Olam International Ltd (SGX:O32) has filed a lawsuit in the Singapore high court against Muddy Waters, LLC. During a conference call in London on Monday, Muddy Waters founder, Carson Block, questioned Olam’s accounting practices and said that the Singaporean commodity trader was on the verge of collapse. Muddy Waters has denied the lawsuit. A spokesman for Muddy Waters, states ‘We have not seen a lawsuit and, should we have to defend ourselves, we will do so vigorously.’ A spokesperson for Olam did not return our call regarding the matter.

Olam CEO

It initiated a war of words between Olam chief Sunny Verghese and Muddy Water’s Carson Block. Verghese said yesterday that Mr. Block has designed the statements to panic shareholders so that he could short sell the world’s second largest rice trader. On Tuesday, Muddy Waters published an open letter on its website echoing Mr. Block’s comments that Olam International was “at the risk of collapsing”, due to its debt load and financial mismanagement.

Olam International Ltd (SGX:O32) responded to it by announcing that it has filed a lawsuit against the Hong Kong and the United States-based short seller. However, the company didn’t confirm whether the suit is for slander, libel, or malicious falsehood. Later, Olam International Ltd (SGX:O32) CEO Sunny Verghese organized a conference call with news media and investors. He accused Muddy Waters of spreading baseless assertions so that they can make money from their short position.

Mr. Verghese also said that Carson Block had secretly joined the representatives of a hedge fund visiting Olam’s office earlier this month. He came under a false name, dressed in jeans, T-shirt, and a baseball cap. Olam recognized this visitor only this week, after seeing Block’s photos on Muddy Water’s website.

Olam shares had plunged as much as 7.5 percent in Singapore trading after Mr. Block’s comments. But the shares gained 5.3 percent on Wednesday, the most in the last three months, after Mr. Verghese said that Block’s comments were nothing more than a concerted short-selling attack. Olam shares are currently trading at 1.695 Singaporean dollars.

Carson Block is known for publishing highly critical reports on Chinese companies listed in North America, and then making money by betting against those stocks. Last year, Muddy Waters criticized Sino-Forest, a Chinese forestry firm listed in Toronto. The stocks of Sino-Forest fell dramatically, causing huge losses to investors, including John Paulson. At the end, Sino-Forest had to file for bankruptcy.

After Olam’s defensive response, Muddy Waters published another letter on its website, saying that it always criticizes publicly-traded companies, but none of them have been as defensive as Olam – not even Sino-Forest Corporation (TSE:TRE). The letter says that Muddy Waters has done exhaustive research on Olam International Ltd (SGX:O32). The short-seller said that instead of attacking the critics, Olam should focus on putting its finances right.

As of September 30, Olam International Ltd (SGX:O32) has total debt of S$8.4 billion, more than quadruple the S$1.9 at the end of 2007. The two biggest shareholders in Olam are Kewalram Chanrai Group that owns 19.8 percent stake and state-owned Temasek Holdings with a 16 percent stake.

It is not the first time Olam’s accounting has been questioned. Earlier in 2011, a (now famous) CLSA Asia Pacific report raised questions over Olam’s accounting and subsidies from Nigeria. It led to 9.3 percent decline in Olam International Ltd (SGX:O32) shares. The commodity trader had denied the discrepancies raised. Muddy Waters mentioned the  February 2011 CLSA report in their response to Olam. They state ‘The February 2011 CLSA report, which raised far fewer concerns than we have identified internally, and that Olam itself made so controversial, should have caused you to work toward repairing what ails your business and your balance sheet. Instead, Olam has since increased its a) debt load by approximately S$900 million, b) cumulative investment cash burn by approximately S$2 billion, and c) cumulative operating cash burn by approximately S$500 million. In other words, you did the exact opposite of what you should have done. Your actions have been an abject failure of leadership.’

We obtained a copy of the report, and summarize the main details below:

olam CLSA 2011 model

Olam makes the biggest investment to date as it enters into a JV with the Gabon government for US$1.53bn. Together they will invest US$1.3bn in a greenfield fertilizer manufacturing plant and US$236m in palm plantations. This amounts to 11% of Gabon’s GDP! These projects will not contribute before 2015. While the projects look good on paper, there are significant execution risks in our view. This project will add atleast S$1bn in debt and raise 2011CL gearing to 284%. They reiterate a SELL.

Fertilizer project

Olam’s has formed a 80:20 JV with the Gabon government and combined will invest US$1.3bn in a greenfield fertilizer manufacturing plant in Gabon. The expected capacity is 1.3m MT per annum (2,200MT of ammonia and 3,850 MT of urea per day). The project is expected to be operational by 1H2014 and steady state July 2015. Olam’s projected steady state EBITDA is US$300-350m (>70% EBITDA margins); NET margin> 50%. Olam has a 10 year tax holiday, 10% concessional tax rate thereafter. We expect EVA/IC of 6%

Palm oil project

Olam also forms a 70:30 JV with Gabon government to develop the first phase (50,000ha) of palm plantations in Gabon with an investment of US$236m. The government has committed the JV a land bank of 300,000 ha of palm and rubber plantation development. The planting is expected to complete by 2016 and the project is expected to generate US$100-120m EBITDA in peak state. They expect EVA/IC of 25.6% based on Olam’s guidance.

Financing

The fertilizer investment will be financed by Debt/Equity ratio of 65:35. The debt portion of US$845 million is expected to be funded through non-recourse debt financing. Olam’s share of the equity investment (80% of total equity) is estimated to be US$364 million, to be phased across the three-year development and construction period. Olam has options to sell down the investment through a partial sale to investors.

Valuation

They maintain sell. While the investments look good on paper execution remains a key risks. Olam has been acquiring assets from 2007 but the returns are still below WACC. They also expect more equity raisings and EPS dilution over next few years. Olam’s Net debt to equity will be 284% end of 2011CL if there are no additional equity issuances.