater equipment had exaggerated sales. Rino, based in Dalian, China, said in a filing eight days later that two years of financial statements weren’t reliable. The shares tumbled 67 percent that month in U.S. trading and the stock is now trading for 2 cents a share over the counter.

Revenue Reporting

Ben Wang, Rino’s chief financial officer, didn’t respond to two calls and an e-mail asking for comment on the report by Muddy Waters, while an e-mail to Orient Paper went unanswered.

Except for Sino Forest and Olam, where the SEC didn’t have jurisdiction, the regulator had commented on accounting matters in each of his short selling targets before Block’s reports. The commission pointed to concerns about revenue reporting at New Oriental Education & Technology in 2009 and lack of clarity in the financial results of Rino going back to 2008.

SEC spokesman John Nester didn’t return an e-mail seeking comment on the regulator’s response to fraud among U.S. listed Chinese companies.

“Block is in the intelligence business where you gather tidbits of information, you fuse them together, connect the dots and then you draw a conclusion,” James Rickards, senior managing director of Tangent Capital Partners in New York, said in a phone interview. He advises clients investing in China. “The SEC is much more like cops. First the crime is committed, and then they go to solve the crime. But Block is looking at the crime in progress.”

John Paulson

Muddy Waters followed its first reports with bets in 2011 against China MediaExpress Holdings Inc. and Duoyuan Global Water Inc., which were both delisted in the U.S. The streak culminated in June with Sino-Forest, which had a market value of about C$6 billion ($6.1 billion) and counted hedge fund manager John Paulson among its biggest shareholders.

Block, who speaks some Mandarin, called the Hong Kong and Mississauga, Ontario-based company a Ponzi scheme after he had 10 researchers spend two months looking at the business to produce a 40-page report, which was supported by at least five follow-up notes with documentation.

Now he is trying to repeat the success by applying his research skills in the case against Olam, a company that counts AllianceBernstein LP and BlackRock Inc. among its shareholders.

“The view of short sellers, if accurately and fairly presented, provides a balance to the investing public who would otherwise be exposed to only positive news from an array of bullishly oriented constituencies,” David Rocker said.

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