David Craigen Short SMC Corp: Sohn London Conference ~ market folly

Monday, December 4, 2017

David Craigen Short SMC Corp: Sohn London Conference

We're posting up notes from the Sohn London conference 2017.  Next up is David Craigen of Lansdowne Partners who pitched a short of SMC Corp (TYO: 6273).

David Craigen's Sohn London Presentation

SMC is a $30bn market cap Japanese company with $5bn of sales.  It is the world’s largest pneumatic components supplier with a wide global coverage (72 subsidiaries). Craigen first looked at SMC after the Olympus accounting fraud which broke in 2011. The key takeaway from Olympus was that the fraud had been going on for 20 years before it was discovered.

There are several accounting issues at SMC:

-    Large companies around the world are usually audited by one of the big four accountancy firms. SMC has had the same auditor since the late 1980s. The auditor is small with only 16 qualified accounting staff. It does not audit any other mega-cap companies. Clients of this company have subsequently been proven to be frauds.

-    There is no global unified audit. There are 36 unconsolidated subsidiaries – far too high and unusual.

-    SMC finances itself via reverse factoring. Seventy percent of payables to suppliers are factored. Why are suppliers of SMC nervous about its ability to pay them?

-    The Chairman is 91 and has been with the company since inception.

This year there have been three allegations about SMC made by FACTA online, the Japanese publication that first broke the Olympus fraud. They have highlighted related party transactions that have been made through a US subsidiary; opaque tax reporting in SMC’s Mexican operations where a private residence was used as the tax address and the late delivery of orders in the US.

Despite this negative news flow, the sell-side and buy-side maintain a bullish stance. Seventy five percent of analysts’ rate SMC a buy whilst the top five holders’ shareholdings remain unchanged this year.

Since FACTA published its findings SMC’s share price is up 80%.

Lansdowne’s short in SMC is hedged out by 3 long positions in VAT 33%, a Swiss company specialising in semiconductors; Airtac, a Taiwan company which is a pneumatic components pure play; CKD 33%, a Japanese competitor, No.2 to SMC.

Revenue growth for the long basket is much higher (x3) than SMC’s. The long basket is also trading at a substantially lower valuation.

Something is not right with SMC’s margins. SMC does not sell the highest value-added products in the industry yet it’s margins are among the highest. This calls into doubt its reported earnings.

Be sure to check out the rest of the presentations from Sohn London 2017.

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