How to Avoid Investing in Enterprises That Will Flop | Bloomberg Radio & TV Anchor Cory Johnson

Another fake. This company was not called Super Surveillance China. Can you guys hear me without the mic? Or do you need it for the— It's good. Okay. This company was not called Super Surveillance China, but I'm gonna call it that for the sake of this presentation. It's a real company. It's a Chinese security hardware software service company, okay? $500 million market cap, so not for nothing. It was a play on the Chinese police state. The 2008 Olympics were coming up in China. Capitalism, for those of you that believe in capitalism. Big Brother, if you believe there's Big Brother in China, for those of you that believe that. All right? If you believe that there's a police state in China, that's kind of a good stock story. If you believe there's going to be Olympics in China in 2008, these are all things a lot of people can get behind and really think is exciting. Citadel, a real firm in Chicago, a very big firm, put $60 million into this little company. The New York Times said this is an opportunity for Wall Street in China's surveillance boom. It's opportunity, it's Wall Street, it's China, it's surveillance. Oh yeah, they printed that article with this picture, with that picture. That, by the way, is not equipment from this company. It was just a cool picture, so they took it and they put it with the story. With this picture in 2007, yes. I think this is more important, this date. September 11th is a date that resonates in a lot of places, but in New York City it resonates particularly. So that was helpful for the stock, that cute little story in the New York Times. There's a share price that goes from about $6 a share to $21 a share. Up, up, up, bye-bye-bye, sell, sell, sell, China. I like China, I like security, I like surveillance, I like capitalism, bye-bye-bye. Look at the stock chart, it's going up to the right, it must be good. All right, that's the extent of the analysis that is often done on business news, my own network included. Progeny, who are these people? Well, this is a roll-up of a dozen Chinese companies over 3 years. The CEO was getting loans from the largest customer. The largest customer was getting loans from this company. The CEO of the largest customer was the wife of the CEO. I kid you not. It was born out of a reverse merger. The reverse merger— and you can't quite see the names on there— but the reverse merger was— I'm going to make it just a little bit bigger. The reverse merger had some really unusual characters, and I started tracing who they were. They had a lot of vowels in their names. Not that there's anything wrong with vowels in your names. I've got a few vowels in my name too. But I just started to do some homework on these things. And so this is a drawing that I did. This is a— I eventually had to do this on a computer because it was getting pretty weird. I thought I was like John Nash. I went to the art— the Blick's Art, and I bought a giant notebook and compasses and pencils and erasers and was kind of going crazy doing all that stuff. But a couple things I want to point out to you, if I can try to read it off my computer screen. So the company that I was looking at was this big rectangle right there. Those bubbles— so this is a timeline. Okay? This is the timeline for their largest customer. This is a timeline for this company that was— what did they call it? Super Secret China or something. I can't tell you the right— I don't want to tell you the real name because I don't want these guys to either fine me or sue me, or fine me and sue me, or fine me and kill me. But over time, they started doing acquisitions. So those little bubbles up to the right are acquisitions that they did. And they did 5 acquisitions one year. And the next year, they did— what was it? 7 acquisitions. And the next year, in just the first couple months, they announced a bunch of acquisitions. The dotted lines are ones that they didn't finish. And that's how they were growing revenues. So Wall Street, which wasn't doing any more homework than saying they were seeing the words China and security and surveillance all together, got so excited. But I started looking at these acquisitions. The nature of those acquisitions— so those acquisitions were growing this— were giving them the sales growth, not having a great product and selling more of it. But again, you'd have to actually take the time to read about it every time. Go back and look at the press releases and figure out when they did the acquisitions. And they wouldn't tell you how much it would add in sales because they'd say, as soon as we buy a company, it's organic, so we can't report the numbers separately. Defies logic, but companies do that all the time. I also noticed that later on in the game, these companies used to take stock for their acquisitions, and later on they were only taking cash. And that said to me that if I thought this stock was going to go up to the right forever, I'd take stock. But if I think that the spinning of the plates is about to end, or the bubble's about to burst, or pick your metaphor, I'm taking cash. And so they were having to pay cash for their acquisitions, which made their balance sheet look worse. And I saw all these cross arrangements where this company, these guys start a company and then sell it to that company, and then this is their largest customer, and they have the same investor. And in fact, if you go back, both of the shells for this company came out of the same couple of investment banks, including one in Chicago. And among the principals of the investment bank in Chicago that created the shells for both of these companies was a guy named Mark Anthony. I thought, huh, that's a funny name for a Chinese guy. Another guy, Anthony Tony Limo Serravola. Why do they call him Tony Limo? 'Cause they found— Anthony, of course, Tony, that makes sense. Limo, Serravola, where'd he get that? Limo 'cause he once maybe stuffed a body in that limo. It was still alive, but he was arrested and jailed for loan sharking. So you got these guys who are— and he's a Lucchese crime family member and was indicted as a hitman. Those are the guys who gave us the shells that led to these 2 companies that are closely connected in every way, including, as I mentioned, the CEO and the CEO's wife. That's the progeny of who these people are. That ain't easy to find. It takes a lot of work. What this told me was there's something fishy going on here. This is not your average company. They did not make this stuff simple to find. And so I put in a position in the stock and shorted it. Turns out the Citadel guy who backed it, which gave it all their great credibility, the $60 million investment from Citadel, he only worked for about 12, 13 months at that firm before he got chased out and went to another firm. Morgan Stanley hired him, and he put more money into the company, and then he just disappeared. Like, just disappeared. Like, nobody could find him. Again, there wasn't a press release about this. I had to call somebody and call somebody. I used LinkedIn to find out that I knew somebody who worked at Morgan Stanley. who used to work at Citadel also, and said, oh, that guy, great story. He was like, he was this, the Citadel guys found him, he was 23 years old, he was fluent in Chinese, just got a Stanford MBA, and so they made him a portfolio manager and sent him back to China, and he had no idea what he was doing. I'm like, really, that's how Citadel does it? Good information when I wanna send my resume to Citadel. The Colombo crime family guys, as I mentioned. And then they just started missing estimates. And I put on a pretty good short position on this one, and this thing collapsed. And it went from— it got as high as $35 a share, traded down to $2.73, I think. I probably covered in the 2s and 3s. And that was out of doing the homework about who these guys were. You know, more homework than the New York Times, not that that's a high bar. It's a story of progeny. How am I doing on time here? You're good. I'm gonna hurry it up here. Um, another one, Fab, right? Okay, this, this company looks like garbage. New age mattress maker, billion 4 market cap, 20 times earnings. It's got $350 million in debt. It looks like it's growing. Inventory is going through the roof. Oil prices are going up and their main product is made out of resin made from oil. Uh, their inventory is bad. They've got competitors across— they make the Tempur-Pedic mattresses, you may know the company. They make these mattresses that are supposed to be really squishy, and they have their formula that no one can beat, although they don't actually have any patents or guarantees on this thing. And the competition's coming, and they've been building a factory in Albuquerque for years. Stock collapses on inventory problems. They say they fix the problems. It collapses a second time on inventory problems. Starts to perk up again. I'm like, I already know everything I need to know here. I start going to stores. I visit over 100 stores all over the country. Every time I go anywhere, I go to stores. Every weekend, I go to stores. Every time I leave the office, I go to stores. I talk to mattress makers or mattress salespeople all the time, and they're everywhere. The sellers love it. The company's adding doors. They're adding more stores all the time. 17% increase in stores in the year that I'm looking at this stock. They're introducing a new model, which means they're going to double the amount— if they've got one mattress in every store, they're about to have 2 mattresses in every store. So just selling into those stores, they're going to sell a lot more. And every customer I talk to, every customer I can find online, They love the product. So I took a long position in the stock and I had the notion that the Albuquerque factory was going to get finished and that meant they wouldn't have to put so many mattresses on boats and move them around so their inventory would go down because they'd get to the customers faster. Without the factory expense, which they're having to pay to build this factory, their debt was going to go down. Indeed, they could pay the debt down. Their interest costs are going to go down, which means the costs on the income statement are going to go away and all of a sudden they're going to start beating earnings. And I would sleep well. And I did. Stock went straight up for a while. And that was a personal position of my wife. Once it had tripled, my wife said, can we get a new mattress now? I'm like, yeah, we can.