I was working as a hedge fund manager in London when a very well-regarded US fund manager suggested I take a look at Eganagoldpfeil as a potential long. Listed in Hong Kong in 1993, and headed by charismatic founder Hans-Joerg Seeberger, EganaGoldpfeil built a portfolio of brands, including Goldpfeil, Madler, Pierre Cardin, Carrera, Junhans, Joop, Sioux and Salamander. Their success had not gone unnoticed, and the proposed purchase of 30% of the business by Richemont further built the “halo affect” around the brand.
My starting point for any new investment is always to scrutinize the financial statements – if you can’t trust the accounting, then there is no reason to move onto the more difficult and time-consuming questions of how the business might perform versus consensus expectations. The financial statements revealed several worrisome signs. Firstly, Egana had sharply increased its borrowings, but invested almost HKD1 billion into “promissory notes” which it counted as cash, reducing the level of net debt.
These notes were consistently rolled over, instead of being repaid, which didn’t exactly sound very cash-like in nature to me. In fact, some of these promissory notes had been building up for years, with little disclosure on the borrower or their ability to repay. Furthermore, receivables less than 30 days old had increased almost 350%, suggesting that sales in the last month before year end were exceptionally strong (normally a sign of “channel stuffing”, where post year end sales were pulled into the current financial year). The troubles with receivables also had a concerning history. The company had previously acquired a German distributor, with the acquisition price primarily consisting of the cancellation of a sizable accounts receivable balance. Through accounting sleight of hand, Egana was able to effectively convert a significant accounts receivable balance into goodwill.
In addition to considering the accounting, it’s always important to investigate the historical actions of the management team (internally, we call this looking at the “paper trail”). It turns out that what your Mom told you about your friends is true: if you hang around with a bad crowd, chances are that you will also be a bad apple. At Eganagoldpfeil, there was evidence that the founder had a history of malfeasance, including an early case of tax evasion. Another Egana executive director was indicted of fraud at another public company in 2007, and this company (Incutech) was a major investor in Egana, and had also purchased investments from Egana at apparently inflated prices.
It was quite clear to me that Eganagoldpfeil wasn’t a long, but a short sale. It didn’t take long for the company to completely implode, with the stock crashing by 95%, the directors being investigated, and the business eventually declaring bankruptcy.
The case of Egana is a wonderful illustration (and cautionary tale) of the importance of coldly scrutinizing the accounting and management history of any potential new investment before diving into detailed fundamental research or meeting the management team. It is also why these steps are done upfront in our investment process.