Friday, 28 February 2014

iCar Asia iCooks its iBooks

Goodwill and other intangibles are commonly used to inflate book assets, overstate profits, and justify fraudulently obtained executive bonuses. The classic method of this fraud goes as follows:
  1. Directors go on an acquisitive spree, buying overpriced companies and booking goodwill
  2. The purchases boost "assets" and "profits", leading to executive bonuses and effusive backslaps
  3. Inevitably the worthless goodwill must be written off, but this loss is labelled "non-recurring" and "non-cash", and most importantly, is not included in the "underlying profit" on which bonuses are based
Some companies ludicrously claim "underlying profit" significantly exceeding "actual profit" for decades. "Underlying profit" basically means whatever number the directors feel like, and likewise intangibles can be freely inflated. This goodwill hustling is common knowledge in the finance industry and entirely condoned by regulators and media.

Australian companies must regularly test their goodwill for impairment, a process which they predictably have turned into travesty. The impairment test usually involves a discounted cash flow (DCF) analysis using inputs that have no basis in reality. Cash flows are forecast and discounted for several years ahead, with a terminal value added by assuming subsequent eternal growth. As any junior investment banker can attest, DCF valuation is notorious for its sensitivity to inputs. The advantage of DCF is that you can arrive at any final number you wish, by minor tweaks to growth or discount rates.

In Australia, directors choose blatantly fraudulent inputs to these calculations, with no objections from auditors or regulators. One of the most extreme examples is iCar Asia (ICQ.AX), part of the iProperty group revaluation fraud and circular investment scam. In its annual report to December 2013, iCar reported losses ballooning to $6.9m on less than $1.8m revenue. iCar reported net assets of $17.6m, of which intangibles accounted for $6.7m. After heavy ramping by cartel owners, iCar sports an entirely reasonable "market" cap of around $200m.

Page 42 of this report reveals the inputs the directors used for impairment testing of iCar's $4.7m goodwill. Presumably with a straight face, the directors assume revenue growth rates of 203% for Malaysia, 376% for Thailand, and a staggering 4766% for Indonesia. Terminal growth rates of 3%, 4% and 6% were assumed for the three countries, respectively, after the forecast period. For perspective, let's say little Johnny runs a lemonade stand, achieving $1000 in annual revenue. After four years with a 4766% revenue growth rate, little Johnny's lemonade stand would be bringing in $5.6 billion.

This is sufficiently divorced from reason and reality to constitute fraud. The auditor of iCar should never have signed off on this. By putting his name to this annual report he committed a criminal act and became an accomplice to securities fraud.

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