A while back, one of my readers asked me to take a look at a company he was evaluating. His simple, implied question was: "Is this business worth $4.00/share?" I'd never heard of the company and I wasn't initially all that interested in spending too much time on it, but, like so many things in life, the more I poked and pondered, the more interesting it got. The company is NQ Mobile, a cute little Chinese ADR that went public back in May of 2011. Of course, when I start these projects, the first place I turn for info is the IPO filing. (Link below - Page refs in the next section are to same)
The company develops and sells Mobile Internet Security/Productivity Software. I won't waste your time with a business summary herein. You can read all about the company at their website if inspiration grips you. Here are the bullet points that popped out at me when I read their May, 2011 424(b)4:
1.) NQ had captured 67.7% of the Mobile Security Market in China. They apparently either have no competition, or nobody cares about mobile security in China based on the size of the business at the time.
2.) A couple of other front page metrics seemed impressive. They report 85,970,000 "Cumulative Registered User Accounts" in 100 countries and 3,670,000 "Average Monthly Paying Users". Apparently, the other 82,300,000 users don't pay for their services.
3.) They have a typical ADR Capital structure. Caymans holding company, HK & US operating subsidiaries with the key operating subs in the PROC. (pg. 6)
4.) The 12/31/2010 Income Statement showed that Revenue tripled from the prior year ($18 million vs. $5 million), but unfortunately, the Net Loss also increased from $6 million to $17 million during the same period. (pg. 12) As an aside, revenue was calculated to be 20 cents a year per "Cumulative Registered User Account". This might explain the increasing losses since you can't even bill an account for 20 cents a year, much less provide any service.
5.) The balance sheet was relatively tiny prior to the offering. Total Assets were $10 Million in 2009, increasing to $48 Million in 2010 after a $48 Million placement of Convertible Preferred Shares. i.e.) There were no assets to speak of prior to the IPO transaction. (pg. 13)
6.) Tangible Book Value immediately prior to the offering was $1.30/share. The IPO price was $11.50/Share. (pg. 55) with an expected Market Cap of about $90 Million after the IPO.
7.) Immediately prior to the IPO the company issued $12.6 million in Share Based Compensation (Included in the Net Loss figure above) . (pg. 2)
8.) In 2010 the company issued convertible preferred shares and received Additional Paid In capital (APIC) of roughly $50 million in dilutive anticipation of the IPO.
9.) Prior to the IPO, the company had never made any money. The Accumulated deficit as of 12/31/2010 was $22 million.
Now let's fast forward to the 12/18/2014 6K describing what's happened recently with the company. (URL below - pg refs to same) During the 9 months ended 9/30/14, covered by the un-audited filing, NQ announced:
1.) The Company reported a Net Loss of $57 Million on Revenues of about $242 Million. (pg. 15)
2.)The company increased "Goodwill & Intangible Assets" by $262 million. (pg. 13)
3.) Quarter over Quarter revenues had been flat at about $80 Million per quarter.
4.) The previously critical metrics "Cumulative Registered User Accounts" and "Average Monthly Paying User Accounts" were not discussed or disclosed. This metric was apparently replaced by "Monthly Active Users" (MAU) of 159 million. Historical/comparative data was not shown.
5.) Share-based compensation was about $64 million (12% of revenue) for the 9 months ended 9/30/14.
6.) At some point in 2013/2014 NQ acquired WAPS, Fanyue and Trustek. Additional acquisitions or joint ventures not discussed in the filing are: Expai, Beijing Science and Technology Development Co., Ltd., Beijing Century Hetu Software Technology Co., Ltd. Shenzhen Bo Technology Co. ,Ltd., Tianjin HuaYong Wireless Technology (vLife). As far as I can tell none of these businesses existed prior to 2011 and are not much more than a collection of websites with no products, brands, services or value to speak of. The terms of these acquisitions/collaborations were not disclosed in the filing, but I can presume that these transactions had something to do with the massive increase in Goodwill in 2014.
Other Revelations (See Bloomberg/Yahoo/etc. URL's below):
1.) The 2013 annual report was delayed and issued seven (7) months late. The 20F was not filed until October 2014.
2.) The Auditor, PricewaterhouseCoopers Zhong Tian (PWC) was dismissed in July 2014, prior to the release of the annual report. The press release reported that PWC had requested additional third party information which NQ management was unwilling/unable to provide. The new auditor is Marcum Bernstein Pinchuk LLP (MBP). Oddly, the investor relations page of the NQ website sill lists PWC ZT as the auditor.
3.) The Chair of the Audit Committee, Ms. Ying Han, resigned in July 2014. The position was filled by Max Yao, a Chinese Investor. There is no published background on Mr. Yao readily available.
4.) The Chief Financial Officer KB Teo resigned in August 2014, replaced by co-founder, Dr. Vincent Wenyong Shi. Dr. Shi has no demonstrated financial/accounting experience or credentials. As of this writing, six months after Mr. Teo's resignation, no new CFO had been hired.
5.) The Co-CEO, Henry Lin was reported to have resigned in December 2014 amid Chinese Media speculation that he was under investigation and/or in jail in Beijing.
6.) The Stock has dropped from $22.50 to about $4.00 since accounting issues and fraud were asserted by research firms.
7.) Henry Lin is reported to be back at the company as of a few days ago. There was no discussion or disclosure as to what capacity There was no filing re: same. Lin owns 12% of the company.
8.) The 2013 20F Annual report listed 18 wholly owned subsidiaries and VIE's acquired. The filing was silent on amounts spent for these businesses as well as the expected profit/loss impact. (pg. F-8)
9.) NQ will announce Full Year 2014 Earnings after market close on 3/18/15. It should be an interesting investor call to say the least. Who needs reality TV when you have NQ Mobile?
The answer to the question...."Is this business worth $4.00/share?"
I'm sorry, I don't even know how to answer the question. I can't even classify this as a real business (It's certainly not run like one) and therefore I have no idea what it might be worth. It's evolved into some sort of misguided start-up with weird baggage. I don't know what to make of it and how it exists as a publicly traded security. It's a "money pit". I can pretty much guarantee it's not worth anything near it's current $300 million market cap. Like so many ADR's on life support, I expect this one to "go dark" at some point soon.
Now let's look ahead toward the ADR Investor's Age of Frustration:
As mentioned in the opening paragraph of this post, the NQ story is an H.G Wells-ian preview of the inevitable parade of Chinese ADR IPO failures coming soon to a stock exchange near you. First, it's important to understand that, unlike US domestic IPO's the goal of the ADR isn't to fund and build a growing, thriving business. The goal of the ADR IPO is to simply get the money, make the owners rich and keep the shell game going as long as possible. Oddly, the means actually is the end. Below is a list of characeristics that most Chinese ADR's have in common (and I've reviewed more than a few):
1.) Financial Structure - The ADR structure, where all operating companies, officers and assets are located and protected in China, beyond the reach of the SEC is critical. Most ADR/IPO's are used primarily as a vehicle to transfer personal wealth out of China to Caribbean shell companies. The ADR structure, with multiple subsidiaries, joint-ventures and related parties is also an important accounting tool to goose revenues through inter-company transactions. You sell to me and I sell to you.....magically, revenue doubles or triples.... if the auditors don't catch it.
2.) Unverifiable Metrics - The 424(b)4 usually includes huge, impressive, unverifiable claims of volume, transactions, market share and operating metrics. E-commerce companies are particularly notorious for inventing, inflating and publishing these metrics.
3.) Acquisitions - Significant acquisitions are rarely disclosed or contemplated in the IPO documents. After the IPO there's usually a prolific acquisition spree where the purchase prices, operating synergies and business purpose of same are either not disclosed or dubious at best. These acquisitions are used primarily to funnel patronage, confuse auditors and increase asset values.
4.) Revenues Increase - As time goes on, the business is managed to show significant top line growth. This is usually through the aforementioned obfuscation created by inter-company transactions disguised to look like revenue from third parties. Operating margins are reduced with the boilerplate explanation that the company is in "investment mode".
5.) Aggressive Accounting - Aggressive accounting methods are applied in order to capitalize expenditures rather than charge them against income. Goodwill, Intangible Assets and Prepayments/Deposits skyrocket.
6.) Share Based Compensation Increases - Share Based Compensation Expense is a significant expense component, again, designed to shift wealth to insiders and employees from US shareholders. The amounts are usually well in excess of what it would reasonably take to retain key employees.
7.) Changes in Company Management - When the train derails, someone has to be blamed. Usually the CFO, Audit Committee, Senior Financial Managers and the Public Accounting Firm are all candidates to fall on their sword.
Now, let's compare what's happened at NQ to what we know so far about Alibaba, my favorite IPO of all time. All of the below are documented and cited in previous posts on this site:
1.) Financial Structure - Alibaba is a VIE with more than 290 separate related operating subsidiaries, numerous "partnerships" and investments in "equity investees". The structure is virtually un-audit-able with any degree of certainty. Any auditor would tell you that even the most carefully planned audit will fail to catch a well conceived fraud.
2.) Unverifiable Metrics - Alibaba's filings contain claims like:
- "Singles Day" sales in 2014 were more than 6x US Black Friday sales.
- Alipay has 900 million registered accounts....3/4 the population of China.
- Alipay has a 45% market share with 300 million active accounts, yet CNNIC reports there are only 292 million on-line payment users in China.
- Alibaba revenue growth is 40% YOY, with an e-commerce market share of 85%. CNNIC published a 9.8% YOY e-commerce transaction growth rate.
- Alibaba posted a 213% increase in mobile GMV in Q4 2014. CNNIC estimates smart phone sales decreased 26% during the period.
- Freight shipped domestically in China actually declined in the last half of 2014 according to the China Bureau of Statistics, while Alibaba's GMV volume skyrocketed.
- Reported Singles Day Shipments generally exceed the capacity of the Chinese distribution system.
- As a point of reference: The January SAIC report claimed that about 60% of Alibaba's sales were suspicious.
3.) Acquisitions -Alibaba has spent more than $10 Billion on at least a dozen acquisitions in the last year. Press releases on additional acquisitions and ventures are announced nearly every month.. The company selectively discloses information on these businesses but freely admits in the filings that these acquisitions are currently not producing meaningful revenue and will decrease operating margins and profits in the near term.
4.) Revenues Increase - Revenues increased 40% YOY in the quarter ended 12/31/14 with GMV increasing at 49% for the same period. Sales to related parties, Shau Dan, fake delivery records, wash sales, channel stuffing, "Red Envelope Giveaways", Big Ticket Item Sales (houses and cars), Credit Card "Cash Back" Fraud and "Brushing" are ubiquitous. The Revenue Enhancement Industry in China has become so prolific that they have developed specific terminology to describe its methods.
5.) Aggressive Accounting - Alibaba's Goodwill Account(s) and "Questionable Assets" have increased by more than $10 Billion during the last year. As described in previous posts, most of these "assets" provide no future value and, in this author's opinion, will eventually have to be written off. Management contends that they have applied certain, mysterious tests to these assets to determine that they do indeed meet the GAAP criteria to remain on the balance sheet rather than charged against income.
6.) Share-Based Compensation Increases - Alibaba's Share-Based compensation in the quarter ended 12/31/14 was $695 million or 16% of revenue. Share-Based compensation was $105 million or about 4% of revenue for the quarter ended 12/31/13.
7.) Changes in Company Management - Well, we only have two quarters in the books since the IPO so this one is up in the air for Alibaba. The financial year end is 3/31/15 and Year End financials are set to be issued on or before May 15th, 2015. (I could have sworn that I had seen an estimated release date of April 27th on the Investor Relations section of the Alibaba Group website, but it no longer seems to be there). Interestingly, PWC Zhong Tian LLP (the mainland affiliate of PWC HK doing the PROC audit work for Alibaba) is the same auditor who resigned from the NQ audit for the failure of NQ's management to comply with audit documentation requests. Small world indeed. If we start to see delays in reports or filings, or possibly resignations of Maggie Wu, board members or key accounting and financial people, usually for "personal reasons" with a hearty "thank you for your service" from Jack, it wouldn't be surprising. Moreover, the March 20F will be the first audited financial statements issued by Alibaba since the IPO. There will be significant pressure on management to "come clean" on the un-audited asset write ups that have taken place during the last year. I smell some "Extra-Ordinary-One-Time-Non-Recurring" items in our future!
So, the drama is about to unfold....is Alibaba the greatest IPO in the history of global finance?......or is it just a gargantuan version of NQ Mobile about to lose 80% of it's Market Cap, destined for the scrap heap of all of those failed ADR's that have come before and unfortunately, will continue, until as investors we simply refuse to buy this junk. I can hardly wait to see what happens next.....
Website:
http://www.nq.com/about-us
NQ - 424(b)4 - IPO Filing:
https://www.sec.gov/Archives/edgar/data/1509986/000095012311046339/h04742b4e424b4.htm
NQ - 6K Filing - 9 months ended 9/30/14 :
https://www.sec.gov/Archives/edgar/data/1509986/000119312514447273/d840367dex991.htm
NQ - 20F Filing - Financial Statements - 2013 Year end 12/31/13:
https://www.sec.gov/Archives/edgar/data/1509986/000119312514382411/d716785d20f.htm
Bloomberg - CEO Leaves
http://www.bloomberg.com/news/articles/2014-12-10/nq-mobile-falls-as-co-ceo-exit-adds-to-list-of-departures
Bloomberg - Notes from the 12/19/14 Investor Call
http://www.bloomberg.com/news/articles/2014-12-19/shortseller-block-bluffs-his-way-on-call-to-confront-nq-mobile
March 3rd News Release - Lin back at NQ
http://sgi.seleritycorp.com/nq-mobile-co-founder-returns-company/
Yahoo Finance chart - 1yr - $20 to $4
http://finance.yahoo.com/q/ta?s=NQ+Interactive#symbol=NQ;range=
Other URL's of note:
http://shareholdersunite.com/mybb/showthread.php?tid=7498
http://seekingalpha.com/article/2166373-nq-mobile-paid-over-80-million-for-a-copyright-violating-live-wallpaper-company
http://www.prnewswire.com/news-releases/nq-mobile-engages-marcum-bernstein--pinchuk-llp-as-its-independent-auditor-267635741.html
http://www.chinaaccountingblog.com/weblog/parsing-nq-mobiles-firing.html
http://ir.nq.com/phoenix.zhtml?c=243152&p=irol-faq
http://www.theflyonthewall.com/permalinks/entry.php/NQid2033507/NQ-NQ-Mobile-audit-committee-chair-to-step-down-from-board
http://www.sec.gov/Archives/edgar/data/1509986/000119312514263088/d756425dex991.htm
http://www.bloomberg.com/research/stocks/private/person.asp?personId=267421904&privcapId=267421395&previousCapId=128512300&previousTitle=NQ%20MOBILE%20INC%20-%20ADR
http://www.nq.com/about-us
http://en.wikipedia.org/wiki/Henry_Lin_Yu
