ValueWalk is planning its fourth Contrarian Investor Virtual Conference in partnership with the Contrarian Investor Podcast and Breakout Point next week, and we have quite a full slate of speakers. One of the firms that will be represented is GlassHouse Research.
Profile of GlassHouse Research
GlassHouse defines its purpose as being "to expose fraudulent companies that have been taking advantage of US GAAP as well as IFRS accounting for their benefit." The firm looks for "companies where GAAP (or even worse non-GAAP) earnings are deviating from true economic earnings." It also looks for a "culture of fraud" at companies.
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The firm consists of forensic accountants and analysts who have worked for prominent hedge funds and boutique forensic accounting firms. GlassHouse doesn't run a large number of campaigns at the same time, but it will be presenting a new idea at ValueWalk's Contrarian Investor Virtual Conference. Earlier this year, the firm published a short thesis on Cubic Corporation, a public transportation and defense contractor.
Short of Cubic Corporation
The GlassHouse team describes Cubic Corporation's percentage-of-completion accounting as "suspect," adding that it suggests the company has repeatedly missed milestones on its major projects. The firm alleges that Cubic management has "obfuscated" the company's financials by "prematurely recognizing revenue." Further, the COVID-19 pandemic amplified the company's milestone delays in major cities that were shut down.
The firm said Cubic Corporation's unbilled receivables dwarfed its customer advances and even surpassed historic levels. The GlassHouse team said surging contract assets and declining deferred revenues caused them to believe that Cubic prematurely recognized about $108.5 million in trailing 12-month sales.
They estimated that Cubic's free cash flow was "cosmetically enhanced by $126.2 million" in fiscal 2019, which would result in a true free cash flow value of -$162.2 million, compared to the management adjusted figure of $14.1 million. They allege that the company adjusted its free cash flow by selling real estate assets, factoring its receivables and delaying payments to suppliers.
They also pointed out that Cubic Corporation has had to restate its financials in eight of the last 13 fiscal years due to errors in revenue recognition. Their analysis led them to believe that the company's earnings quality is in an even worse state now and predicted that Cubic will have to restate its financials again "based on the magnitude of these ominous trends."
Use of accounting "gimmicks"
The GlassHouse team said Cubic management had been "patting themselves on the back for a job well done reaching their Goal 2020 targets set back in late 2015." However, the firm's analysts reported that management moved the goalposts, changed the way they calculate performance metrics and obfuscated their original targets "to appease investors/analysts."
The firm alleges that Cubic Corporation management used "a variety of accounting gimmicks to turn around a company that previously reported depressed margins and earnings." GlassHouse took issue with what they said was financial engineering at Cubic. The firm believes Cubic has been manipulating its accounting to bring significant gains to its income statement. The GlassHouse team also said that as the issues start to reverse, the manipulation of all those balance sheet accounts suggests the company's stock price will fall.
They drew comparisons with another construction company, Tutor Perini, which they covered in 2016. They believe Cubic Corporation has many of the same accounting red flags and added that the end result for Tutor Perini wasn't pretty. They said the company has been "decimated" by litigations, claims and unapproved change orders. Further, its stock price plunged by more than 80% as a result of what they describe as "management's malfeasance."
Elliott Management targets Cubic Corporation
Unfortunately, the Cubic short hasn't worked out well for GlassHouse, as the company's stock has been moving upward, at least partially due to intervention by Elliott Management. Elliott issued a statement on Cubic last month about the company's shareholder rights plan.
The firm said it has been talking privately with Cubic Corporation about a potential acquisition. Cubic decided to make the dialogue public, and Elliott said it acquired about a 15% economic interest in the company and partnered with a top private equity firm to pursue the transaction. The firm also said it is "fully prepared to acquire Cubic."
Although for now it doesn't look like the Cubic short will pay off, GlassHouse has had other winning short positions. Aside from its win on Tutor Perini, the firm has also done well with its short of Natus Medical, which has declined this year. NuVasive shares also dropped off in 2017 around GlassHouse's research.