NQ Mobile Inc., a Chinese mobile services provider, spent six years preparing to go public. It took Muddy Waters LLC one hour to erase half of the company’s market capitalization.
NQ Mobile tumbled more than 60 percent in a span of about 54 minutes on Oct. 24 after Carson Block, the Muddy Waters founder whose short sales outside of China have borne little fruit, said the company fabricated revenue and lied about its cash. The Beijing-based company’s shares closed last week with a two-day loss of 54 percent even as NQ Mobile said the assertions were false.
Declines such as those that sent NQ Mobile shares from $23 to $10.63 last week used to be common for Block, a 37-year-old lawyer who switched to investing after he moved to Beijing in 1997. Since leaving China a year ago, Block’s bearish research on Singapore-based Olam International Ltd. and Boston-based American Tower Corp. did far less damage. NQ Mobile led a 4.7 percent slump in the Bloomberg China-US Index of the most traded Chinese stocks in the U.S. last week.
“It speaks to the credibility that Carson has built in the marketplace over time by conducting very high-quality work in prior reports,” Sahm Adrangi, who manages $250 million at New York-based hedge fund Kerrisdale Capital Management LLC, said in a phone interview on Oct. 25. “He has proven himself to be one of the premier short sellers.”
Block wrote in an Oct. 24 report that investors should sell NQ Mobile, saying the company inflated revenue and misrepresented cash balances. The short seller said in an interview with Bloomberg Television on Oct. 25 that the company will end up like Sino-Forest Corp., the Chinese plantation company listed in Canada that filed for bankruptcy protection last year after Muddy Waters claimed it exaggerated revenue.
NQ Mobile denied the allegations, holding a two-hour conference call Oct. 25 with analysts and investors in which it detailed its financial statements and answered questions about Block’s accusations.
“We welcome any third party the opportunity to check the company cash,” Matt Mathison, the vice president of capital markets at NQ Mobile, said in the conference call. “The truth and the facts are on our side.”
NQ Mobile, whose co-chief executive officer is Omar Khan, a former Samsung Electronics Co. chief strategy officer, raised its 2013 revenue estimate to as much as $188 million on Aug. 12 from the upper limit of its prior forecast of $184 million.
“We believe it is a zero,” Block wrote in his report. “At least 72 percent of NQ’s purported 2012 China security revenue is fictitious.”
NQ said it will set up an independent committee that will review Muddy Waters’ allegations, according to a PRNewswire statement on Oct. 25.
“We take all of these allegations very seriously. They are all completely false,” Khan said in a phone interview with Bloomberg TV on Oct. 25. “We are a very transparent company. We have had two independent investment banks validate our cash balances.”
Analysts at Topeka Capital Markets and Piper Jaffray Cos. have reiterated their bullish recommendations on NQ Mobile. Topeka’s Frederick Ziegel kept his buy rating and $33.50 price estimate on the stock after the Oct. 25 conference call, while Piper’s Mark Murphy maintained an overweight rating and $27 price target. The average of four analysts’ share-price projections compiled by Bloomberg is $28.88, or 172 percent above last week’s close.
Henry Lin, the co-CEO, started NQ Mobile in 2005 with $15,000 he and a high-school classmate cobbled together, Bloomberg Businessweek reported in its Aug. 12 issue. He scored investments from Sequoia Capital, Qualcomm Inc. and Fidelity en route to an $89 million initial public offering in 2011. To expand the company outside China, he recruited Khan, who had just joined Citigroup Inc. to run the bank’s worldwide mobile business.
Short sellers have increased bets against NQ Mobile to a one-year high over the past three months. Bearish wagers on the stock rose to 25 percent of shares outstanding on Oct. 23, the day before Block’s report was made public, from 8.6 percent in July, according to data compiled by Bloomberg and Markit, a London-based research firm.
The average short interest for the Standard & Poor’s 500 Index is 2.3 percent and the stock would be the second-most shorted in the benchmark gauge for American equities if it were a member, the data show.
Ownership of put options to sell NQ Mobile shares soared to a record 105,194 on Oct. 23. That’s 34 percent more than the number of calls to buy, according to open interest data compiled by Bloomberg. Almost 17,000 bearish contracts traded on average each day in the five days before the report was released, more than 12 times the daily mean this year.
The China-US Index posted the biggest weekly decline in 17 months on speculation gains that sent the measure to a two-year high were overdone. The Shanghai Composite Index was little changed at 2,133.87 today.
Chinese Politburo member Yu Zhengsheng said over the weekend that reforms to be discussed at a meeting next month will be unprecedented, adding to signs that leaders are resolved to push through far-reaching policy changes. Premier Li Keqiang has pledged to cut the state’s role in the economy, change the financial and fiscal systems, and overhaul land and household registration rules to sustain growth in the world’s second-biggest economy.
NQ Mobile is at least Block’s 10th target after he began to publish his research in June 2010. Block gained fame for his short-selling calls in Asia after regulators halted trading in four of the first five companies he wrote about. Hedge fund manager John Paulson sold his Sino-Forest stake at a loss after Block said the company overstated its plantation assets.
“We have seen companies defraud auditors numerous times in China with forged bank statements,” Block said in the Bloomberg Television interview. NQ Mobile “cited certain companies elsewhere in China that had all-cash at Level 2,” but that is not the case, Block said. “This is a major red flag.”
Critical reports by Muddy Waters drove down the shares of eight companies by an average of about 77 percent, according to data compiled by Bloomberg. Bets against American Tower, his first American target, and New Oriental Education & Technology Group Inc. have backfired.
Investors in American Tower, the Boston-based operator of cell-phone antennas, were unshaken by Block’s claims on July 17 that the company is worth less than its share price, and the stock has gained 8.2 percent since the report.
New Oriental has soared 85 percent after Block said the financial statements of the education services provider’s units are fraudulent. Olam’s shares have dropped 11 percent since Block said he was betting against the agricultural commodity trader on Nov. 19, 2012.
Their “track record is spotty, but it definitely had an impact,” David Semple, who manages international equity investments at the Van Eck Emerging Markets Fund in New York, said by phone on Oct. 25.
Muddy Waters said Tianjin Yidatong, NQ Mobile’s largest trade debtor, is controlled by NQ Mobile and not an independent company. NQ Mobile’s market share in China is about 1.5 percent, not the 55 percent it reports, Block wrote. The company’s paying user base in China is fewer than 250,000, versus the 6 million it claims, he said.
Oppenheimer & Co. reduced its recommendation on the shares to the equivalent of neutral from buy and removed its price estimate, according to a report on Oct. 25.
“While many of the allegations raised were not new, the report did provide some anecdotal evidence supporting these allegations,” Andy Yueng, an analyst at Oppenheimer, wrote in the report. “The controversy is likely to remain an overhang on NQ in the near term.”