Muddy Waters is short Noble Group Limited (“Noble”). Noble seems to exist solely to borrow and burn cash. According to Bloomberg, Noble has been free cash flow positive only four out of 20 years – in other words, it literally generates positive free cash flow once every five years! According to Bloomberg, since 1997 Noble has raised from banks and markets net $7.7 billion. Noble’s debt is now almost four billion dollars. (A recent estimate, which Noble has not contested, is that due to repo-style transactions, Noble’s intra-quarter debt is approximately $3 billion greater than reported.)

We are really short Noble’s management. With a company as complex and opaque as Noble Group, there is no way for investors to definitively answer certain key questions. It becomes a question of how much investors should trust Noble’s management to be straight with them. Noble’s management has adamantly insisted that its accounting is conservative, and by implication, is reflective of reality. We do not believe Noble’s management.

Noble Group Limited

Noble Group’s Accounting: Fueling the Cash-Burning Fires

Muddy Waters is short Noble Group Limited (“Noble”). Noble seems to exist solely to borrow and burn cash. According to Bloomberg, Noble has been free cash flow positive only four out of 20 years – in other words, it literally generates positive free cash flow once every five years!1 According to Bloomberg, since 1997 Noble Group has raised from banks and markets net $7.7 billion. Noble Group’s debt is now almost four billion dollars. (A recent estimate, which Noble has not contested, is that due to repo-style transactions, Noble’s intra-quarter debt is approximately $3 billion greater than reported.)

Noble might encourage investors to exclude its working capital changes from calculations of operating and free cash flow. We think that approach would be selfserving and disingenuous. We are puzzled by why, when given a 20-year runway, this company is still unable to stop burning cash. Really, what is the point of Noble growing, if after all of this time, it still cannot consistently generate cash? We think Noble Group’s growth is a means to no end, other than to keep the credit flowing.

Noble depends on its income statement to survive. When a company borrows and burns cash as consistently as Noble does, it needs to generate EBITDA for its lenders, and net
income for its equity investors (a company’s ability to issue equity is comforting to lenders). For a company such as Noble, with significant amounts of Levels 2 and 3 fair value assets and an ever-expanding balance sheet, EBITDA and net income can be relatively easy to produce. The key questions about Noble Group are:

  • Is Noble effectively borrowing just to repay its existing debt? (In other words, if Noble Group stopped growing its balance sheet, would the business actually generate free cash and repay debt?)
  • Is Noble in a vicious cycle whereby it will spend cash in value destroying ways in order to generate accounting gains (and keep its credit flowing)?

The reality of Noble’s financial statements has recently been criticized by a supposed former employee. 3 4 Recently released details on 2014 results suggest concerning answers to the above questions. In 2014, 70% of Noble’s net income came from unrealized net gains on Level 3 assets.5 $2.1 billion of Noble’s 2014 fair value gains are on contracts maturing in over four years,6 which represents 30% of Noble’s 2014 fair value gains and 41% of shareholders’ equity.7 With $4.0 billion in debt on Noble’s balance sheet and funding costs that have recently been volatile, the degree of substance underlying Noble Group’s financials is critical.

We are really short Noble’s management. With a company as complex and opaque as Noble, there is no way for investors to definitively answer the above questions. It becomes a question of how much investors should trust Noble’s management to be straight with them. Noble Group’s management has adamantly insisted that its accounting is conservative, and by implication, is reflective of reality. We do not believe Noble’s management.

If “adversity introduces a man to himself”, in the public company context, it also introduces management to investors.9 Management’s actions taken on the eve of Noble reporting its first quarterly loss since being public, give a clear view of how they operate.

Through a highly questionable acquisition followed by a series of suspicious transactions, Noble Group reduced its first reported quarterly loss by approximately two-thirds. The reported gain was equivalent to roughly 10% of Noble Group’s 2011 net income. In this report, we present the details of these transactions. After amassing this information, the truly disturbing aspect of Noble is that it has over 12,000 contracts – i.e., a lot of opportunities to do similar things again, and again.

Third party behavioral analysis strongly supports our opinion of Noble management. Muddy Waters engaged Qverity to analyze management’s statements on the February 26th Q4 2014 results call for deception. (The call is the only time Noble Group management has spoken extemporaneously in public about the recent criticism.) Qverity provides behavioral analysis, and is founded and staffed by former United States Central Intelligence Agency experts in detecting deception. Its principals authored the books “Spy the Lie” and “Get the Truth”. We have included the Qverity analysis in this report. Qverity’s opinion is that Noble management has been deceptive in addressing the criticism.

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