Following up - MFRM

News is out that shares of Steinhoff are collapsing amid 'accounting irregularities' and the CEO's resignation. Steinhoff is the South Africa-based retail empire that acquired MFRM in 2016. MFRM's troubling trends (and profitable short-sell investment) were well documented on these pages - a quintessential debt-fueled retail roll-up disaster. It may be the end of the line for Steinhoff (equity holders at least), especially given the writing on the wall for retailers in general as Amazon takes over the world.

12/1/17 Links

I always learn something new when I read Mauboussin

Warren Buffett’s favorite books

I haven’t read Tobias Carlisle’s books, but plan to do so

The yield curve is becoming extremely flat

A couple of interesting discussions around bitcoin

New Constructs interesting questions for Morningstar

Goldman: current return levels cannot persist

Add more Fama to your portfolio

The truth behind AMZN’s reported earnings

Cohodes changes his tune on OSTK

Itron (ITRI): new idea up on Seeking Alpha

I've got a new idea posted over on Seeking Alpha.

Please take a look and let me know what you think.

A few links and new idea in the works

It has been awhile since I’ve been able to write here, but I wanted to share a few earnings quality links I came across lately. I’m also working on a new short sell idea, which I hope to be able to share soon.

Decent sites that are also working to cut through the accounting fog

The growing difference between GAAP and reported earnings is really important, and largely ignored

Another good discussion of this topic, with Valeant as a specific example

Warren Buffett wrote about this last year

Interesting take at the end of this one, looking at specific sectors getting particularly aggressive at the top of the cycle

MFRM: there's never just one cockroach

Yesterday, MFRM filed their 2016 Q1 10-Q. Buried at the very back of the document was this interesting disclosure:


"Even though management did not perform the evaluation of Sleepy’s internal controls over financial reporting, we became aware of the following material weaknesses that existed at the end of Sleepy’s fiscal year 2015 and are still unremediated:

• Sleepy’s does not adequately document its vendor agreements relating to incentives offered by vendors and does not document changes to its vendor agreements.
• Sleepy’s does not adequately document its agreed upon firm prices for, and does not timely bill for the sale of, damaged, clearance, outlet and obsolete inventory to third parties.

The Company intends to address these material weaknesses as part of its plans to integrate Sleepy’s processes and systems during fiscal 2016, but they remain unremediated at May 3, 2016."

During the first quarter of 2016, we identified a material weakness in our controls over financial reporting related to the accounting for significant transactions that occurred during the quarter.  Specifically, we did not design and maintain effective controls related to the recording of the expense for the flow through of the inventory step up fair value adjustment in the Sleepy’s acquisition.  We believe the financial statements included herein properly reflect the correct amount and proper classification of the flow through of the Sleepy’s inventory step-up adjustment."


Given the extent of other issues previously outlined at length around MFRM, this is yet another red flag that could potentially be quite significant. There's a lot of ambiguity around the way the above is worded, but basically it sounds like MFRM's diligence around Sleepy's 'missed' a few things related to Sleepy's treatment of clearance/obsolete inventory and vendor incentives. Given the significant downward revision to full year guidance that was rolled out with the Q1 release, putting the pieces of the puzzle together gives the impression that margins are going to suffer a previously unforeseen hit during FY 2016.


Despite the sharp move downward already, these developments could be a catalyst for a further move, now that momentum is squarely to the downside.

Recent earnings quality links

Non-GAAP presentation and management incentives
What would make Jeff Gundlach bullish
Chinese accounting shenanigans at US listed companies
Accounting issues at Alibaba
The growing difference between GAAP and pro forma profits
More on non-GAAP games

Closing MFRM for now

Over the past week I’ve closed out my MFRM short position, as the share price has come more in line with the following company-specific and broader market realities:

• MFRM is a rollup acquisition model with exploding debt
• From a profitability standpoint, the company has yet to prove that this model has economies of scale
• Q1 earnings reports have been horrible for retailers

Finally, I’ve seen various short cases for MFRM put forward from others. While I am by no means turning bullish on MFRM, I do think that shares have started to price in much of the (still valid) risks to the story.


Here is a valuation table with updated figures based on MFRM’s 2016 guidance put forth in the Q4 earnings release.

With EV per store having fallen well below historical levels given the current stock price, the valuation here in the low $30’s has provided a nice return from the mid-$40’s where the short recommendation was initiated. While I do think it could easily go lower, the risk-reward has become more symmetric.