Noble's Giant Writedown Proves Iceberg Research Right After Two-Year Fight

  • Anonymous research group predicted writedowns in 2015
  • Noble to write down mark-to-market gains from coal contracts

Carson Block Says 'Wheels Falling Off' Noble Group

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In early 2015, a previously unknown entity called Iceberg Research published a series of scathing reports attacking the accounting practices of Hong Kong commodity trader Noble Group Ltd.

Among Iceberg’s central accusations was that Noble had inflated the value of long-term commodity contracts and carried billions of dollars in profits on its books. The trading house would eventually be forced to write down the value of those gains, Iceberg said.

At the time, Noble dismissed the claims as the work of a disaffected ex-employee who was using the Iceberg handle to make anonymous attacks on his old company. Yet, more than two-and-a-half years later, Noble has done much of what Iceberg predicted.

Noble, due to report earnings later on Thursday, said in a statement in July that the company expects to post a second-quarter loss of as much as $1.8 billion including writedowns of up to $1.3 billion. The board concluded “that a more conservative balance sheet valuation should be implemented,” it said.

“Iceberg has been proven completely correct here,” said Carson Block, the U.S.-based short-seller and head of Muddy Waters LLC. “Our conclusion, at the time, was that we shouldn’t trust management and we should short them. That has very clearly been vindicated.”

For Iceberg, validation has taken a while. Initially slow to react, Noble fought back once the allegations began denting the trader’s share price. The company sued Arnaud Vagner, a former employee and the man the company claimed was behind the research group. The lawsuit remains ongoing in Hong Kong.

To read a story on Iceberg’s latest research note, click here.

The aggressive response did Noble little good. After investors started selling, the company was forced to pay increasingly nervous banks more to finance day-to-day operations. Today, Noble’s shares trade more than 95 percent below their pre-Iceberg value, founder Richard Elman has been ousted as chairman and senior management replaced. The new board has put almost all Noble’s businesses outside Asia up for sale.

Noble declined to comment for this story.

An unidentified representative from Iceberg reiterated in an email that neither the research group nor its members hold or have held positions in Noble securities since publishing the reports. The person declined to comment further beyond statements posted on its website. Vagner has never confirmed or denied a link to Iceberg.

"The board, regulators, auditors, rating agencies, many in the media and research analysts, all were slow to see the gathering storm, which was so obvious to us," said Michael Dee, a long-time Noble critic and formerly a senior executive at Singapore’s state investment firm, Temasek Holdings Pte. "The question that must be answered is ’Why?’"

At the heart of Iceberg’s work were criticisms of fair-value gains on Noble’s long-term contracts to trade commodities, principally coal. For example, the company might sign a long-term agreement to handle production from a mine and then assign value to that deal based on the company’s prediction for commodity prices.

For years, Noble booked profits from those gains, also known as mark-to-market, more aggressively than its major competitors.

Accounting rules compel traders to put mark-to-market gains in three buckets depending on how concrete the valuations are. For the riskiest Level 3 contracts, traders can use their own estimates of future commodity prices.

At the end of 2014, Noble reported $1.05 billion in positive Level 3 fair-value gains. Now, Noble is writing off the remaining gains from those contracts: about $660 million.

To read a story on Noble’s profit warning in July, click here.

Noble has consistently said its accounting practices comply with International Financial Reporting Standards (IFRS) and its auditor, Ernst & Young LLP, has continued to sign off on its accounts. An Ernst and Young spokesman declined to comment for this story because Noble remains a client.

The board appointed PricewaterhouseCoopers LLP to review its accounting practices in 2015 and the accountant published a report saying Noble’s method for assessing the fair value of its contracts was in line with relevant standards. However, PwC did recommend that Noble strengthen its compliance to improve the way it values some contracts.

Noble reported total net fair-value gains of $2.8 billion at the end of 2016 compared with $3.2 billion at the end of 2015, it said in its annual report. In addition to the Level 3 gains of about $660 million, the company had about $2 billion worth of Level 2 fair-value gains on its books at the end of 2016, it said.

Level 2 fair values for commodity contracts and derivatives are based on models for which "all significant inputs to the measurement are observable," Noble said in its annual report. Level 1 fair values, are quoted market prices taken from relevant active markets.

The financial reports of Noble’s trading house rivals show Level 3 fair-value gains that are much smaller than Noble’s even though the other houses are much larger.

Trafigura Group, which trades coal, oil, LNG and other commodities, reported net Level 3 financial assets and inventories including debt securities, equity investments and physical forwards of $375.3 million, $603 million of assets and inventories and $228 million of liabilities, according to its 2016 annual report. Trafigura’s 2016 revenue was $98.1 billion, more than double Noble’s $45.5 billion.

“Trafigura only accounts realized profit on the trading business,” a company spokeswoman said in an emailed statement. “Level 3 values are adjusted in our balance sheet to reflect fair value (mainly in relation to our fixed assets) but this does not have any bearing on profit from trading activity.”

Glencore Plc, the world’s biggest commodity trader with annual revenue of about $153 billion reported Level 3 net fair value of negative $54 million in 2016, according to its annual report.

Vitol Group, the world’s largest oil trader, recorded no Level 3 financial assets or liabilities during its 2015 fiscal year, the last full results available.

As Noble fights to remain a viable business, Iceberg says the company’s accounting shakeout still has some way to run.

“Our main argument against Noble was that this company fabricated profit by inflating the value of these contracts by billions,” Iceberg said in an Aug. 3rd posting on its website (its first since February) titled ‘Noble Group Is Sinking.’

“Noble had already impaired these contracts by $1.1 billion in its 2015 results. So the total is now $2.3 billion, and it’s not over” Iceberg said.

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