By Tom Winnifrith, The Sheriff of AIM | Sunday 13 August 2017
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.
Over the past week I have shown that Telit Communications (TCM) is run by a man who fled fraud charges in the US but changed his name to avoid investors knowing, I have flagged up banking covenant breaches, red flag strewn interims and an Italian criminal investigation. But that was just an appetizer. Today I give you a full dossier with shocking NEW material, which shows this is Globo Mark 2. it is a fraud and its shares are going to zero.
Let us start with the Italian job. Back in March 2007 Bartolini After Market Electronic Services Srl (“BAMES”) agreed to invest EUR 16 million in new shares to acquire a 10% stake in Telit subsidiary Telit Wireless Solutions Srl, which housed most of Telit’s M2M business (the group was in the process of disposing of its mobile phone and accessories business). This valued the subsidiary at EUR 160 million. By comparison Telit’s total market capitalisation at the time was about £12 million (with net cash of £5million)!
Net proceeds from the EUR 16m invested across 2007 and 2008 were EUR 14.6 million, implying fees of EUR 1.4 million (Oozi Cats received “a one-time bonus of €240,000 for [his] role in connection with the equity investment”). At the same time as BAMES made its initial investment, Telit agreed to acquire 19.9% of BAMES subsidiary Services for Electronic Manufacturing Srl (“SEM”) for one euro and to a 5 year manufacturing agreement whereby SEM would exclusively produce Telit’s M2M modules; Telit immediately wrote the value of this investment up to EUR 1.6 million.
In December 2008 Telit also sold to SEM the right to use its trade name (“Telit”) on Wimax products for EUR 3.5 million (payable from March 2010 to March 2012), of which EUR 1.5 million was recognised as license income in 2008. In 2009 BAMES and Telit renegotiated the SEM manufacturing agreement, ending the exclusivity, with SEM due EUR 2.8 million in compensation (to be offset against the trade name license fee receivable from them). Telit moved production of its modules to China. In 2010 BAMES sold its stake in Telit Wireless Solutions Srl back to Telit for c.EUR 1.5 million, an overall loss of c.EUR 13.5 million.
BAMES and SEM were declared bankrupt in 2013. Thirteen people were subsequently investigated by the public prosecutor in Monza on suspicion of fraud, including Telit CEO Oozi Cats in relation to the EUR 16m investment made in Telit’s subsidiary. A final decision on indictment is yet to be handed down. The obvious questions are why did BAMES invest at such a massive premium in 2007, what happened to this cash and why did they then sell out at a c.90% loss in 2010?
In response to a Reuters article Oozi Cats cited Telit’s prior success winning tax cases in Italy, noting that the country “is quite complex from a fiscal point of view.” That may be true but this is not a fiscal but a criminal case. The track record of Board members is less successful in that regard. In 2014 Telit’s co-founder and former Chairman Avigdor Kelner was sentenced to three years in jail for bribing politicians in Israel.
Finding management with colourful pasts is one obvious way to discover shorts. With Telit we have Avigdor and of course Uzi Katz/Oozi Cats, the Boston fraudster. But there is a third colourful fellow involved as well. At IPO the Board included David Hobley who was also a Director of Velti PLC, a Greek based fraud that unravelled some time ago. Okay this is interesting but it does not let us know what Telit is or what it is worth.
On the face of it the company is a low tech developer of modules that house chips for machine to machine (“m2m”) communication. I say low tech because it has no patented technology. Manufacturing is outsourced and the highest value add component, the chip, is bought in (usually from Intel or Qualcomm). On a reported basis Telit nevertheless
appears to be profitable and able to generate a high return on net operating assets (“RONOA”):
2009 2010 2011 2012 2013 2014 2015 2016
Operating margin (%) 1.7 5.0 3.3 3.9 6.3 6.2 6.7 7.3
RONOA (%) 5 17 12 12 19 21 23 22
The problem is that cash flow tells a different story to the income statement:
2009 2010 2011 2012 2013 2014 2015 2016
Reported net profit (4) 8 1 4 11 12 14 17
Free cash flow to equity (3) 4 0 (9) 6 8 6 6
The deficit is largely explained by Telit’s high level of capitalised R&D – $31 million in 2016, compared to only $12 million amortised. In fact, although the company has made much of the fact that it has been able to generate free cash flow, we note that in 2016 this was only possible because share based payments increased to $8 million (from less than $1 million three years prior). Ultimately this is a real cost to shareholders that is just settled with a different kind of paper - Telit shares instead of bank notes.
It is also worth recognising that Telit’s low level of free cash flow comes after receiving tens of millions in grants and other subsidies from the Italian government in recent years (to be fair it is also after paying many millions to CEO Oozi Cats).
Telit’s reported accounts seem to tell us that it is tough to make money doing what it does. The high level of capitalised spending could imply it is investing a lot for the future but a comparison with listed peers does not seem to bear that out. That makes it a poor business but not what one might term a Norfolk.
However, now we move up a gear and, to put it bluntly, Telit’s accounts don’t make any sense at all. When an associate of mine spoke to one competitor it told us that its finance team had tried to reconcile Telit’s numbers and couldn’t. I have similar concerns.
My first issue is with the customer base and, in particular, sales reportedly made through distributors. Telit announced revenue of $370 million for 2016 but does not say that much about the customers buying all of this product. It does disclose that there are a few large ones, which are often different from year to year, and claims to have over 5,000 in all. The company was asked if it would put us in contact with some for references (a standard part of any due diligence process) but Telit declined.
It is, however, a bit easier to do due diligence on Telit’s distributors which the company has told us account for about 25-30% of revenue.
According to its 2016 annual report Telit uses 78 “exclusive distributors”. I have not been able to identify all of these but most are listed on the company website. Anyone spending a few minutes looking can see that several do not look like promising sales partners. For example, the domain for the WE Components website has been suspended and the phone number is not recognised. The website for Aviv Mobile Communications does not work and the phone line was dead when a colleague called. The website for Group iTech, Telit’s ‘Competence Center’ in Brazil, has been out of action since at least early 2016. Some of the websites that do work are, if anything, even worse. Eddas HG has a half-started WordPress website with no information on it other than an address and phone number. Design in Vietnam (“DIV”) has two products listed on its website - a very basic mobile sim controlled lock and a USB charger for a scooter – but again the website is non-functional and mostly just a template (e.g. their ‘Partners’ are a list of stock photo and graphic shops and the ‘What customers say about us’ section is made up of meaningless Latin quotes from apparently generic people at non-existent companies).
A colleague approached DIV as a potential customer using the contact information on its website and got no reply. When he called by to take a look at the office address it appeared to be a courier business with a different name.
In my experience it is unusual for a material proportion of a company’s distributor base to be non-operational. As you read about the "distributors" above I am sure that you were at once screaming Globo! This is Globo mark 2.
In addition to the patently bogus distributors, several of the other distributors listed do not appear to carry Telit products. Many of the others file their own accounts and most seem too small to generate a significant amount of sales.
There are some larger distributors but the company confirmed that the biggest, Arrow Electronics Inc., is not more than 5% of group sales. I am, therefore, a little surprised that Telit is able to generate overall revenue of c.$100 million from this channel.
The distributors I am most interested in, though, are those listed for Korea. Martner and Melper were both incorporated in 2009 and do not appear to have existed prior to becoming Telit resellers (the relationship was apparently very close indeed because the administrative contact for the martner.co.kr website is Noh Jae Kwang and his LinkedIn profile states he is a Telit employee). Since a colleague began looking into the company the Martner website appears to have been taken down. We know Melper was significant because in 2012 it was selected as Telit’s ‘Korea Competence Center’, playing “a critical role in offering M2M design, development and integration assistance to customers”.
But it doesn’t appear to have much substance today. Its website had only a handful unique visitors in the past few months, all related to our research. While it does list a dozen or so Telit products almost all of them have been discontinued (some as long ago as 2014). My associates called Melper dozens of times over the space of several weeks to try and speak with them. No one ever answered, it just rang without going to voicemail. There is no email address contact.
Despite these less than substantial distributors Telit’s reported sales performance in Asia Pacific has been remarkable (the company stated to us that revenue by geography is disclosed based on the location of the entity making the sale). Below is reported external revenue for the APAC region since 2007, in millions of dollars for comparison:
2007 2008 2009 2010 2011 2012 2013 2014 2015
APAC external sales 19 14 21 21 31 25 28 41 71
These numbers are particularly remarkable because the only Asian country where Telit generates significant revenue, based on the disclosure it gives every year on receivables, is Korea:
“The Group's trade receivables are principally derived from sales to customers in Israel, Italy, the USA and Korea.”
In fact before 2012 there was only one active Asian entity - Telit Wireless Solutions Co Ltd (“Telit Korea”) - which was known internally as “APAC”. And yet external sales by Telit Korea, which is required to file accounts under Korean law, have been anything but remarkable:
2007 2008 2009 2010 2011 2012 2013 2014 2015
Telit Korea external sales 19 19 20 17 13 10 7 5 8
Delta to reported APAC sales 0 5 (1) (4) (18) (15) (21) (36) (63)
This is my second big issue with Telit’s accounts. For 2011 Telit initially states in April that Korean sales were up “around” 20%. Later in the year its magazine, Telit2Market, reports Korea sales up “over 25%” in 2011. But the Korean subsidiary accounts show reported external sales down by nearly a quarter. This deficit seems impossible to reconcile based on management’s disclosure and has become significantly larger in subsequent years. When the company was asked to clarify this point it initially avoided answering and finally, after several emails, refused to communicate further.
I note that the difference between reported APAC sales and Telit Korea’s actual revenue cannot have been a simple inter-company accounting issue because there was a minority shareholder in the latter up to 2014. Telit bought its original 75% stake for $6.2m in 2006 from Bellwave, a Korean mobile phone manufacturer that went bankrupt in 2008. It had an option to buy out the other 25% but did not exercise this. Instead, in 2007, it subscribed for $2.4m in new shares, an implied valuation of $6m. In 2011 it put in for another $1.1m at an implied valuation of USD 55.1m – the same year the entity reported sales down by nearly a quarter and an operating loss. Only in 2014, with reported APAC sales booming but Telit Korea sales still going backwards, did the minority shareholder sell out – for just $100,000. Despite this Telit took no writedown on its Korean investment.
Telit Korea’s filings also show significant discrepancies with the public filings of other Telit subsidiaries, including the main one in Italy (Telit Communications Spa, “Telit Italy”). For example, in 2015 Telit Korea shows net sales from it to Telit Italy, the Italian accounts the opposite. Net working capital between the two is similarly different and in opposite directions (oddly the Italian accounts show a negative receivable from Korea).
The accounts for Telit Communications Cyprus Ltd (“Telit Cyprus”) don’t exactly add up either. There are, for example, $1m in trade receivables from outside the group when all of its sales (actually a little more than all of its reported sales) were apparently made internally. Telit Cyprus is principally responsible for “the purchase of cellular modules and component parts, and management of related operations and logistical functions up until the sale of cellular modules to intercompany entities within Telit Group.”
It reportedly bought $163m of inventory in 2015 (excluding inter-company purchases). And this is where I find another big issue with Telit’s accounts. Telit Italy’s cost of goods (“COGS”), on the same basis, was around $54m and the vast majority is classified as products. External COGS for Telit Korea were c.$9m, again almost all of this being products. That adds up to externally purchased products of somewhere around $220m for those three entities alone, on a consolidated basis (the other major subsidiaries in Israel and the USA do not publicly file accounts). But at group level the cost of “inventories recognised as an expense” is only $189m in 2015. There appears to be around $30 million unexplained.
It is not sitting on the balance sheet – inventory declined from $21.5 million to $20.1 million in 2015. Some may be in capitalised R&D, which amounted to $26 million in 2015, but when colleagues asked the company it said almost all of this total was staff costs and other charges such as getting new products tested and certified externally. In other words it cannot explain much of the missing inventory.
We know Telit Cyprus was dormant at the start of 2015, because the 2014 group accounts tell us it was (the subsidiary has not filed accounts for 2014 as far as we can see, though it did for 2013). We do not know what date it became active in managing Telit’s module supply chain because it has made no meaningful disclosure about it.
We can, however, see that the entire Board changes on 10th May 2016. The changes include the removal of Kokos Skoullos, an employee of M Papadakis & Co, the firm which audited Telit Cyprus’s 2013 accounts (and which provided its registered address). This suggests to us that Ernst & Young were not appointed as auditor for Telit Cyprus until this date, two months after the group level accounts for 2015 had been audited. We note that the Telit Cyprus 2015 accounts were not signed off until several months later again, on 29th December 2016.
I think the pattern is clear (the picture is anything but). Telit’s reported accounts contain too many errors and inconsistencies for us to rely on them. That and the obvious lack of significant cash flow mean that on a fundamental basis this is a trainwreck which is only partially completed. Throw in the fact that the founder and CEO is now unmasked as a fraudster who was a an undeclared fugitive from US justice when he floated Telit and so many other things and there is only one conclusion.
This is a zero. sell. Target price 0p or suspension following the resignation of the board/Nomad or pending clarification.
 The deal to buy back the minority stake was structured such that BAMES received 2.7m Telit shares (and its 19.9% stake in SEM back) – if the Telit shares were worth less than EUR 1.5m on 1st February 2011 Telit would make BAMES whole but if they were above this value BAMES would pay half of the difference to Telit (and all of it above EUR 2.5m); BAMES sold its Telit shares in February 2011 and this allowed Telit to report USD 1.2m of other income in 2010 (an intra-year reversal of contingent consideration).
 Telit Communciations AR 16, p.5
 +972 9 76659 15
 Telit Communciations AR 15, p.81
 Telit Communications 2011 preliminary results, p.10
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