Shares of Chinese furniture maker Man Wah Holdings Ltd. fell 10% in Hong Kong after short seller Muddy Waters founder Carson Block announced a short position in the company and said that "there is no pixie dust" in the companies' sofas.
According to its filings, Hong Kong-headquartered Man Wah is more profitable than U.S. tech giant Apple Inc., but the only explanation for the outlier profitability is fraud, Block said at the Sohn Conference in Hong Kong today, while displaying a photo of a destroyed sofa made of wood, glue and foam.
Founded in 1992, Man Wah makes and sells mattresses, reclining sofas and other furniture to North America, Europe and China. Its net profit jumped 31.9% to HK$1.75 billion for the year ended March 31, with a 6.2% increase in sales to HK$7.8 billion.
Block said that Man Wah is likely much less profitable and generate much less free cash flow than it reports, because the company has undisclosed borrowings that could be used to fake its cash balance and pay dividend. Total debt at Man Wah is at least 48% greater than reported HK$1.05 billion as of May 31, as one of the company's manufacturing unit has debt of HK$1.55 billion alone, according to Block.
In addition, Man Wah has inconsistencies in its taxes, a strong indicator of fraud, as Chinese companies often use incorrect tax rates or preferences to artificially lower their tax burden and therefore fake higher profits.
Block said that Man Wah Furniture Manufacturing (Huizhou), a subsidiary of Man Wah, received a preliminary approval for a preferred tax rate from local government in January 2013, but was retroactively effective to one year earlier.
Mah Wah also books over half of its consolidated profits from an entity in Macau, and claims that a Macau preference gives it a 0% tax rate. But it's difficult to see how Man Wah could get away with a transfer pricing scheme that has booked profits in Macau greater than ten times those of the Huizhou factory. This is tax evasion at best, but is more likely a major component of financial fraud, Block said.
When researchers at Muddy Waters visited Man Wah's 57 company-owned and 39 distributor-owned stores in China that sells sofas, mattresses and other furniture, they found that sales are poor and unlikely to have generated claimed revenues.
According to Man Wah's filing, company-owned stores recorded HK$5.3 million on average per store in 2016, up from HK$4.48 million in 2015 and HK$3.66 million in 2014. But researchers at Muddy Waters found that 15 of the 57 company-owned stores were out of business, and at least 15 closed but are still registered as stores. For those that remain open, sales seem to fall short of the reported sales.
"Return of capital is not a return on capital," said Block in conclusion. "Man Wah has raised HK$2.8 billion (from the pubic markets) including its IPO, and paid dividends to outside shareholders of HK$1.5 billion." But it appears that any dividend or buyback may be financed by undisclosed debt.
San Francisco-based Block and his Muddy Waters recently shorted Asanko Gold Inc., an Africa-focused gold producer, and shorted China Huishan Dairy Holdings Co. in December 2016. Huishan Dairy's shares have been frozen since they tumbled 85% a few months after the short-sell report came out.
Man Wah did not immediately respond to an inquiry from China Money Network to comment on the call to short its shares.