Confessions of an S-Share CEO

Recently, it came to my attention that an anonymous letter had been penned and circulated to various parties regarding “confessions” made by a (supposed) CEO of a Singapore-listed S-Share company. This letter was supposed to be written to let the whole world know about the shady insider dealings in relation to the IPOs of China Companies listed on the Singapore Bourse, as well as to reveal the inner machinations which went on “behind the scenes” which enabled many parties to get rich; but which ultimately left the retail investor “holding the baby”.

While the authenticity of such a “confession” can be debated, what was written (yes, I do have the full copy of the text but it would be too lengthy to post it here, so please follow this link ) constitutes a peek into the shady and dubious world of deal-making, private equity and the eventual listing. Even Ms. Teh Hooi Ling of the Business Times wrote an article on this in yesterday’s Business Times commenting on various aspects of such deals and how these companies can be hyped up, marketed and eventually sold to the public. It is not unlike the heydays of the dot.com IPO boom which led many new companies to aggressively sell their shares to unwary investors, all with the promise of growing revenues and soaring profits. I would like to use this article to illustrate some aspects of IPOs and deal-making which I feel can be learnt and which are significant to retail investors like myself.

It was mentioned in the article that if you pumped enough money into a company, it could look very much more “alive” than it really is. This was alluding to the fact that if one wished to “promote” a company, all one needed to do was to find some private equity investors (“angel” investors), put money in, aggressively spend on capex and new products; then push them to customers all on credit, all the while booking in the revenues but not collecting the cash. Such an accounting “trick” is widespread in commodity businesses (the letter stated that it was a “chemical fibre” business in the textile industry, which led some to speculate that it may be the recently suspended Fibrechem). Barriers to entry are low and as margins are thin, so introducing new products and investing in technology is risky especially if customers are not willing to take up the new products. Hence, the deal-maker (Mr. D in the article) is the one responsible for making a mountain out of a molehill (figuratively speaking) and transforming the company to something much bigger than it actually was. In other words, mediocrity was perceived as quality based on a change in appearances.

The article also highlights the fact that in most IPOs, the ones who benefited the most are the original people who pumped money into the company at very low valuations (perhaps 1-2X PER), and which later filed an application to list under bullish conditions, thereby garnering gains of 5 to 20 times of their initial investment. Since companies could be “dressed up” to look very nice, the numbers may not be heavily scrutinized by the general public prior to IPO, and anyway everyone knows that IPOs are hot during bull markets as everyone wishes to “stag” it on its first trading day. This is probably one reason why IPO stands for “It’s Probably Over-priced” ! Companies will choose to sell their shares during periods when their shares can command the highest valuations, as this means they can raise the maximum amount of money possible, even if they don’t need it ! IPOs are sometimes also mechanisms for the existing owners to cash out and get filthy rich in a short period of time.

Investors who buy into such growth stories have to be wary of the people pushing the IPOs, as the article clearly states that everyone in the IPO-cycle benefits in some way from the listing – except the retail investor. A very noteworthy paragraph which I will reproduce here states as such:

“Everyone got what they wanted. The Chinese companies got their money to expand their business (which at a later stage, no one is really sure which company really had any business to start with), the entrepreneurs were handsomely rewarded for the risks they undertook, the deal makers got their fees, the angels made their killings, the bankers collected their fees and dished out new loans, the lawyers and accountants recruited more young graduates to cope with the record work volume, the stock exchange got their “new mandate as the second board of the Chinese companies”, the investors got their hot-and-sizzling China concept stocks and above all, the rich and the influential members of the “invisible clubs” were all happily enriching their own pockets”.

I think the above is self-explanatory and only serves to reinforce the fact that everyone has a part to play to push through an IPO as there is a lot of money to be made even before a company gets listed. Investors have to spend time separating the wheat from the chaff and this is admittedly not easy; but one easy thing to note is that the quality of IPO companies drops as the bull market gets hotter and hotter, and valuations get more and more crazy.

One final point I wish to highlight is that the bubble eventually HAS to burst, just as it did for the dot.com companies in 2000. The immense hype, easy money and over-leveraging were the perfect storm for a crash and the subsequent bust. Even in 2006 and 2007, when S-Shares were touted as the next big thing, there was already an element of “bubbling” as the China growth story was pushed and touted again and again by a myriad of analysts. Everyone wanted the party to last and indeed, everyone acted like Cinderella dancing in a room without clocks. When midnight struck, everything was reduced to pumpkins and mice. This is a lesson for me and other investors too – beware of hype and slick marketing; don’t leave your brains at the door when evaluating companies. It takes a very clear, sharp, objective, rational and analytical mind to see through the thick coat of gloss which covers the true prospects and financial situations of many a company.