Prescience Point Research is short shares of Celadon Group, Inc. (NYSE: CGI).
Prescience Point Research Opinions:
- CGI shares are worth $0.00 per share.
- Over 95% of CGI’s reported tangible book value does not exist. CGI’s actual TBV is no more than $.42/share.
- CGI will restate its historical results because of the issues exposed in this report.
- CGI will be bankrupt or insolvent within 1-2 quarters; existing shareholders will be wiped out.
- CGI stock should be de-listed from the NYSE.
- Regulatory and law enforcement agencies with subpoena power should launch a full investigation of the company, its accounting, and its practices.
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- Disclosure of a sham ‘daylight loan’ transaction in the JV subscription agreement directly contradicts Celadon’s representations of having collected on a $31.8m receivable; in our view, it amounts to incontrovertible proof that CGI has inflated its financial position and falsified its financial reports.
- CGI’s use of off-balance sheet transactions involving its JV with Element Fleet Management and related party 19th Capital inflated Q2’17 TBV and LTM profits by an estimated $104.2m, comprising 34% of reported TBV.
- CGI failed to record a $36m estimated loss from Quality equipment sales on its income statement despite its cash flow statement suggesting that such a loss was incurred
- CGI’s Balance Sheets and corresponding Statements of Cash Flows do not reconcile. Discrepancies indicate CGI systematically overstated property and equipment by ~$78.8m, comprising 26% of CGI’s reported TBV.
- Divergence between net income and adjusted CFFO has exploded. Net income now exceeds Adj CFFO for the first time in 8 years.
- CGI management appears to have bilked shareholders out of $4.6m when 19th Capital, a related party, was redeemed at an inflated equity value of 4.5x invested capital, just ~1.25 years after its formation. The redemption may have been paid for with cash misappropriated from CGI’s balance sheet.
- CGI’s sudden jump (67.4% growth) in Other Revenue from Q2’17 to Q4’16 cannot be reconciled with a reported contraction in trucking assets needed to drive that growth.
- After CGI fired KPMG as its auditor and hired a smaller regional (BKD), its audit fees rose 180%, which would make sense if it was a fraudulent company.
- Deeply negative and rapidly deteriorating FCF indicates business is fundamentally broken. Our analysis indicates CGI will be insolvent in 1-2 quarters, based on projected cash burn of $80.1m in 2H FY’17 against revolver availability of only $54.3m.
- CGI would have defaulted on its leverage ratio covenant had it not concealed operating losses; concealing losses by falsifying financial results is an Event of Default, in its own right.
- Incestuous hiring practices and nepotism may have created an environment lacking in accountability and ripe for fraud.
- Prescience Point reached out to CGI management numerous times and never heard back.
We believe that Celadon Group (“CGI” or “the company”) is a house of cards on the brink of collapse. In this report, we present evidence, which in our opinion, indicates that CGI used a series of off-balance sheet transactions, manipulative accounting practices, and material misrepresentations to skirt covenant violations and hide catastrophic losses from shareholders and creditors. Absent these interventions, we believe that CGI’s creditors would already have forced a restructuring, and its share price would be trading at pennies.
CGI initially caught our attention last year when we learned it was engaging in questionable non-arm’s length transactions with 19th Capital, an off-balance sheet entity owned in-part by CGI and CGI management. Per renowned accounting expert Howard Schilit,1
“…transactions that lack a reasonable arm’s-length process are sometimes appropriate. But prudent investors should bet against it. That is, most related-party transactions that lack an arm’s-length exchange produce inflated, and often phony, revenue.”
Our interest was piqued when Celadon announced the formation of a new off-balance sheet entity that would retire 19th Capital, resulting in a payout to management of ~$4.6m in exchange for their incentive units, based on a redemption value of >$27m. Peculiar. This entity was formed with a $6m investment, meaning that it generated a whopping return of 4.5x since its formation – only 1.25 years back! And this massive return was generated as the tractor resale market and lease utilization rates contracted, and comparable companies posted losses…? Based on our analysis, 19th Capital’s equity was actually worthless at the redemption. As discussed in this report, we can’t help but think the cash payout to 19th Capital’s owners was misappropriated from CGI shareholders.
The more we dug, the more we found. Our investigation entailed a thorough scrub of CGI’s public disclosures and filings (including ones Sell Side analysts seem to be ignoring), conversations with former CGI employees and various trucking insiders, and consultation with a 3rd party forensic accounting firm. In our opinion, Celadon appears to exhibit many of the troubling hallmarks of accounting frauds past. Its books do not seem to reconcile, and its disclosures often seem to conflict.
We were especially concerned when we discovered what, in our view, amounts to smoking gun evidence that Celadon is fabricating its financial reports. In this report we detail the basis for our research opinions, which include the following:
- CGI has used off-balance sheet entities (i.e. 19th Capital, JV with Element) and manipulative accounting practices to hide its insolvent condition from investors and creditors.
- In total, we estimate that CGI’s accounting shenanigans inflated its Q2’17 TBV and LTM profits by $219m. To put that in perspective, $219m represents 71% of CGI’s Q2’17 reported TBV of $305.8m!
- A sham Daylight Loan, as revealed in the JV subscription agreement, clearly shows that CGI’s claim it collected on a $31.8m receivable is false – in our view, serving as incontrovertible proof that CGI has inflated its financial position and falsified its financial reports.
- KPMG forced a PP&E restatement in 2012; soon after CGI replaced KPMG with BKD, a much smaller and less reputable audit firm. CGI’s audit fees since retaining BKD have risen an astonishing 179.6%, indicative of an elevated risk of accounting issues.
- Management appears to have bilked shareholders out of $4.6m when 19th Capital, a related party, was redeemed at an inflated equity value. Evidence suggests the redemption was paid for with cash misappropriated from Celadon’s balance sheet.
When considering the total body of evidence, we conclude that Celadon is materially misrepresenting its reported financial performance and that its management is so untrustworthy that CGI is simply uninvestable. Regardless, we expect the company to become insolvent in the next 1-2 quarters as its projected cash burn in 2H FY’17 of $80.1m far exceeds its borrowing availability of just $54.3m. We estimate CGI’s ‘true’ TBV to be only ~$12m, meaning that we expect it cash burn to blow through this equity cushion. Thus, we initiate CGI with a price target of $0 per share.
We hope that current and future investors and creditors familiarize themselves with the risks we have addressed and take immediate action to preserve the value of their holdings. We also hope that the NYSE, regulatory and law enforcement agencies, and CGI’s auditor take necessary precautions in protecting investors.
Is >95% of Celadon Group, Inc. (CGI)’s Reported TBV Attributable to Accounting Fabrications?
Prescience Point does not trust Celadon’s reported financial statements. In fact, the following sections in this report detail why we believe that over 95% of CGI’s reported TBV is suspect. We calculate CGI’s ‘true’ TBV to be ~$11.9 million, or $0.42 per CGI share:
Celadon Group Makes Leveraged Bet on Tractor Resale Market; Results in Massive Losses
In 2014, Celadon made a highly leveraged bet on the then-robust tractor resale market. In doing so, it pivoted its subsidiary, Quality Companies (“Quality”), to a bulk tractor purchase and resale model. Quality bought large amounts of tractors, leased these tractors to independent operators, and then sold the leased equipment to third-party financing providers.
In late 2015, softness in the trucking industry caused used tractor prices and lease utilization rates to nosedive. The contraction has continued ever since. In the subsections below we detail the mistakes Celadon made, which have led it to the brink of insolvency.
CGI Puts It All on the Line, Essentially Wagering its Status as a Going Concern
Per the FY’15 10-K, “Quality has placed initial orders for 13,000 tractors… at an aggregate estimated purchase price in excess of $1.5 billion.” (CGI had just $0.5B in equipment the year prior.) By FYE’15, CGI’s debt levels had skyrocketed to $587.5m. At the same time, from FY’14 to FY’15, property and equipment levels surged from $492.8 million to $788.5 million and equipment held for resale ballooned from $3.2m to $102.5m. 2
CGI Agrees to Deal Structure with Element that Would Seal its Fate in a Downside Scenario… Downside Scenario Ensues
From April 2014 to September 2015, Quality’s tractors were purchased almost exclusively by Element Fleet Management (“Element”), a large fleet management company based in Canada. In its 8-K filed on 10/19/2016, Celadon disclosed that it had “sold approximately $740 million of assets to Element.”
The terms attached to the leased tractors Quality had sold to Element were quite onerous for CGI:3
- CGI agreed to cover up to 10% of any losses incurred by Element from its tractor purchases. For example, if Element purchased $100m of equipment from Quality, CGI would cover up to $10m of losses on these purchases.
- CGI also agreed to cover any shortfall on the lease payments Element received from its operators. So, if an operator owed Element a monthly lease payment of $2,000 but paid just $800, the company would cover the $1,200 shortfall. CGI refers to these payments in its filings as “lease shortfall advances.”
In late 2015, used tractor prices and lease utilization rates began to nosedive. The declines have persisted to this day and, as discussed later in this report, are projected by other trucking companies and industry insiders to continue for years. As CGI explained in its FY’16 10-k (issued 9/13/16), a weakening in both factors resulted in negative cash flows, attributable to its obligations to Element:
Recently, the demand for trucking services and the market for used tractors have both weakened. This has negatively impacted Quality’s operating results by reducing the amount of leased equipment sold by Quality to the Quality Financing Parties and resulting in a higher than expected number of unseated tractors among Quality’s tractors under management. These factors have depressed Quality’s earnings and created negative cash flows associated with our obligation to advance certain amounts to the third party financing provider under the Lease Shortfall Advance.
See the full PDF below.