Techtronic Industries (HKG: 0669) (OTCQX: TTNDF) got accused, a few months back, of fraud. Of course, it was a short seller that made the accusation, and it was one of those slightly complicated to follow things. It was also one of those things where there was no immediate disaster likely for the company. It could be a problem down the line, yes. But this isn’t like the Hindenberg accusations against the Adani companies (which were, massive, concealed borrowings to buy their own shares). Or even The Big Short against mortgage bonds where it was just a matter of waiting for the disaster to strike – but keeping nerve until it did.
Jehoshaphat Research claimed that Techtronic was actually ripping off its own major customer, Home Depot (and possible others). The background is that Techtronic makes many of the gadgets – OK, DIY tools, drills, sanders, that sort of thing – for large American brands like Home Depot. The business model here is very similar to clothes factories in Bangladesh actually. The factory makes for the brand – H&M, Zara, other Inditex etc. And the business model continues in similarity. Those clothes factory outlets where you can buy brand names at 80% off (!!) are actually selling the seconds. The brand doesn’t pay the factory for things not up to snuff. But the factory can sell them retail as long as they point out that they are seconds. For the factory the price gained from selling in those outlets can actually be higher than selling to the original brands.
All OEMS face the same incentives
The big brands screw price down so hard that selling the seconds at 80% off normal retail can be more profitable. Weird but true.
Well, OK, so we’re all adults we can see the incentives here. How about if we up the number of seconds being made, have a higher failure rate, so we’ve more to sell direct? Tsk, and tut and even Tsh! But we can see that it might happen.
And that’s the accusation against Techtronic. The informed consumer knows that Techtronic runs those factory outlets. And that the machines are the Home Depot and other brands at significant price savings. And also, that something’s wrong with the machine – that’s why it’s in the outlet. But Techtronic makes more money selling direct through those outlets than it does under the original; OEM contract. So, the incentives? Jehoshaphat was, essentially, claiming that Techtronic had given into temptation.
The short selling allegation at Techtronic was about OEM seconds
Well, you know, maybe it did and maybe it didn’t. The price fell markedly on the release of the report then increased gradually following. Actually got back to $97 (HK, of course), close to the $100 before the revelations, after hitting $75 on the downside. At which point, well, accusation, nothing to it, recovery, and?
Which is exactly where I think it gets interesting. Say, just as an example, you got accused of having your hand in the till – and you had. So, after the accusation, you stop. One of the proofs that you did is that the numbers immediately improve after the accusation. Or try this the other way around, you’re accused of making excessive profit by mis declaring seconds that you can sell direct. Well, what might you do?
So, how do you recover from a short sellers allegations?
One thing you won’t is “Fair Cop, Guv” because that will leave you open to vast damages claims from your OEM customers. Imagine that you had actually been doing this too. Well, you’d probably stop, or at least cease being so egregious about it. After all, if Home Depot can send the guys ’round to the outlet shop and see vast piles of perfectly good kit then you’re going to be facing damages again, right? But what you were doing 3 and 9 and 18 months ago? Well, as long as you’ve stopped they might not worry all that much – after all, you are still their main OEM supplier. And how much proof can they get on kit that’s been in garages across the country for a year or more now?
Well, future results might be depressed a little bit.
So, a possible – do note possible – outcome is that having been accused your next profits announcement is somewhat disappointing. Because you’ve just stopped doing what was making you that excessive – according to your contracts excessive – profit. “Techtronic Industries (0669) said its first-half net profit declined by 17.7 percent from the prior year to US$476 million (HK$3.70 billion) but kept the interim dividend unchanged at 12.2 US cents. The Hong Kong-based power tools maker’s sales dipped by 2.2 percent, or 1 percent in local currencies, to US$6.88 billion during the period. Among them, revenue from North America dropped by 4.2 percent to US$5.2 billion while Europe rose by 7.3 percent to US$1.15 billion, a filing showed yesterday.”
Ah. Even, Ahh.
Now, we’ve no evidence whatsoever, other than those Jehoshaphat allegations, that anything has been going on at all. But it is possible for us to think about two different ways that those accused of wrongdoing – if they’ve been doing it – can react.
There’s one, like Polly Peck, where once the game was up the game was up. There that game was even listed in the accounts but in the bits no one bothered to read. Ah well. There are those like Adani and here Techtronic. Where hands have not been thrown up. No admission has been made and it’s entirely possible that the bad things weren’t being done. But the solution, over time, is to reverse the claimed bad things – which definitely weren’t happening – but that will obviously impact on the reported numbers.
And that then becomes a clue for us. Sure, maybe the short sellers allegations aren’t wholly, entirely true. Or not provably so. But if after them we see the accounts being affected in the way that reversing those claims would cause then…..
Well, then actually we’ve got evidence that those shares were formerly overvalued and so shouldn’t expect any short term return to those highs.
This isn’t perfect as an indicator, of course it’s not. But a bad set of accounts after a short seller’s allegations is, possibly indicative. Which is fun, isn’t it?
