Neil Shen Venture CapitalistShen is a board member of Focus Media, a major Shanghai-based advertising company that Muddy Waters, a West Coast-based short-selling research boutique, recently savaged in an 80-page report. Authored by Carson Block, whose credits include being the first to sound the alarm over the fraud and improprieties at RINO and Sino-Forest, the report details a level of insider self-dealing and board-level incompetence at Focus rarely seen on these shores, even in the wake of the financial sector’s debacles in 2008.

Shen has a small but important role in Focus Media’s strange doings.

Consider Focus’ March 2007 purchase of Allyes Information Technology for just under $297 million. Touted then as “The largest Internet advertising company in China,” the deal was nicely timed for Allyes’ investors, where, as recently as 2005, a trade publication pegged its valuation at $120 million.

What hadn’t been known was that the selling group included Focus chief executive Jason Jiang and board member Neil Shen. Shen, whose given name is Nanpeng, controls a British Virgin Islands shell, Smart Master International Limited, that held his personal investments, including the 0.45% Allyes stake, which was worth about $540,000 before the March 2007 deal, according to Securities and Exchange Commission documents. After the deal, it was valued at $1.33-million, for a profit of $793,000 in under two years time and a 146% return on his capital.

Focus’ disclosure on this deal, to be charitable, was virtually nonexistent. Buried in an exhibit attached to page 22 of an underwriting agreement is a carve out for Focus insiders to “a passive investment” in Allyes. This, it should be noted, defines “passive” so broadly as to be pointless since Focus bought–and later sold–the company. Focus insiders, in other words, were the very opposite of “passive.”

That was merely the pre-game, however. The self-dealing really kicked in when nine months later, in December 2007, Focus wrote the Allyes investment down to $82 million–it would take $259 million in write-downs by the end of 2010–before selling 38% of the then seemingly worthless unit to company insiders for $13.3 million.

As Muddy Waters’ Block noted, the move to allow the insiders to buy-in was odd, in that 87% of the book value had been written down at that point. Odder still was that the $13.3 million figure valuing the entire company at $35 million, a $5 million discount to the cash on hand and a 42% discount to the $60 million book value. Warren Buffett dreams of buying companies at a discount to cash value in his billionaire sleep. It’s challenging–absurdly challenging–to imagine a scenario or accounting regime where a company without liabilities of note would be forced to value itself below cash value.

The reason given for the insider’s purchases are also difficult to grasp.

Ostensibly they were to “incentivize” management to find a way to rationalize the seemingly collapsing Allyes business, but chief financial officer Kit Leong Low, a former Goldman Sachs analyst who covered the company, and CEO Jiang, are both multimillionaires (with Jiang on the path to Billionaire-dom with nearly 101 million shares, amounting to a greater than 15% stake in the company,) so the notion of them not being aware of the need to turn the unit around (or of being problematically under-compensated) is far-fetched.

One can’t argue with results, however, and Silver Lake Partners, a major private equity firm, bought 90.8% of Allyes just nine months later for $181 million.

Cutting to the chase, there are two ways of viewing this sale. Seen Focus’ way, it was a fortuitous rally in the value of online advertisers allowing them to sell Allyes at over three times book value to one of the world’s most sophisticated financial shops. This argument of course assumes Silver Lake, one of the biggest players in Chinese mainland private equity, has no ability to discern or price value, especially in the Internet sector where they own (or owned) numerous high-profile companies.

On the other hand, Focus investors, who booked over $160 million in losses in two years–while insiders repeatedly reaped millions in profits from private, non-disclosed deals they could not participate in–would likely see this as self-dealing with their capital.

Evaluating Shen’s performance as an independent director is easy assuming that everyone is clear on the criteria being used. If U.S. standards were applied, he would likely have been sued into the next dimension of time and space. Alone among his fellow board members, Shen–with a dozen years of U.S. corporate executive experience prior to becoming a VC–has an understanding of what so-called best practices are in terms of conduct and disclosure.

That Shen didn’t show the least interest in them, and actively used Focus’ corporate working capital to help make almost $800,000 shows that he both didn’t care and, just as likely, had nothing to fear from being exposed.

[For what it’s worth, the SEC has expressed some interest in the Allyes transaction, having filed two comments requesting additional public information.]

Of the 9.2% remaining stake in Allyes, The Financial Investigator has been unable to discern the ownership structure of two British Virgin Island trusts that hold one-third (or 3%) of the remaining non-Silver Lake shares, Bronco Venture Ltd. and Unidex Holdings Ltd. It is highly likely those entities, however, are owned in some combination by CFO Low and Jiang.

The Financial Investigator sent Shen an E-mail seeking comment trying to reconcile these transactions with the idea of being an independent director but did not receive a reply. FI called Mark Dempster, Sequoia’s chief of U.S. marketing, but he declined to comment. An E-mail sent to Focus’ Investor Relations department was not returned.

Link to full article: http://www.thefinancialinvestigator.com/?p=576