Jim Oberweis, whose China-focused fund is the best performer this year, said he’s doubled his stake in NQ Mobile Inc., betting that claims by Muddy Waters LLC about the company’s finances are unfounded.
Oberweis Asset Management Inc. increased its holding to 1.8 million shares of NQ Mobile, from 990,894 on Sept. 30, he said in a telephone interview on Nov. 18 from Lisle, Illinois. This would make the firm the second-largest shareholder with a 5.8 percent stake, according to data compiled by Bloomberg. His China Opportunities Fund has returned 53 percent this year.
The share purchases, which follow those by fund managers including Altimeter Capital Management LLC and Toro Investment Partners LP, show how some investors are seeing consumer companies benefiting from China’s growing middle class. Shares of the mobile-service provider have tumbled 42 percent since Muddy Waters, the research firm founded by short seller Carson Block, said NQ Mobile inflated sales and misrepresented cash balances. The company, which has headquarters in Beijing and Dallas, has denied the claims.
“When you look at the business prospects, their position in the marketplace, their ability to start to monetize and most importantly, the valuation, the valuation, the valuation, the business begins to look pretty compelling,” said Oberweis, who flew to Beijing after the Muddy Waters report was published.
Carson Block said by e-mail yesterday that he stands by his sell call on NQ Mobile.
The first sentence of the 81-page report by Muddy Waters on NQ Mobile on Oct. 24 said: “NQ is a massive fraud.” The report went on to say that at least 72 percent of NQ’s purported 2012 China security revenue is fictitious.
NQ Mobile denied the allegations, holding a two-hour conference call on Oct. 25 with analysts and investors in which it detailed its financial statement and answered questions about Block’s accusations.
NQ Mobile’s market capitalization has dropped to $695.4 million as of Nov. 19 from $1.2 billion on Oct. 23, the day before Block published his sell recommendation. The decline sent valuations to 10 times estimated earnings, down from a multiple of 18 last month.
The report also alleged that Tianjin Yidatong Technology Development Co., NQ’s largest trade debtor, is controlled by NQ and not an independent company.
Yidatong’s owner Xu Rong said in an interview that the Muddy Waters report isn’t accurate, and that her company has no relationship with NQ Mobile besides a contract to process online payments from mobile subscribers.
“I met personally with Xu Rong,” Oberweis said. “She knows what is going on, she understands the business, she is very clear. My guess is she was friends with the NQ people and was able to leverage that relationship to make some money.” This relationship doesn’t constitute a fraud, he said.
Oberweis’s China Opportunities Fund has beaten all competitors in 2013 and over the past five years, according to data compiled by Bloomberg. He invests in small-capitalization companies. The “magic formula” has been buying into entrepreneurial companies in industries serving China’s growing consumer market, he said.
Altimeter Capital increased its holdings to 6.1 percent of shares outstanding from 1.5 percent, becoming the largest shareholder in NQ Mobile, according to a regulatory filing on Nov. 13. Toro Investment owns 4.9 percent and Chinarock Capital Management disclosed a 5.5 percent stake.
Oberweis’s China Opportunities Fund more than doubled its stake in NQ Mobile to 540,000 shares as of Nov. 18 from 260,000 on Sept. 30, the fund manager said.
In the past two weeks, Oberweis has added to holdings in 21Vianet Group Inc., which operates data centers in China, and Hong Kong-listed China Modern Dairy Holdings Ltd., which he visited on his recent trip there. His father owns, and his brother runs, Oberweis Dairy Inc., which has a chain of stores in Chicago and St. Louis.
While the technology and dairy industries are very different, they both benefit from growing consumer demand, according to Oberweis.
“People don’t understand the growth potential,” he said. “They’re focused around the rising spending power of the middle class in China, and there’s a mismatch between supply and demand.”
NQ Mobile is now the largest position in five of six Oberweis funds, he said.
The company posted profit that beat analyst estimates on Nov. 12, boosted by sales of game software. Net income more than doubled to $17.4 million in the third quarter, from $8.13 million a year earlier, NQ Mobile said in a statement. The average of five analyst estimates compiled by Bloomberg was $16.2 million.
“It says something that they released their earnings on time,” Oberweis said. “I don’t think Pricewaterhouse would let them if they had significant concerns.” PricewaterhouseCoopers LLP is the auditor for NQ Mobile’s financial statements.
Block said in an interview with Bloomberg Television on Oct. 25 that NQ Mobile will go the same way as Sino-Forest Corp., the Chinese plantation company listed in Canada that filed for bankruptcy protection last year after Muddy Waters said it exaggerated revenue.
“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 Oct. 25 conference call. “The truth and the facts are on our side.”
Oberweis and his staff verified the bank accounts by going to Standard Chartered Bank with employees of NQ Mobile. Bank employees printed out a letter confirming the deposits and showed it to them.
“I found that, step by step, most allegations made by Muddy Waters are really easy to disprove, the most important one being the cash,” he said. “The money is there and this illusion that there is no cash is completely false.”