Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

HK Type 4 license through Ballingal Investment Advisors Ltd. ("BIA" or "BIAL")

BACKGROUND
I have 20+yrs experience in Asia doing alternative strategies (i.e. non-delta1 non long-only) in fixed income, equity derivatives, and activist/catalyst/event-driven and long-short equity strategies with most of that time spent managing money. 

4 years in fixed income macro, 8 years running internal hedge fund and 4yrs investment banking at Citi in Japan, 3 years running an Asia multi-strat portfolio at a hedge fund, 4+yrs as an independent special situations analyst.

Pan-Asia Catalysts/Events

Western Digital Attempts to Block Toshiba Chip Business Sale to Outside Parties

Potential Surpises?? Comparing Foreign and Domestic FY1 EPS Estimates in Japan

Toshiba - What Really Is the Reason for WDC Threatening a Veto?

Toshiba: Delisting Now Highly Probable in Our Opinion

Timeline for Toshiba Troubles - Two Days Til A Tempest?

Who Will Bear the Brunt of Westinghouse's Bankruptcy?

Quiddity Advisors

Event-Driven

Yesterday, <a href="https://www.smartkarma.com/entities/637" target="_blank" data-smartkarma-citation="entities:637:1">Toshiba Corp (6502 JP)</a> met the extended April 11th deadline to file its April-December 2016 financial results, avoiding having to ask the Financial Services Agency for an unprecedented third extension. Getting the numbers out of the way quickly, the net loss for the 9 months was 532.5bn yen. The negative shareholder equity position as of end-December was -225.7bn yen, but because of the bankruptcy of Westinghouse at the end of March, that number is likely to worsen by 450bn yen (the presentation materials appear to be somewhat in conflict) by March end to finish at a negative 620-675bn yen. That means a net loss for the year of more than a trillion yen. That's a thirteen-digit number, folks.But even though the numbers were larger than provisional numbers put forth in February and this is a large hole to fill, this will not be the important topic of discussion near-term.<h2>The Two Big Points:</h2><blockquote>"There are material events and conditions that raise substantial doubt about the company's ability to continue as a going concern"</blockquote>and...<div class="content-highlight">The financial reports were issued with a <a href="http://www.toshiba.co.jp/about/ir/en/news/20170411_1.pdf" target="_blank">Disclaimer of Opinion</a> by the Auditor.</div>The first is pretty easy. They lost a ton of money, and they have a lot of debt.They owe more in terms of guarantees on Westinghouse, and even though they don't have to mark down anything yet on their LNG exposure, it looms in the distance. A really big net loss where your equity goes significantly negative leads to this kind of comment. The second is more problematic.<h2>What Happened in the Disclaimed Opinion?</h2><ol><li>Toshiba conducted internal investigations which found internal controls lacking. The Audit Committee then outsourced to external law firms the investigation and judgment of whether there was impact from "inappropriate pressure" to influence accounting treatment. </li><li>The Audit Committee took the results of the 3rd party law firms and found no specific need to recognize an impairment loss prior to Q3 2016 (the Oct-Dec 2016 quarter). </li><li>PwC Aarata - the external auditors - found evidence enough that there had potentially been inappropriate pressure from 'certain senior managers' related to the Purchase Price Allocation accounting process related to the CB&amp;I Stone &amp; Webster acquisition (the read-between-the-lines here would be that perhaps the acquisition was structured in such a way so as to hide other problems for a while). PwC is 'still evaluating the data' so was unable to define the impact, if any, of such undue pressure, and therefore declined to issue an opinion. It should be noted, however, that all of the media - which appears to have sources who know - seems to suggest that PwC thought it necessary to rerun accounts to March 2016 and Toshiba thought not. </li><li>Toshiba, despite not receiving an opinion, decided to go ahead anyway and release the numbers. This was, as the CEO put it, because the numbers (i.e. the balance sheet) weren't going to change, and it wasn't clear Toshiba and PwC would reach an accord by the next deadline. The CEO was apologetic, and CFO Hirata seemed extremely apologetic - Toshiba wanted to clarify things for stakeholders as soon as possible. That word is important - the word used was 'stakeholders', not shareholders. In this case that means banks, regulators, employees, customers, suppliers, governments, potential bidders, and also perhaps shareholders.</li><li>In the press conference, subject to the persistent questions of irritated reporters, Toshiba announced it would release its full fiscal year numbers on time, in mid-May. The CEO's insinuation was that it would be done with or without PwC numbers, though Ryoji Sato, the chairman of Toshiba's Audit Committee hinted that they might try to find another auditor. With a month left? Good luck with that. </li></ol><div class="content-highlight">Looking back... The implications here are that Toshiba is suggesting, despite the fact there may have been 'inappropriate pressure', at no time did it further affect accounting between March 2015 and December 2016. All of the previous "accounting irregularities" over a period of 7 years, resulting from "systematic coverup" based off similar types of pressure, had obviously ceased. And between March 2015 and December 2016 for 6 quarters everything was fine (even better - there were upward forecast revisions) but in the Oct-Dec quarter, there were suddenly massive losses to be recognized. And these losses only needed to be recognized AFTER the TSE rejected Toshiba's preliminary Internal Management System report filed in mid-September 2016 citing inadequate accounting procedures. But controls were in place, and it was all good. Until it wasn't. I note that the details of the Stone &amp; Webster buy were limited at the time of the purchase (which took place AFTER Toshiba had been required by the TSE to submit the IMS report), and had been signed and closed by the new management and board. All of the hearings in Georgia for cost overruns, and the year of haggling between Toshiba and Stone &amp; Webster's previous owner Chicago Bridge &amp; Iron apparently did not seem to hint to Toshiba that there might be a problem.My takes? 1) To not dig deeper is odd. 2) The auditors did not want their name on a report which did not dig deeper. 3) I expect now it is unlikely PwC will agree to full-year numbers either.</div><h2>What Are the Implications of a Disclaimed Opinion?</h2>There are generally four types of Opinion issued by auditors with regard to companies' financial statements:<ol><li>Unqualified Opinions:These are good. It means the auditor believes statements conform to accounting rules and fairly represent an entity's financials.</li><li>Qualified Opinions:Much less good. It means the auditor believes the statements contain misclassified entries, may have incorrect data, the audit may be restricted in scope, and the auditor is unable to fully guarantee the financials are conforming and fairly representative.</li><li>Adverse Opinions:These are BAD. It means the statements do not comply with accounting rules, and do not fairly represent the entity's financial condition or position. </li><li>Disclaimer of Opinion:This is weird. It means the auditor recuses itself from profferring an opinion, because of limited scope or lack of data, or issues with conservatism or matching. It says "We refuse to give an opinion because we would be unwilling to support it." </li></ol>But this was an interim quarterly report. The Exchange does not require that quarterly reports have auditor opinions, but a big company reporting and specifically not being able to obtain the auditor's opinion is rare. An auditor's opinion is expected, and not obtaining one quite often leads to a company being designated a Security On Alert as per the Listing Regulations (Rule 501 1.(2)), though this is at the discretion of the Exchange.<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/024/095/original/20170412_SecListingReg501Quarterly..png?1491931815" class="editor-image img-responsive" data-smartkarma-image-id="24095"></figure><div class="content-caption">excerpted from the <a href="http://www.jpx.co.jp/english/rules-participants/rules/regulations/tvdivq0000001vyt-att/securities_listing_regulations_(r1-r826)_20161104.pdf" target="_blank">Securities Listing Regulations</a> (p85)</div>The thing is... Toshiba is already designated as a Security on Alert (since <a href="http://www.jpx.co.jp/english/listing/market-alerts/alert/b5b4pj000000q9du-att/TOSHIBACORPORATION-150914EN.pdf" target="_blank">14-Sep-2015</a>, continued <a href="http://www.jpx.co.jp/english/listing/market-alerts/alert/b5b4pj000000q9du-att/TOSHIBACORPORATION-161219EN.pdf" target="_blank">19-Dec-2016</a>) AND a <a href="http://www.jpx.co.jp/english/news/1021/20170314-12.html" target="_blank">Security Under Supervision</a> (since 15-Mar-2017). As discussed in <a href="https://www.smartkarma.com/insights/timeline-for-toshiba-troubles-two-days-til-a-tempest" target="_blank" data-smartkarma-citation="insights:9871">Timeline for Toshiba Troubles - Two Days Til A Tempest?</a>, the TSE is examining the content and results of the Internal Management System report that Toshiba filed for a second time on 15 March 2017 because the first submission was deemed inadequate.<div class="content-highlight">Rule 601 of the <a href="http://www.jpx.co.jp/english/rules-participants/rules/regulations/tvdivq0000001vyt-att/securities_listing_regulations_(r1-r826)_20161104.pdf" target="_blank">Securities Listing Regulations</a> which governs the Delisting Criteria for the Main Markets (p88-91 are relevant here), would suggest thatToshiba is currently in danger of delisting from TWO separate angles.</div>Rule 601 Paragraph 1 Items (11) and (11)-2 below describe them.<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/024/098/original/20170412_SecListingRule601.png?1491934677" class="editor-image img-responsive" data-smartkarma-image-id="24098"></figure><div class="content-caption">excerpted from the Securities Listing Regulations</div>(11) False statement or adverse opinion, etc. The important word here is "etc" because it refers to Rule 501 Para 1 Item 2 which is highlighted above. A "no opinion" (or disclaimed opinion) is enough to trigger delisting if the Exchange deems that it [is] clearly difficult to maintain order in the market if the listed company is not delisted immediately. The result here is flexible. The Exchange must determine that keeping the stock listed is detrimental to the maintenance of order in the market.  (11)-2 Securities on alert, etc The operative section here would be section c. Where the Exchange deems that the internal management system, etc of the listed company has not been improved within one (1) year and six (6) months from the designation as a security on alert. This is the examination process Toshiba is currently undergoing after the submission of its report in mid-March. The result here is binary.Interestingly, in the Enforcement Rules, out of all the methods prescribed to deal with the various items in Paragraph 1 of Rule 601 regarding delisting, none appear to talk about Item 11 which is what we are concerned with. Rule 606 of the Securities Listing Regulations, however, discusses to some extent how all this gets done. The TSE talks to everyone involved, and obliges the company to ensure such cooperation. <figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/024/100/original/20170412_SecListingRule606.png?1491942087" class="editor-image img-responsive" data-smartkarma-image-id="24100"></figure>Interestingly, in what may later be known as a supreme irony, in February this year, the TSE changed the rules companies should abide by in providing quarterly results. Audited quarterly results will not be necessary. But only for fiscal years which start AFTER March 31, 2017 - and for the avoidance of doubt, no early adoption is allowed. The document is available only in Japanese as far as I know and the relevant section is on page 4 <a href="http://www.jpx.co.jp/equities/listed-co/format/summary/tvdivq0000004wuh-att/tvdivq000000up10.pdf" target="_blank">here</a>.Below the fold I discuss...<ol><li>The Takeaways of the Filing and Lack of Auditor Opinion</li><li>A Brief Recap of Subsequent Events</li><li>My Conclusions.</li></ol>

Yesterday, Toshiba Corp (6502 JP) met the extended April 11th deadline to file its April-December 2016 financial results, avoiding having to ask the Financial Services Agency for an unprecedented third extension. Getting the numbers out of the way quickly, the net loss for the 9 months was 532.5bn yen. The negative shareholder equity position as of end-December was -225.7bn yen, but because of the bankruptcy of Westinghouse at the end of March, that number is likely to worsen by 450bn yen (the presentation materials appear to be somewhat in conflict) by March end to finish at a negative 620-675bn yen. That means a net loss for the year of more than a trillion yen. That's a thirteen-digit number, folks.But even though the numbers were larger than provisional numbers put forth in February and this is a large hole to fill, this will not be the important topic of discussion near-term.The Two Big Points:"There are material events and conditions that raise substantial doubt about the company's ability to continue as a going concern"and...The financial reports were issued with a Disclaimer of Opinion by the Auditor.The first is pretty easy. They lost a ton of money, and they have a lot of debt.They owe more in terms of guarantees on Westinghouse, and even though they don't have to mark down anything yet on their LNG exposure, it looms in the distance. A really big net loss where your equity goes significantly negative leads to this kind of comment. The second is more problematic.What Happened in the Disclaimed Opinion?Toshiba conducted internal investigations which found internal controls lacking. The Audit Committee then outsourced to external law firms the investigation and judgment of whether there was impact from "inappropriate pressure" to influence accounting treatment. The Audit Committee took the results of the 3rd party law firms and found no specific need to recognize an impairment loss prior to Q3 2016 (the Oct-Dec 2016 quarter). PwC Aarata - the external auditors - found evidence enough that there had potentially been inappropriate pressure from 'certain senior managers' related to the Purchase Price Allocation accounting process related to the CB&amp;I Stone &amp; Webster acquisition (the read-between-the-lines here would be that perhaps the acquisition was structured in such a way so as to hide other problems for a while). PwC is 'still evaluating the data' so was unable to define the impact, if any, of such undue pressure, and therefore declined to issue an opinion. It should be noted, however, that all of the media - which appears to have sources who know - seems to suggest that PwC thought it necessary to rerun accounts to March 2016 and Toshiba thought not. Toshiba, despite not receiving an opinion, decided to go ahead anyway and release the numbers. This was, as the CEO put it, because the numbers (i.e. the balance sheet) weren't going to change, and it wasn't clear Toshiba and PwC would reach an accord by the next deadline. The CEO was apologetic, and CFO Hirata seemed extremely apologetic - Toshiba wanted to clarify things for stakeholders as soon as possible. That word is important - the word used was 'stakeholders', not shareholders. In this case that means banks, regulators, employees, customers, suppliers, governments, potential bidders, and also perhaps shareholders.In the press conference, subject to the persistent questions of irritated reporters, Toshiba announced it would release its full fiscal year numbers on time, in mid-May. The CEO's insinuation was that it would be done with or without PwC numbers, though Ryoji Sato, the chairman of Toshiba's Audit Committee hinted that they might try to find another auditor. With a month left? Good luck with that. Looking back... The implications here are that Toshiba is suggesting, despite the fact there may have been 'inappropriate pressure', at no time did it further affect accounting between March 2015 and December 2016. All of the previous "accounting irregularities" over a period of 7 years, resulting from "systematic coverup" based off similar types of pressure, had obviously ceased. And between March 2015 and December 2016 for 6 quarters everything was fine (even better - there were upward forecast revisions) but in the Oct-Dec quarter, there were suddenly massive losses to be recognized. And these losses only needed to be recognized AFTER the TSE rejected Toshiba's preliminary Internal Management System report filed in mid-September 2016 citing inadequate accounting procedures. But controls were in place, and it was all good. Until it wasn't. I note that the details of the Stone &amp; Webster buy were limited at the time of the purchase (which took place AFTER Toshiba had been required by the TSE to submit the IMS report), and had been signed and closed by the new management and board. All of the hearings in Georgia for cost overruns, and the year of haggling between Toshiba and Stone &amp; Webster's previous owner Chicago Bridge &amp; Iron apparently did not seem to hint to Toshiba that there might be a problem.My takes?  1) To not dig deeper is odd. 2) The auditors did not want their name on a report which did not dig deeper. 3) I expect now it is unlikely PwC will agree to full-year numbers either.What Are the Implications of a Disclaimed Opinion?There are generally four types of Opinion issued by auditors with regard to companies' financial statements:Unqualified Opinions:These are good. It means the auditor believes statements conform to accounting rules and fairly represent an entity's financials.Qualified Opinions:Much less good. It means the auditor believes the statements contain misclassified entries, may have incorrect data, the audit may be restricted in scope, and the auditor is unable to fully guarantee the financials are conforming and fairly representative.Adverse Opinions:These are BAD. It means the statements do not comply with accounting rules, and do not fairly represent the entity's financial condition or position. Disclaimer of Opinion:This is weird. It means the auditor recuses itself from profferring an opinion, because of limited scope or lack of data, or issues with conservatism or matching. It says "We refuse to give an opinion because we would be unwilling to support it." But this was an interim quarterly report. The Exchange does not require that quarterly reports have auditor opinions, but a big company reporting and specifically not being able to obtain the auditor's opinion is rare. An auditor's opinion is expected, and not obtaining one quite often leads to a company being designated a Security On Alert as per the Listing Regulations (Rule 501 1.(2)), though this is at the discretion of the Exchange.excerpted from the Securities Listing Regulations (p85)The thing is... Toshiba is already designated as a Security on Alert (since 14-Sep-2015, continued 19-Dec-2016) AND a Security Under Supervision (since 15-Mar-2017). As discussed in Timeline for Toshiba Troubles - Two Days Til A Tempest?, the TSE is examining the content and results of the Internal Management System report that Toshiba filed for a second time on 15 March 2017 because the first submission was deemed inadequate.Rule 601 of the Securities Listing Regulations which governs the Delisting Criteria for the Main Markets (p88-91 are relevant here), would suggest thatToshiba is currently in danger of delisting from TWO separate angles.Rule 601 Paragraph 1 Items (11) and (11)-2 below describe them.excerpted from the Securities Listing Regulations(11) False statement or adverse opinion, etc. The important word here is "etc" because it refers to Rule 501 Para 1 Item 2 which is highlighted above. A "no opinion" (or disclaimed opinion) is enough to trigger delisting if the Exchange deems that it [is] clearly difficult to maintain order in the market if the listed company is not delisted immediately. The result here is flexible. The Exchange must determine that keeping the stock listed is detrimental to the maintenance of order in the market.  (11)-2 Securities on alert, etc The operative section here would be section c. Where the Exchange deems that the internal management system, etc of the listed company has not been improved within one (1) year and six (6) months from the designation as a security on alert. This is the examination process Toshiba is currently undergoing after the submission of its report in mid-March. The result here is binary.Interestingly, in the Enforcement Rules, out of all the methods prescribed to deal with the various items in Paragraph 1 of Rule 601 regarding delisting, none appear to talk about Item 11 which is what we are concerned with. Rule 606 of the Securities Listing Regulations, however, discusses to some extent how all this gets done. The TSE talks to everyone involved, and obliges the company to ensure such cooperation. Interestingly, in what may later be known as a supreme irony, in February this year, the TSE changed the rules companies should abide by in providing quarterly results. Audited quarterly results will not be necessary. But only for fiscal years which start AFTER March 31, 2017 - and for the avoidance of doubt, no early adoption is allowed. The document is available only in Japanese as far as I know and the relevant section is on page 4 here.Below the fold I discuss...The Takeaways of the Filing and Lack of Auditor OpinionA Brief Recap of Subsequent EventsMy Conclusions.

Toshiba Files - A Disclaimed Opinion Makes Delisting More Likely