Saturday, September 13, 2014

Nouvelle Vague live in Cologne

Very sick in bed, so looking for (very light) YouTube entertainment to see me through the fever...

The cover of Blondie's Rapture is worth the price of admission. It starts at 7 minutes 11 seconds.


Wednesday, September 10, 2014

In 2014 the New York Times has gone off line becoming a print-only newsletter for the elite and the elderly

A decade ago Robin Sloan and Matt Thomson made a cheap flash movie on a simple premise. The movie was a production of the Museum of Media History, was made in 2014 and had dropped to the year 2004 through a wormhole in time.

I guess you could think of it as predictive (though Robin Sloan specifically disavowed that).

Some of it is surprisingly good. Some less so. They seem to think that Friendster and not Facebook was what would matter. Enjoy.

http://idorosen.com/mirrors/robinsloan.com/epic/ols-master.html




John

Saturday, September 6, 2014

The Gobi Desert people like their Nu Skin, so do Wild Yaks, Donkeys and Bears

Not all of Western China is thinly populated. Chongquing is big modern city (though I have not been there since 1981 when it felt medieval).

However some of China is very thinly populated indeed. Parts of the Tibetan Plateau are almost as thinly populated as Antarctica. I was flattering when I described them as being for nomadic herdsmen (though Nu Skin is also opening stores for them too).

Here again is the map of Nu Skin's store openings - but this time I have marked a few stores.




Note the several stores planned for the Gobi Desert. This area is thinly populated - but they are planning multiple stores.

The map shows an existing store in Hohhot (a reasonable sized city). That store is marked in red. The proposed stores do not correspond to any reasonable looking population centres. However as China hands observe - the area has a surprising population density given how infertile it is.

The store that stands out though is the one marked in Hoh Xil. Hoh Xil is an elevated part of the Tibetan Plateau and the whole area is above the altitude at which sustained human existence is possible. According to Wikipedia Hoh Xil is the least populated part of China and the third least populated part of the world. The population density is comparable to the Greenland Ice Cap.

But it warrants a Nu Skin store and a couple more on the periphery of the wilderness.

There are no people in Hoh Xil, so I guess the Wild Yaks, Donkeys and Bears like their multi-level marketing schemes.

Speculations

There is little chance they will ever open a store in Hoh Xil. A store on Baffin Island is more likely. Indeed many of these marked stores are implausible.

The question arises how did this slide get into a Nu Skin presentation?

There are lots of possibilities. Perhaps it is a mistake as per Richard M. Nixon signing the debt covenant.

Perhaps the Chinese management are having the Provo Utah head-office on. After all if they "build" this store the management could just steal the money. It would be a long time before the Provo Utah team get to visit all these Chinese facilities. This is a company that bought back shares only to breach its debt covenants. That does not speak to good financial controls. This map speaks to further poor financial controls.

At this point I am just speculating. The company issued an 8-K to correct the Richard M. Nixon signature. Perhaps they could also give more accurate store opening plans for China.





John

Friday, September 5, 2014

Nu Skin's remarkable store opening plans in China

Several people did not get the significance of my last post. This post showed a remarkable lack of correlation between the location of the Chinese population and the sales of Nu Skin in China.

Western China - even if you include the populous provinces of Sichuan and Yunnan is still only a small percentage of the Chinese population - and it is a smaller percentage of Chinese disposable income.

But Western China looms large in Nu Skin's China sales. China hands I talk to know no other consumer company that has sales so weighted to the West.

For most companies (and over the whole industry) almost all Chinese retail sales come from populous and relatively rich Eastern Provinces. China Business Review published a reasonable summary. To quote:

Because of the wide disparities among China’s regions and the country’s rural-urban income gap, purchasing power and retail demand vary greatly. According to the PRC National Bureau of Statistics, 42 percent of China’s total retail sales in 2008 came from (by rank) Guangdong, Shandong, Jiangsu, Zhejiang, and Henan—most of which are prosperous eastern provinces. In comparison, Tibet, Qinghai, Ningxia, Hainan, and Gansu had the lowest retail sales that year.

The old-hands think Nu Skin's sales distribution is very unlikely. But according to Nu Skin's auditor it is profitable in China.

Nu Skin is - at least according to their presentations - actively opening stores in the most unlikely places in Western China. Here - from November last year is a store-opening plan:





There are no stores planned in Tibet, but plenty in other poor and thinly populated provinces. Indeed there are several in Chinese high-altitude desert where there are no permanent settlements, only pastoral nomads.

Nu Skin's sales distribution figures in China seem implausible but the aggregate sales are audited - so they should be believed.

Moreover the company's plans are indicative of their past-success in Western China. They are (proudly) setting up shops where nobody lives.

Not only are they good at selling to Uyghur women, but they also appear to have big plans to introduce network marketing to pastoral nomads.





John

Uyghur women like their Nu Skin

In the 2012 investor day Nu Skin published a map of their Chinese sales by region.




(Source - slide 81.)

Here is a map from Britannica of the population density of China.




On these numbers the women (and maybe men) of Western China are giant consumers of the product relative to population - indeed probably relative to anywhere in the world.

Nu Skin it seems has a knack of selling to Uyghur women.

Perhaps they could explain it one day.






John

Wednesday, September 3, 2014

Richard M. Hixson pardoned Nu Skin

Yesterday I put up a popular post noting that Nu Skin, a multi-level marketing company - had breached its debt covenants and was pardoned by its bank.

The banker who signed on behalf of JPMorgan Chase was none other than Richard M. Nixon - the (presumably) deceased former President.

Prior to posting I confirmed that there was no easy-to-trace Richard M. Nixon working at JPM.

But hey - Nixon used to hang around with Elvis, and Elvis is still alive - so why not the President?

--

Anyway Nu Skin lodged an SEC filing stating that they had been pardoned by Richard M. Hixson (declaring a typographical error).

I have confirmed through back-channels there is a Richard M. Hixson working for JPM and in an appropriate role at the bank.

I accept the Nu Skin explanation.

--

Nu Skin has neither confirmed nor denied they needed a pardon on their debt covenant - and they neither confirmed nor denied that they will breach their covenants again at the end of this quarter.

Those calculations are on the original post.

The buried punch-line of the original post was this:
In July 2014, the Company's subsidiary in Japan borrowed 3 billion Japanese yen (approximately $30.0 million), which is due on September 30, 2014.  In July 2014, the Company's subsidiary in South Korea borrowed $20.0 million, which is due in December 2014, with a right to extend the term for an additional six months.
The company borrowed $30 million for two months without an obvious reason. It's like hey, I got $234 million in the bank, can you spot me $30 million for two months?

--

Whatever - they breached their debt covenants. And they needed a pardon. Richard M. Hixson did the job. And they are borrowing money offshore despite saying in their last conference call they have no trouble repatriating their (considerable) offshore balances.

--

At this point though I feel a little like Kermit the GORF.





John

Tuesday, September 2, 2014

Nixon pardons Nu Skin

Richard M. Nixon did many amazing things in his life.

He hung out with Elvis:



He hung out with Mao Zedong:




But by far the most amazing thing he has done is rise from the dead and get a job at JPMorgan Chase Bank.

You might think I am kidding, but Richard Milhouse Nixon as Saint Lazarus of Bethany is a thought/nightmare interrupting my sleep.

====

Attached to the last Nu Skin 10-Q were several contracts for Nu Skin's debt facilities.

This is a link to the fifth amendment to the JPMorgan Chase debt facility dated 5 May 2014.

And here is the signature block for JPMorgan Chase's signature.


JPMORGAN CHASE BANK, N.A., as
Administrative Agents and as a Lender

By:                        Richard M. Nixon
Title:                    Senior Underwriter

The facility is signed by Richard M. Nixon on behalf of JPMorgan - the same name including middle initial as the (presumably) deceased President of the United States.

I was surprised.

I did a full text search of the SEC database for any other persons named "Richard M. Nixon" and I only found references to the former President.

I searched LinkedIn - and whilst there are many people with the same name as the former President none I could find works for JPMorgan.

I rang JPMorgan Chase and asked whether they had a staff member called Richard Nixon and was informed they did not. I asked for that in writing.

I received an email saying that they did have someone who worked at JPMorgan called Richard Nixon (but they had no reference to the middle initial). However they noted he would not have signed the document as he did not have the authority.

I asked JPMorgan to put this in writing but they would not, however I rang other people in the bank and received the same answer.

When you ring the switch it turns out there is a Richard Nixon in their internal phone book with no phone number and no initial. He is not an employee of the bank, but rather a consultant paid by an external party. They would not tell me which external party. They said categorically that he was not entitled to sign for the bank.

They did tell me he was based in Texas - which makes him an unlikely person to sign for a Utah Company under New York law. Moreover Richard Nixon does not have an internal email at JPMorgan. Quote them: he is a ghost.

There may - despite my concerted and failed efforts to find them - be a person called Richard M. Nixon who is authorized to sign for and did sign for JPMorgan - but much effort has got me nowhere.

One alternative however is unthinkable. It is that Nu Skin has been hawking fake documents which modify their debt covenants - possibly so they can make undisclosed borrowings contrary to their debt covenants.

Either "Richard M. Nixon" is a real person who has signed a single SEC document for Nu Skin or Nu Skin's CFO (the other signature on the document) has some explaining to do.

The strange signature block

It is so comically unlikely that Tricky Dick has been resurrected as a bank underwriter, that I would naturally lean towards the existence of some Richard M. Nixon working somewhere in the giant institution that is JPMorgan.

There is one minor detail which leans you towards nastier interpretations. In the signature block JPMORGAN CHASE BANK is acting as "Administrative Agents and as a Lender". The word "Agents" has an "s".

The phrase "Administrative Agent and as a Lender" where Agent is in the singular [no "s"] is a common phrase in the SEC database. Other than this filing the phrase "Administrative Agents and as a Lender" does not appear anywhere in the SEC database or for that matter anywhere in the Google database. It is like there is a one-off typo in this document to go with the rather unusual name. Everywhere else in the same document the spurious "s" is absent.

I would like a confirm/denial from JPMorgan in writing as to whether Richard Nixon actually signed this document on behalf of the bank. I promise I will post it as soon as received.

The covenants matter

That Richard Nixon signed the covenant modification for Nu Skin is very convenient for Nu Skin because Nu Skin has been in breach of their loan covenants (at least pre-modifications) since the end of the first quarter of this year. They have however managed to get modifications.

They breached their covenants and received what looks to be an (ex) Presidential Pardon.

Linked is a public google sheet of Nuskin's cash flow statement, quarterly since time immemorial. The data is courtesy the indispensable CapitalIQ.

I have given you this spreadsheet because it is required to work out the debt covenants. There are many covenants (eg restrictions on related party transactions, restrictions on types of finance lease, limitations on amounts that may be borrowed by foreign subsidiaries).

The key covenant is dependent on cash flow from operations less capital expenditures. And they have breached that covenant.

To quote the 10-Q (which again mentions the JPMorgan Chase loan):

As of June 30, 2014, the Company was in violation of its restricted payments covenant under its amended and restated note purchase and private shelf agreement (multi-currency), dated as of May 25, 2012, among the Company, Prudential Investment Management, Inc. and certain other purchasers, as amended (the "Prudential Agreement") and the amended and restated credit agreement, dated as of May 25, 2012, among the Company, various financial institutions, and JPMorgan Chase Bank, N.A. as administrative agent (the "JPMC Agreement"), which restricts the Company from making dividend payments or stock repurchases to the extent the aggregate amount of such payments exceed $100 million plus the cumulative cash flow from operations less capital investments since June 30, 2012. Effective August 8, 2014, the Company entered into an amendment of the Prudential Agreement that allows the aggregate amount of restricted payments to exceed the allowed threshold by no more than $110 million for the quarter ending June 30, 2014 and $50 million for the quarter ending September 30, 2014, to avoid default or acceleration provisions of the Prudential Agreement. The JPMC Agreement expired pursuant to its terms on August 8, 2014, prior to which all amounts outstanding thereunder were repaid in full. 
On the spreadsheet I have done the calculation of whether they breached the debt covenant two ways. One way is looking at buy-backs of shares net of shares issued (which seems reasonable but is contrary to the words of the coveant). The other is the covenant as written.

It doesn't matter which way you look at it. They breached the covenant in the first quarter. This is disclosed in the first-quarter 10-Q.

As of March 31, 2014, the Company was in violation of its restricted payments covenant under its amended and restated credit agreement, dated as of May 25, 2012, among the Company, various financial institutions, and JPMorgan Chase Bank, N.A. as administrative agent, as amended (the "JPMC Agreement") and its amended and restated note purchase and private shelf agreement (multi-currency), dated as of May 25, 2012, among the Company, Prudential Investment Management, Inc. and certain other purchasers, as amended (the "Prudential Agreement"), which restricts the Company from making dividend payments or stock repurchases to the extent the aggregate amount of such payments exceed $100 million plus the cumulative cash flow from operations less capital investments since June 30, 2012. Effective May 6, 2014, the Company entered into amendments of the JPMC Agreement and the Prudential Agreement that allow the aggregate amount of restricted payments to exceed the allowed threshold by no more than $50 million for the quarter ending March 31, 2014, $100 million for the quarter ending June 30, 2014 and $50 million for the quarter ending September 30, 2014, to avoid default or acceleration provisions of these agreements. The amendment of the JPMC Agreement also fixed the applicable interest rate at LIBOR plus 0.75%, increased the commitment fee to 0.25% and extended the term of the agreement from May 9, 2014 to August 8, 2014, with $15 million reductions in the commitment amount on June 30, 2014 and July 31, 2014.

They amended this breach after quarter end (which it seems required the signature of Richard M. Nixon).

You will note however the wording of the amended covenant changed between the first quarter filing and the second quarter filing. This is pursuant to more modifications of covenants dated 8 August as described above (and repeated here):

Effective August 8, 2014, the Company entered into an amendment of the Prudential Agreement that allows the aggregate amount of restricted payments to exceed the allowed threshold by no more than $110 million for the quarter ending June 30, 2014 and $50 million for the quarter ending September 30, 2014

Strangely they breached that covenant too (as demonstrated in the attached Google sheet).

This restricted them from paying dividends (and presumably also led to default debt acceleration).

Dividend delays

The second page of the spreadsheet contains the dividend announcement, ex and payment date since 2001. That data is courtesy Nasdaq's website.

These are quarterly dividends. They went "ex" a dividend in August of every year since 2005 except this year.

This year they are going "ex" the dividend in September. The announcement was similarly delayed.

The reason they delayed the dividend was that they were in breach of their loan covenants. The day after the dividend was announced they announced yet another loan amendment. This one was on the Bank of America agreement and unfortunately we cannot see who signed on behalf of BofA.

The agreement extends the term from September to December.

Cash scramble

Nu Skin's balance sheet shows $234 million of cash, equivalents and current investments. Most of that cash is offshore (see the 10-Q).

The CFO states in the conference call that there is no difficulty repatriating this foreign money. To quote:

Yes, generally our cash is fully available, with the exception of Venezuela. There are some timing issues throughout some of our markets in Asia where you declare a dividend and then you can remit the dividend back to corporate headquarters. But even in -- especially our larger markets like China, we can get money out through back-to-back loans. So yes, it really is not a cash issue,having the cash tied up overseas.
Okay - so we should not have any difficulty getting cash back to head office. It's really not an issue.

However the company has been borrowing fairly aggressively offshore. This disclosure from the Q is interesting (and involves borrowing up to the limits of covenants).
In July 2014, the Company's subsidiary in Japan borrowed 3 billion Japanese yen (approximately $30.0 million), which is due on September 30, 2014.  In July 2014, the Company's subsidiary in South Korea borrowed $20.0 million, which is due in December 2014, with a right to extend the term for an additional six months.
The borrowing of $30 million in Japan for two months is outright strange. It's like hey, I got $234 million in the bank, can you spot me $30 million for two months?

Meeting covenants in the third quarter

The covenants require that they get the "aggregate amount of restricted payments" to exceed the defined cash flow amount by less than $50 million by the end of the third quarter.

This requires something like $150 million of net cash generation in this quarterThis would be inconsistent with the guidance but is within the range that they generated in the last two quarters of 2013.

It seems unlikely to me that the company is going to exceed its guidance by such a massive amount in this quarter.

But miracles happen. After all - even with all his bad karma Richard M. Nixon seems to have been reincarnated as an accommodating but hard to reach banker at JPMorgan Chase.







John

PS. Ford pardoned Nixon on Sep 8, 1974, almost exactly 40 years ago. It is good to take this occasion to remember.

======================

Post script:

I am barely awake (early morning in Sydney) but the company has put out a brief SEC filing in response to this blog post. To quote:
In response to questions regarding the Fifth Amendment (the "Amendment") to the Amended and Restated Credit Agreement (the "JPMC Agreement"), among Nu Skin Enterprises, Inc. (the "Company"), various financial institutions, and JPMorgan Chase Bank, N.A. as administrative agent, filed as Exhibit 10.3 to the Company's quarterly report on Form 10-Q on August 12, 2014, the Company notes that the Amendment, as filed, contained an inadvertent typographical error on the signature page. The Amendment was signed by Richard M. Hixson, Senior Underwriter, JPMorgan Chase Bank, N.A., not Richard M. Nixon. As previously disclosed, the JPMC Agreement expired pursuant to its terms on August 8, 2014, prior to which all amounts outstanding thereunder were repaid.
This it appears clears up the resurrection of a dead President. It does not clear up the (substantial) breach of loan covenants - a breach I think is inevitable next quarter.

I am intrigued as to how the typo arose. I have not had time to confirm or deny that the document was signed by Richard Hixson but I would be surprised if it were not. There is press focus on the issue now.

I have found a Richard Hixson of appropriate rank at JPMorgan - however he works in IT so is not really a candidate. But JPM is a big place. There is also a George Bush there...

There is no reference (other than this filing) in the SEC database to "Richard M. Hixson" and no reference at all to "Richard Hixson". I have not yet tried all the other spellings.





Thursday, August 28, 2014

Valeant Pharmaceuticals Part XII: the rolling solvency calculation

I am short Various parts of the Valeant capital structure and long a few thousand put contracts.

This is a bet that is levered to terrible outcomes at Valeant. It is not quite a bet on insolvency - but it is a bet on financial stress.

It is a very non-consensus bet. Valeant is considered extremely profitable. Bill Ackman gave a presentation that explained just how profitable Valeant is compared to average pharmaceutical companies and the numbers are breathtaking.

If Bill Ackman's assertion is correct (and it may be) then my bet is guaranteed to lose money.

--

That said the enormous profitability of Valeant is not evident in the audited accounts.

Valeant's audited accounts show large an increasing cumulative losses.

The difference between the GAAP earnings and Valeant's cash earnings estimates are large restructuring and other charges which Valeant management assert are one-off results of acquisitions.

The argument is that if the acquisitions stop these one-off expenses will also stop and so the GAAP earnings will rise to converge with the so-called "cash EPS".

--

The problem with this argument is that the one-off costs which are more than 100 percent of profits are not audited in that no auditor asserts that they are truly "one off".

You have to take management's word for it.

Some of these costs I have managed to verify are truly one off. In one instance I have verified the reverse, however that one instance was trivially small.

So you are really left with management's word.

At the end Valeant is a "trust me" story. The sole question is do you trust management and in particular their estimate of non-recurring costs. If you do you see a well run company at ten times earnings.

If you don't trust management then alas the company becomes very hard to value because there is clearly some truth in the management assertion of "one-off costs" and the true underlying earnings are somewhere between GAAP EPS and management's "cash EPS". Alas that is an enormous gap.

If 80 percent of the one-off costs are truly one-off my short is also a bad idea. Valeant would not be trading at ten time true earnings - but it would not be expensive.

For my short to be right I need a substantial proportion of the one-off costs to actually be recurring.

Genuinely this is an assessment I can't make.

--

Still against GAAP cash flows Valeant looks insolvent. GAAP cash flow from operations over the past four quarters sums $1.3 billion and net debt is about $16.8 billion. There is also some compulsory capital expenditures which need to be funded out of cash from operations.

Consider this against personal finances: someone with debt more than ten times their cash flow is not obviously refinanceable. A company is more refinanceable than the person because a person needs to hold a fair bit back just to eat. The company can dedicate most of its cash flow to servicing debt. But this is edge-of-refinanceable whatever you want to count.

On the pure GAAP numbers this company looks particularly difficult especially as much of their debt needs to be refinanced starting in 2017.

Linked here is a Google Spreadsheet with the quarterly numbers for Valeant (and legacy Biovail) going back to the March quarter of 2007. The raw numbers come from CapitalIQ. The first three pages of the spreadsheet are my calculations from the raw numbers. [You can reconstruct the data if you wish.]

In this table - from 2011 only - I have listed

(a). the GAAP cash from operations,
(b). the sum of the GAAP cash from ops over the last 4 quarters
(c). the net debt at the end of the quarter
(d). the net debt averaged over the last four quarters

and (e) a calculation of the average debt divided by the cash from operations over the last four quarters.

The last calculation in appropriate for an acquisitive company as it accounts for the rising cash flow given acquisitions.

For the Fiscal Period EndingCash from opsCash from ops - trailing four quartersnet debtnet debt - averaged last 4 QsAverage annual debt/cash from ops
3 months




3 months
Q1
Mar-31-2011
86.3304.84,310.32,569.78.4
Restated
3 months
Q2
Jun-30-2011
190.7386.54,304.93,611.99.3
3 months
Q3
Sep-30-2011
173.7449.34,969.44,194.99.3
3 months
Q4
Dec-31-2011
189.8640.56,480.65,016.37.8
3 months
Q1
Mar-31-2012
167.2721.46,671.95,606.77.8
3 months
Q2
Jun-30-2012
254.6785.37,161.36,320.88.0
3 months
Q3
Sep-30-2012
166.8778.47,382.26,924.08.9
3 months
Q4
Dec-31-2012
67.9656.610,110.17,831.411.9
Restated
3 months
Q1
Mar-31-2013
255.3744.610,203.48,714.211.7
Restated
3 months
Q2
Jun-30-2013
305.1795.18,254.78,987.611.3
3 months
Q3
Sep-30-2013
201.7830.016,808.411,344.113.7
3 months
Q4
Dec-31-2013
279.91,042.016,779.413,011.512.5
3 months
Q1
Mar-31-2014
484.31,271.016,787.414,657.511.5
3 months
Q2
Jun-30-2014
376.01,341.916,763.116,784.612.5


Note that debt is 12.5 times GAAP cash flow. On the GAAP numbers the company looks extraordinarily difficult.

--

It is even worse when you consider the GAAP cash flow has to fund some stay-in-business capital expenditures. Valeant is known for cutting capital expenditures to a minimum so this is not a big consideration but here is another table with the GAAP cash flows less capital expenditure compared to average debt.


For the Fiscal Period EndingCapital expenditureFree cash (ie cash from ops less capex)Free cash, trailing twelve monthsnet debt - averaged over last 4QsAverage net debt/cash from ops
3 months




3 months
Q1
Mar-31-2011
(21.5)64.8270.12,569.79.5
Restated
3 months
Q2
Jun-30-2011
(12.5)178.2342.23,611.910.6
3 months
Q3
Sep-30-2011
(9.6)164.1396.44,194.910.6
3 months
Q4
Dec-31-2011
(15.0)174.8581.95,016.38.6
3 months
Q1
Mar-31-2012
(11.1)156.1673.25,606.78.3
3 months
Q2
Jun-30-2012
(13.6)241.0736.06,320.88.6
3 months
Q3
Sep-30-2012
(57.1)109.7681.66,924.010.2
3 months
Q4
Dec-31-2012
(25.9)42.0548.97,831.414.3
Restated
3 months
Q1
Mar-31-2013
(14.0)241.3634.08,714.213.7
Restated
3 months
Q2
Jun-30-2013
(12.8)292.3685.38,987.613.1
3 months
Q3
Sep-30-2013
(24.9)176.8752.411,344.115.1
3 months
Q4
Dec-31-2013
(63.6)216.3926.713,011.514.0
3 months
Q1
Mar-31-2014
(58.1)426.21,111.614,657.513.2
3 months
Q2
Jun-30-2014
(113.5)262.51,081.816,784.615.5

On this measure the average debt is now 15.5 times the available cash flows to service it. There is a word for that: stuffed.

In other words if you believe the GAAP numbers this company is so dead it is pushing up daisies.

--

The company however should not be dead if what the management says is correct. The management have continuously asserted that there are (literally) billions of dollars of non-recurring costs and that when there are no more acquisitions the operating cash flow will rise by billions of dollars.

If that is the case then the solvency calculations above are entirely moot. All will be well for the company.

--

Strangely the solvency measure deteriorated sharply lately - rolling average debt is now 15.5 times trailing twelve month available cash flow - and that is despite it being more than a year since the mega-acquisition of Baush + Lomb closed. The company has done many small deals since - but the plausibility of one-off costs associated with old mega-acquisitions is declining.

--

If you believe management vis the one-off costs incurred by Valeant then the solvency measure above - average debt to trailing cash flows - is going to improve dramatically over time.

My plan: to continue updating this post until either (a) the cash flows improve as management guides or (b) the company loses all credibility and maybe dies.

The whole process could take years. I am patient. I hope my clients are too. And as always I could be entirely wrong.







John

Monday, August 18, 2014

Nuskin - an MLM with wonky accounts

Regular readers will know that I am not an unbridled fan of multi-level marketing schemes MLMs - but I don't think they are all evil either.

They do provide a service that is valuable - they provide community support for whatever product they are selling.

But they have a tendency to sell the business opportunity rather than the product. And they have a tendency to decentralized law avoidance - for instance selling snake-oil cures in breach of FDA regulations.

I wrote a post once about good-and-bad MLMs - where I went through Avon and Pampered Chef as mostly good MLMs and Nuskin as a business built on decentralized law avoidance.

Herbalife was a fair way up the Pampered Chef end of the scale.

Nuskin sells mostly vastly overpriced vitamin pills. This is a picture of some:



Nuskin is in the process of blowing up.

Nuskin's main product is overpriced and is sold under the ridiculous label of "lifepak nano" as if they contain nano-technology. The pills promise "enhanced molecular delivery" without an explanation of what that might be. The pills are maybe 50, maybe 100 times overpriced. And they have a bunch of claims for them. Look at the original post for the whole comical list but they do (falsely) promise the fountain of youth. Here is one claim:
Advanced anti-aging formula helps protect the body with key nutrients such as NanoCoQ10™ and nano carotenoids*
The asterisk - which I am sure the distributors ignore - is to say that the claim is not evaluated by the food and drug administration.

But lets get into the true snake-oil here.
NanoCoQ10 utilizes cutting-edge nanotechnology to deliver highly bioavailable coenzyme Q10 for potent cardiovascular and cognitive benefits.
There was no asterisk where I took that quote from!

It is gobbledygook - but suffice to say that Coenzyme_Q10 is synthesized in pretty well all tissues in the body. There is some evidence that it reduces some headaches - so I guess there are cognitive benefits - if poorly explained.

Anyway - I am not writing about the business model - which on my observation differs substantially from Herbalife - I am writing about the accounts. And those are disastrous.

Here is the balance sheet:


June 30, 2014
December 31, 2013
ASSETS
Current assets:
Cash and cash equivalents
$
219,501
$
525,153
Current investments
14,227
21,974
Accounts receivable
41,712
68,652
Inventories, net
389,650
339,669
Prepaid expenses and other
180,957
162,886
846,047
1,118,334
Property and equipment, net
429,332
396,042
Goodwill
112,446
112,446
Other intangible assets, net
79,258
83,168
Other assets
136,531
111,072
Total assets
$
1,603,614
$
1,821,062
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable
$
35,836
$
82,684
Accrued expenses
383,012
626,284
Current portion of debt
99,828
67,824
518,676
776,792
Long-term debt
111,621
113,852
Other liabilities
81,559
71,799
Total liabilities
711,856
962,443
Commitments and contingencies (Note 9)
Stockholders' equity:
Class A common stock – 500 million shares authorized, $.001 par value, 90.6 million  shares issued
91
91
Additional paid-in capital
410,440
397,383
Treasury stock, at cost – 31.3 million and 31.6 million shares, respectively
(844,615)
(826,904)
Accumulated other comprehensive loss
(42,284)
(46,228)
Retained earnings
1,368,126
1,334,277
891,758
858,619
Total liabilities and stockholders' equity
$
1,603,614
$
1,821,062



And here is the P&L:


Three Months Ended
Six Months Ended
June 30, 2014
June 30, 2013
June 30, 2014
June 30, 2013
Revenue
$
650,027
$
671,328
$
1,321,088
$
1,212,633
Cost of sales
156,010
111,273
262,654
201,318
Gross profit
494,017
560,055
1,058,434
1,011,315
Operating expenses:
Selling expenses
283,575
297,170
596,676
530,264
General and administrative expenses
155,705
148,302
305,824
283,809
Total operating expenses
439,280
445,472
902,500
814,073
Operating income
54,737
114,583
155,934
197,242
Other income (expense), net
(21,119)
(1,187)
(38,627)
(1,075)
Income before provision for income taxes
33,618
113,396
117,307
196,167
Provision for income taxes
14,111
38,961
42,946
67,450
Net income
$
19,507
$
74,435
$
74,361
$
128,717


Now I want you to notice $389 million in inventory versus six months cost of goods sold of 263 million. It has about 270 days of inventory. By contrast Herbalife has about 50 days of inventory.

It looks like Herbalife is professionally run and Nuskin is not.

But I think it might be worse. Nuskin has $389 million of inventory and the inventory is mostly vitamin pills. Can you imagine what $389 million in vitamin pills sitting in warehouses at production cost looks like? It is kind of strange thinking just how much that is...

--

But the asset padding at Nuskin continues. It has less than half the sales of Herbalife but has $429 million of property plant and equipment. Herbalife has $363 million and that is after Herbalife has built some large impressive plants.

By comparison Nuskin seems profligate with plant - but hey - I have never seen one of their factories. Maybe they are gold-plated.

--

But the whole thing becomes worse on the cash flow line. Herbalife is massively cash generative - almost comically cash generative.

Nuskin is not.

Here is Nuskin's cash flow statement.

Six Months Ended
June 30,
2014
2013
Cash flows from operating activities:
Net income
$
74,361
$
128,717
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
24,965
15,527
Foreign currency (gains)/losses
48,264
863
Stock-based compensation
13,726
11,411
Deferred taxes
3,871
(2,901)
Changes in operating assets and liabilities:
Accounts receivable
27,121
(24,647)
Inventories, net
(54,218)
(45,228)
Prepaid expenses and other
(31,157)
(25,515)
Other assets
(14,797)
(10,987)
Accounts payable
(46,503)
3,593
Accrued expenses
(233,532)
132,787
Other liabilities
3,034
5,237
Net cash provided by (used in) operating activities
(184,865)
188,857
Cash flows from investing activities:
Purchases of property and equipment
(57,136)
(82,515)
Proceeds of investment sales
22,011
9,701
Purchases of investments
(13,655)
(5,077)
Net cash used in investing activities
(48,780)
(77,891)

You might notice that 186 million of cash was used in operating activities and a further 49 million was used in investing activities.

The cash balance dropped from $525 to $220 million. And there is a bunch of long term debt as well. It has more cash than long term debt - so survival is at least possible. But they better turn around awfully fast.

With Nuskin we have to analyse in terms of survival which is far from guaranteed just on the accounts.

It is that bad.

--

Now as readers know I am a bit of a Herbalife fan. When I visit Herbalife distributors I see people providing a real service. The real service is emotional and physical support during dieting. Some sell Herbalife and run fitness clubs. Sometimes it looks more like a café. Some sell Herbalife out of "spiritual healing massage centres". Where I live in Australia it is often the personal trainers who sell Herbalife on the side - and comment (favourably I guess) on the new svelte bodies in their charge.

But in all cases there is a support network for dieting behind successful sellers. The product is not just the shake - it is the support network that goes with it - and the support network fits into the culture from where it is from. In Queens they reflect low-wage Hispanic workers. In more middle class areas of Miami the clubs are larger and better appointed. In Sydney they are fitness obsessed and at the beach and with upper-middle class customers.

And it shows. Herbalife generates more cash every year. The cash flow statement tells the story. This is for six months:


  
Six Months Ended
  June 30,
2014
June 30,
2013
  (In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
  
Net income
  $194,160  $262,035  
Adjustments to reconcile net income to net cash provided by operating activities:
  
Depreciation and amortization
  44,776  42,310  
Excess tax benefits from share-based payment arrangements
  (6,693(15
Share-based compensation expenses
  23,398  15,253  
Non-cash interest expense
  19,021  1,295  
Deferred income taxes
  (7,838(7,939
Inventory write-downs
  12,373  10,448  
Unrealized foreign exchange transaction loss (gain)
  2,532  (44
Foreign exchange loss relating to Venezuela
  86,108  15,116  
Other
  3,717  (674
Changes in operating assets and liabilities:
  
Receivables
  (1,163(312
Inventories
  (2,409(14,094
Prepaid expenses and other current assets
  (50,669(13,150
Other assets
  (4,642(534
Accounts payable
  13,038  4,586  
Royalty overrides
  (12,113(2,051
Accrued expenses and accrued compensation
  16,661  43,761  
Advance sales deposits
  20,915  4,481  
Income taxes
  (8,158(12,546
Deferred compensation plan liability
  4,569  3,527  
  




NET CASH PROVIDED BY OPERATING ACTIVITIES
  347,583  351,453  
  




CASH FLOWS FROM INVESTING ACTIVITIES
  
Purchases of property, plant and equipment
  (105,482(56,048
Proceeds from sale of property, plant and equipment
  11  33  
Investments in Venezuelan bonds
  (7,588—  
  




NET CASH USED IN INVESTING ACTIVITIES
  (113,059(56,015)

Note 348 million produced in operating cash flows, 113 million consumed in investing (but that includes the construction of the above-mentioned large and impressive factory). I suspect investing cash drain falls and Herbalife becomes even more cash generative.

The net free cash after six months is 234 million or 470 million annualized. I suspect it will be higher because the investing cash use should drop.

This does not look expensive versus market cap (or even market cap plus net debt).

Its a real business, providing real and valuable service to at least ten million people - and it is highly cash generative.

But hey - that was where I started. Not all MLMs are equal. And not all outcomes are equal either.

Billy Bob shorted the wrong MLM.




John

Disclosure: Long Herbalife, short a little Nuskin. I regret not having the Nuskin short on earlier. The balance sheet was always a little stretched - the inventory build in 2013 was insane - and the business model did not make sense - but the denouement is more rapid than I thought possible.

At least one person I talk to got that entirely right including timing both the long Herbalife and short Nuskin legs.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.