Muddy Waters Breaks Cold Streak Going Back to China in NQ Short

Carson Block, the Muddy Waters LLC founder whose short sales outside of China have borne little fruit, reclaimed a measure of success this week targeting a company in the country where he started out.

NQ Mobile Inc., a Beijing-based mobile services provider that started the week with a market capitalization of more than $1 billion, lost half its value after Block said on Oct. 24 that it fabricated revenue and lied about its cash. The shares extended a two-day slump to 54 percent yesterday even as the company labeled the assertions false, inaccurate and malicious.

“It speaks to the credibility that Carson has built in the marketplace over time by conducting very high quality work,” Sahm Adrangi, who manages $250 million at New York-based hedge fund Kerrisdale Capital Management LLC., said in a phone interview on Oct. 25. “I’ve always had a very high opinion of Carson’s work and he has proven himself to be one of the premier short sellers in terms of putting together very high-quality research.”

Share declines such as NQ Mobile’s from $23.20 to $10.63 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. had done less damage.

‘Massive Fraud’

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 that it exaggerated its revenue.

NQ Mobile denied the allegations, holding a two-hour conference call 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 a conference call on Oct. 25. “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.

‘Very Seriously’

“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.”

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.

10th Target

Ownership of put options to sell NQ Mobile shares soared to a record 105,194 on Oct. 23, 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.

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 “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.”

Previous Calls

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, Beijing-based Fushi Copperweld Inc., a maker of copper-clad metal wire and Focus Media Holding Ltd. have backfired.

Focus Media, the Hong Kong-based advertising firm that Block claims overstated its network, recovered share price losses of as much as 39 percent when it went private earlier this year in a Carlyle Group LP-led takeover. New Oriental Education & Technology has soared 85 percent after Block said the financial statements of the education services provider’s units are fraudulent.

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.

‘Track Record’

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’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.”

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