Short-Seller Glaucus Targets Itochu in First Japan Report

  • Itochu responds, says it applied appropriate accounting
  • Says Itochu shares are poised to fall by as much as 50%

Activist short-seller Glaucus Research Group published a report on Itochu Corp., criticizing the Japanese trading company’s accounting and saying its shares are poised to plunge.

Itochu is a “strong sell” and is set to fall as much as 50 percent, Glaucus wrote in the 42-page “short-biased” report published before the Tokyo stock market opened on Wednesday. The shares sank as much as 10 percent before paring losses to end down 6.3 percent, which was the biggest drop on the Nikkei 225 Stock Average.

“In our opinion, Itochu will likely become the next Japanese company to be forced to restate its financials,” Glaucus wrote in the report.

Itochu follows correct accounting procedures and its financial statements are approved by its outside auditor Deloitte Touche Tohmatsu, the trading house said in a stock exchange filing responding to the report. Glaucus’ view of its accounts is “completely different” from Itochu’s own, the company said. In a statement after the market close, it provided a more detailed response to Glaucus’s allegations.

Glaucus has a short position in Itochu’s stock, the firm said in the report. Short sellers borrow shares and sell them, hoping to profit by repurchasing the securities later at a lower price. Itochu is Glaucus’s first target in Japan, with the U.S.-based investor hiring a Japanese analyst to help with its push into the market, Soren Aandahl, director of research at Glaucus, said last month.

Three Investments

Glaucus questioned Itochu’s accounting treatment of three investments in the report. It asked whether the trading company inappropriately reclassified a stake in a Colombian coal joint venture to avoid an impairment charge in the year ended March 31, 2015, which Glaucus estimated at 153 billion yen ($1.5 billion). In its response, Itochu said the reclassification was done because the company lost some approval rights when preferred shares were issued.

The short-seller queried whether Itochu should consolidate profits from its equity interest in Citic Ltd., which is majority owned by the Chinese government. Itochu said it applies the equity method for its accounting of the Citic stake because it owns 50 percent of it.

Itochu also expressed doubt about a reclassification and one-time gain related to Ting Hsin Cayman Islands Holding Corp. in March 2015, in the final weeks of Itochu’s financial year. Itochu responded that it’s because it partially sold its Ting Hsin stake and therefore revised a shareholder agreement to reflect a decrease in involvement.

“Two reclassifications happened,” Aandahl said by phone. “In one case they perform a revaluation and recognize this gain that saves them in their earnings. And in the other case, when this investment is obviously impaired, if the reclassification is justified they should have done a revaluation.”

Commodity Woes

Thanh Ha Pham, an analyst at Jefferies Group LLC who rates Itochu a buy, was unconvinced by the Glaucus report. It’s “not a game changer in terms of the way we look at the stock,” he said on Wednesday. “This was everything we knew already. There was a big fuss about this company coming to Japan and how deep research they do. I expected a bit higher-quality research.”

Japan’s biggest “sogo shosha,” or general trading houses, posted a combined 1.23 trillion yen in writedowns in the fiscal year ended March after investing heavily in metals and energy at the height of the commodities boom, only to see prices tumble. The writedowns forced Mitsubishi Corp. and Mitsui & Co. to announce their first annual net losses ever.

Itochu had net income of 240.4 billion yen last fiscal year, the highest profit among the five largest trading companies. It booked 95.5 billion yen of impairment losses during the period, the least among the firms.

Itochu “appeared to be immune to the same secular headwinds that were affecting its peers,” Aandahl said. It “seemed unafflicted by the ills that plagued the other commodity houses.”

Glaucus History

Glaucus, which publishes most of its research reports on its website, had targeted 22 companies around the world, Aandahl, who is based in Austin, Texas, said last month.

Glaucus issued a “strong sell” report on U.S.-listed Universal Travel Group in March 2011, claiming the Shenzhen, China-based company falsified its financial statements. The company voluntarily delisted in April 2012. The next year, Universal Travel and two former executives agreed to pay $935,000 to settle a U.S. Securities and Exchange Commission lawsuit alleging that it defrauded investors.

Sell-side analysts are much more positive on Itochu than Aandahl, who says Glaucus worked on the report for months, spending at least 500 hours. Of 12 analysts covering the stock, eight say buy, four have hold recommendations and none suggest selling, according to data compiled by Bloomberg.

“It’s a marketplace of ideas,” Aandahl said. “All we can do is put forward our investment opinion and the basis for it,” he said. We think Itochu should “nominate an independent investigative committee, composed of independent board members and an outside accountant, to review these issues that we’ve brought up.”

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