26 October 2016
Japanese trading house Itochu has faced questions from a US-based activist short-seller over accounting practices. Photo: Bloomberg
Japanese trading house Itochu has faced questions from a US-based activist short-seller over accounting practices. Photo: Bloomberg

Short-seller Glaucus targets Itochu

Glaucus Research Group last week targeted trading house Itochu Corp., marking the first time that the US activist short-seller has taken aim at a Japanese entity.

In a report released on July 27, Glaucus accused Itochu of inappropriately reclassifying its stake in a Colombian coal mining joint venture in a bid to avoid an impairment charge.

The short-seller also questioned Itochu’s treatment of financials in relation to an equity interest in Chinese conglomerate CITIC Ltd. (00267.HK).

Due to its accounting practices, Itochu may have inflated its net income by a huge extent for the 2015-16 financial year, Glaucus said.

It valued Itochu at 631 yen per share, a downside of 50 percent from its current traded price.

In October 2011, Itochu acquired 20 percent interest in Drummond International, which owned, operated and controlled the Colombian coal mining operations of American mining firm the Drummond Company.

By FY 2015, Itochu carried its interest in the Drummond joint venture at 198 billion yen on its balance sheet.

But the price of thermal coal declined from a 2011 peak of US$132 to lows of US$47 in 2016, a 64 percent fall in the commodity price.

The report said Itochu’s interest in the Drummond joint venture was worth no more than 45 billion yen. By not recognizing an impairment loss, Itochu may have overstated its net income by at least 153 billion yen, it said.

In January last year, Itochu agreed to invest 600 billion yen to acquire a 10 percent stake in CITIC. Glaucus believes that Itochu’s stake in CITIC should not be consolidated using the equity accounting method, since Itochu do not have “significant influence” on CITIC’s policies and financial decisions.

CITIC was said to account for about 20 percent of Itochu’s projected net income. So if Itochu is forced to reclassify the investment, the Japanese trading house will have to materially reduce the forecast profits, Glaucus said in its report.

Glaucus has targeted more than 20 companies since its establishment in 2011. Most of the firms it targeted did turn out to have some problems and suffered a steep slide in their share prices.

Among its targets was China Metal Recycling (00773.HK), which later went through liquidation. China Lumena New Materials (00067.HK), another target, has been suspended from trade for more than two years.

As for Itochu, the Japanese firm saw its shares fall as much as 10 percent last Wednesday after the Glaucus report.

Glaucus made two points about Itochu, focusing on inappropriate accounting rather than question the sales figures.

Itochu quickly issued a response, saying its books have been approved by an auditing firm and that there was no inappropriate accounting.

Following the statement, the shares recovered some of the earlier losses.

Glaucus disclosed that it has a short position on Itochu stock.

Short-sellers usually borrow shares and sell them, hoping to profit by repurchasing the securities later at a lower price.

But Glaucus is unlikely to make any profit from the Itochu short position unless the share price falls over 10 percent, given the borrowing costs.

Glaucus has been targeting companies in Hong Kong and US over the years. It picked a Japanese target this time, prompting observers to focus on Itochu’s links with CITIC, among other things.

CITIC, which was formerly known as CITIC Pacific, has faced various troubles with an investment in an iron ore project in Australia.

Mining has been one of the top sectors targeted by Glaucus.

This article appeared in the Hong Kong Economic Journal on August 1.

Translation by Julie Zhu

[Chinese version 中文版]

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