|Shares Out. (in M):||52||P/E||0.0x||0.0x|
|Market Cap (in $M):||633||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
Short: NQ Mobile
Share Price: $12.30
Market Cap: $630 M
$ volume (daily): $72 M
Borrow: None available, -86% rebate
Trade idea: short NQ mobile through the options. Borrow is not available at this time.
I have been aware of some red flags on NQ, and know other smart guys were short, but had no position prior to Muddy Waters’ report due to lack of catalyst. I think the report will cause investors to take a closer look at the company and discover that it is largely fraudulent. The main credit here goes to Muddy Waters and this writeup is an analysis of the MW report and some other public information.
Why I think NQ is a fraud:
Very Low Market Share amidst a highly competitive mobile AV market. NQ was claiming 60% market share, while Qihoo was claiming 70%. While Qihoo’s claim is highly credible, my informal surveys indicate that NQ has nowhere near 60% market share. I would guess that brand recognition of NQ in China is likely to be in the low single digits.
Sanity Check vs. Qihoo. In 2012, Qihoo generated $221M from online advertising and $100M from internet value-added services (largely in-game virtual goods sales). The vast majority of online advertising revenues in 2012 is from the portal website which is the default homepage of the 360 Safe Browser. Qihoo doesn’t break out mobile revenues, but the CEO stated during the Q1 conf call that mobile “business is still in its early stage”. Now compare this to NQ’s purported revenue in 2012 of $92 million. I think this number simply isn’t credible. And this is taking Qihoo’s number’s at face value – it’s quite possible that Qihoo is overstating its portal revenues. Citron and others have written quite a bit on this.
Sanity Check vs. Lookout. Lookout is the VC-backed market leader in mobile AV and claims 40 million worldwide users on its website and 45 million users on its Android page. These numbers may be slightly outdated, but probably not significantly so (they would be updated if they have grown significantly). Lookout offers a free AV product and charges $30 / year for a premium product which includes cloud backup and other features. NQ claims 98 million MAUs broken down as follows:
57 total MAUs in China
41 total MAUs overseas
6 paid MAUs in China
3 paid MAUs overseas
It’s inconceivable to me that a product as little known as NQ could have over twice the userbase of Lookout. Even if we stipulate NQ’s China usage, it is claiming the same userbase as Lookout ex-China. How can this be possible? And we doubt that even Lookout can achieve a 7% free-to-paid conversion rate. For NQ to achieve it in its weak market position is even harder to believe.
Lookout was valued at $1 billion in a venture round last year. At the current market price, NQ is valued at over $600 million. Even if you believe that NQ has a real business, is that business worth 60% of Lookout’s business?
Senior Management is really just an investor relations team. The level of over-promotion here is absurd. NQ hired a US based CEO, Omar Khan, to be its public face to investors. Mr Khan appears to know very little about the business. When asked on the conference call who NQ’s 2nd and 3rd largest customers were, Mr Khan did not know the answer, and had to ask Co-CEO Lin for the answer. Granted, Khan is not responsible for China operations, but it seems clear that Khan doesn't really know NQ. Matt Mathison, the IR person (“VP Capital Markets”) who also appeared on the call, appears to still work for Wedge Partners according to his LinkedIn profile. Wedge is one of the sell-side firms that has been relentlessly pumping NQ.
Smoking gun: Purported Partners are Claiming no Relationship with NQ. As reported by the Chinese media and confirmed by multiple sources publicly, NQ’s purported OEM partners, ZTE, Huawei and Lenovo are denying that they pre-installed NQ’s apps. This is a smoking gun – some of the accused China frauds have bounced back but I am not aware of a single case where all of a company’s purported business partners have publicly repudiated it in the Chinese media and then it turned out not to be fraudulent. Having a partnership doesn’t even require a cash outlay. NQ could not even bribe personnel at these purported partners to confirm a relationship of any size. Furthermore, the unequivocal public disavowal by the OEMs is a strong signal that they do not intend to do business with NQ in the future. This likely reflects NQ’s weak market position and the security flaws in NQ’s product. The fact that the pre-install partnerships do not exist, and NQ has such little brand recognition / downloads, means that NQ’s business is largely fake. I think the public repudiations reduce the risk of a fraudulent buy-out.
The intermediary, Yidatong, is also a smoking gun. Muddy Waters attempted to demonstrate that NQ’s largest customer, Yidatong, is a fake, shell company. Yidatong is fighting back with a photo of the CEO smiling in her office in Bloomberg today. The debate over whether Yidatong exists or not is largely noise. Of course we have seen Chinese frauds fake entire factories for IR tours, and Yidatong’s Chinese filings show a shell company, so it is most likely fake, but the key here is that the mere presence of an intermediary between the customers and NQ is a very strong proof of fraud. Think about it logically: if you are NQ mobile, why would you pay a middleman cut to Yidatong, a newly formed business created by a former NQ mobile employee? What purpose would such an intermediary serve? One of the great features of mobile is that it is quite easy for mobile businesses to collect payments. Carriers already have payment information and relationships with their customers and are happy to rent that relationship to developers for a fee.
The real purpose of the intermediary is to obscure the fact that there are no end customers. If NQ reported that China Mobile were the top revenue source with $X million, then this could easily be disproven by speaking to someone from China Mobile. This is very reminiscent of Sino-Forest where much of the business was conducted via intermediaries.
(note: NQ did argue why it should go through an intermediary in its response presentation. I found the arguments unconvincing. You can read and decide for yourself)
An independent security review of NQ's mobile app confirmed MW's analysis. (http://www.bloomberg.com/news/2013-11-03/muddy-waters-viewed-right-on-nq-mobile-payments-wrong-on-cash.html). This is a third-party commissioned by Bloomberg that appears to confirm that NQ is sending back private information in clear text, which is an obvious security risk. Even if you believe that NQ has a real business, it is very bad for business to have a very public revelation of basic security flaws in a application that is supposed to provide security.
A Note on the Cash Controversy. There’s been a lot of debate over the Level 1 vs 2 treatment of cash. I think this is largely overblown – the real question is, is the cash there? The stock rebounded somewhat on news that NQ plans to transfer $100 million to an account at Standard Chartered (about half has been completed). This is just noise as the company recently raised $166 million through a convertible and in any case, we do not know whether the Stanchart account has been borrowed against (meaning that the money isn’t really even there).
Trading / execution issues:
This should be sized small due to short squeeze risk but I think it will drift lower over time. Most of my position is a long put initiated at lower IVs than today (I am not adding) but I also like short calls as they are bid at 180% IV at this time. I sold some calls today. This is as much a short vol. position as it is a bearish position on NQ.
Short squeeze, CDB-backed LBO. Frauds don’t always go to zero…
Disclaimer: We are short NQ and may transact in securities of NQ without disclosure. This report is written solely for the use of VIC members who are assumed to be investment professionals. Investing in securities is highly risky and should only be performed by investment professionals. The information in this report is believed to be correct but we make no guarantee that it is correct, and we will not update the report if we obtain information contrary to that contained in the report. We do not intend to update the report or disclose when we exit the investment.