Friday, June 25, 2010

Marketing, The Wrong Way

Shareholders are best served when company resources are utilized to grow a company's earnings power. Or, as Warren Buffett likes to say, "Our managers focus on moat-widening". But when top management is busy spending its time touting the stock price rather than improving the business itself, shareholders are likely not well-served.

Consider China Marine Food Group (CMFO), a distributor of seafood products. The company's top management is going on a road show to NYC in the coming weeks. But there is no stock being sold on its road show! Apparently, the company simply wishes to talk up the stock to prospective and current investors. In other words, there's likely no increase in the company's intrinsic value by this use of company resources, only an attempt to pump up the stock price.

Perhaps an argument could be made that such actions make sense if management felt that shares were undervalued. That argument appears moot, however; apparently, management does not feel its shares are undervalued, as it recently issued almost $30 million worth of shares for "general corporate purposes" at what was the prevailing market price. The company has no debt, and would still have had $20 million of cash on hand without the offering (to put this amount in perspective, consider that the company's quarterly operating expenses are but $1.6 million). As such, it appears that there was no pressing need for the cash, suggesting that management did not care about dilution and is more interested in empire-building than in increasing each share's value.

And an empire-building spree appears to be what's going on, as recently the company spent $28 million for a control stake in a beverage company. Of major concern to shareholders is the fact that only $2 million of hard assets (net their liabilities) were acquired, meaning the company paid $26 million for intangibles! Some was classified as goodwill ($2.5 million) while the rest ($23.5 million) was actually classified as "Algae-based drink know-how"!

This acquisition and all its intangibles generated but $1 million of gross profit in the latest quarter, but the company sure has ambitious plans for it. The company issued a release claiming expectations of a 60% year-over-year growth in revenue for this acquisition, and "normalized long-term net profit margins of 25%". To put this in perspective, Coke (KO), which can be described as the most successful beverage company at keeping competitors at bay, generates net profit margins of just over 20%. As such, it's hard to believe that even CMFO management believes its own projections!

As a commenter on this site wrote recently, it is better when management focuses on intrinsic value rather than stock price, though the two will converge in the long run. Clearly, CMFO management is focused on the stock price, which is just the sort of situation value investors seek to avoid.

Disclosure: None

1 comment:

Robert Pio Molloy said...

Hi Barel,

I fear that CMFO could be even more insidious than you suspected.

In my experience, once there's even a suspicion of a scam with a company, usually it follows in 90% cases that there is something fishy going on.

I could of course be wrong, but I would rather not take the chance!