09 October, 2015

Blog roll: John Hempton

Periodically I'll highlight some of the blogs I read on a regular basis - and share with you why I find them valuable.

Today, that's John Hempton of Bronte Capital in Sydney, Australia.  First some background, then I'll narrate a specific recent post and highlight what makes it a "good" example of strategic analysis of a business.


Hempton invests in long/short equity positions for non-retail clients and often shares thoughts about positions he holds or is considering - particularly potential frauds.

His posts are thoughtful, incisive, and full of wit.  Usually, he's sharing a contrarian position on something that has been hiding in plain sight that "public" investors aren't spending the requisite amount of intelligence on when analyzing.

Sometimes, Hempton is contrarian to the contrarians - like his long-running series opposite Bill Ackman's take that Herbalife is a ponzi scheme.  If you aren't familiar, the best single post on Herbalife to start with is probably here.

Other times, Hempton attempts a public service which also helps his book - like confidentially warning Deloitte in 2014 that a client's accounts appear to be falsified.  It's a common theme: earlier (2011) Hempton wrote about blowing the whistle on Longtop Financial Technology, then defended Deloitte's inability to detect the fraud over six years of auditing the books.

Interestingly, Hempton's 2011 post on Longtop/Deloitte concluded with the observation that "If this level of corruption is pervasive in Chinese banks then we are all looking in the wrong place for the next crisis. The next crisis comes from China.

Several weeks ago I shared with you Hempton's concerns on Alibaba, concerns which were picked up by Forbes.  Earlier that week, Barron's did an excellent long-form piece about Alibaba, including concerns about substantial governance issues.  Apparently shareholders of Alibaba don't actually own Alibaba, rather a company with a somewhat unenforceable agreement to receive Alibaba profits.  The distinction therein was highlighted when Alipay was spun off.

Hempton - a narrated example of "good" strategic analysis

I assigned one of Hempton's recent posts on Sun Edison to my "Strategic Analysis of Business" class last week.

It's hard to find excellent examples of narrative-form "good" strategic analysis of a business, because (a) few exist and (b) the ones that exist that I've seen are almost entirely client confidential.

Here's what I like about this post, on a company that Hempton is long (investing for upside) but concerned about management's current approach:

  • Leads with a concise answer that preserves sufficient detail (Exec summary)
    • Background context is brief yet specific - two sentences describes the nature and dynamics of the business as a capital intensive yield-co that happens to do solar power to generate that yield.  
      • I cannot overstate how important this type of up-front framing is to good strategy, and how hard it is to convince people whose personal and professional identities are tied up in "adjectives" that their business is special just like all the other ones and we need to focus on nouns and verbs instead of adjectives
    • Next the thesis statement - three main issues - are again brief yet detailed
    • Final piece of intro is a guiding theme for the rest of the post - "SunEd is a trust-me narrative"
  • Diagnostic begins with more context about what matters in a yield co (Situation)
    • Yield co's abstracted to non-bank financial company
    • What matters in non-bank financial is trust/relationship with investors
    • What causes non-bank financial to fail is often financial not operational.  Three red flags:
      • Credit risk
      • Duration mismatch between funding sources and revenue
      • Unstable access to funding
  • Analysis continues with concerns of SunLife framed around the 3 types of failures in a yield co (Complication)
    • SunEd recently didn't want to provide operational level of detail sufficient to clear red flags for a potential investor
    • This causes financial-type people to fear a Northern Rock type failure, meaning that investor conversation may indicate a burning platform, not an inconsequential nitpick
      • Subprime credit overextention and inability to repackage/sell...
      • ...caused a mismatch in funding/revenue...
      • ...resulting in a bank run and nationalization
  • If SunEd is structured and functions like a financial institution, it needs to behave like a financial institution (Resolution)
    • Must get more comfortable with adequate disclosure, of operations and acquisitions
    • Will be challenging with current CEO - a visionary who has built an institution he is "woefully inadequate" to run
    • There are three broad options to move forward for a "safe landing"
      • Keep visionary CEO and install disciplined operating team and risk management culture underneath him
      • Replace CEO with risk-averse former banker and change the operating team too
      • Fire everyone and put the company into run-off mode (it will continue to generate cash for many years, and this will prevent it from destroying value down the road)

I know very little about SunEd, and it's possible - even likely - that Hempton's (external) diagnosis is flawed in some way.  Even if correct, there are likely significant organizational/financial/stakeholder power issues that could make the decision & execution of the path forward challenging if not unlikely.

What's important here is that his thesis follows the grammar and syntax of good strategy.

Which gives me confidence that Hempton's overall thesis stands a good chance at being at least directionally correct and therefore worth looking into further if you're an investor or stakeholder.

And if you choose to look into it further, because the narrative is so clear, someone farther from the problem (like I am) can quickly see past all the adjectives of the specific business and get straight to taking a closer look at the nouns and verbs to see for themselves what's really going on in this company's strategy and execution.

Thanks for reading,


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