Toro DD in Beijing: Day 1

[tacitusk]

From: http://seekingalpha.com/article/1788942-nq-mobile-behind-smoke-and-mirrors-lies-the-truth-part-2#comment-25374372

Day 1 of DD in Beijing:



We are working on documenting our observations on Part 3 but wanted to provide an update on our DD. We arrived in Beijing a couple of days ago and finished our first full day of DD, which included:



1. Verification of cash at SC. It's there.



2. Verification of YDT office. YDT is still where we last visited, same building, same section of their floor. We have pictures that we will upload in our next report. Our interviews confirmed the analysis and observations we shared in our Part 2 report.



3. Verification of channel partner contracts. We reviewed the original physical paper contracts (each signed and sealed by NQ and the partner in question) for all major deals executed in 2012 and 2013. This included, among various others: 



-- Carrier China Mobile, with whom NQ has three separate contracts (e.g. security scanning software to protect China Mobile's own app store, deal with Music Radar, and a regional deal with the Guangdong province branch for comprehensive security products).

-- Top 5 Chinese OEMs: Lenovo, ZTE, Huawei, Coolpad, and Gionee

-- Music portals: TTPod, Kugou (top 3 Chinese music sites) and Yinlong



4. Retailer field trip. We traveled to the electronics retail section of the area in Beijing known as the "Silicon Valley" of China to visit several physical retail points of sale for handsets. In a large, electronics department store of sorts, we visited five separate retailers of NQ prepaid cards. We then walked over to DXT (a Best Buy-like physical electronics retailer with 3,000 stores across China) and verified that they sold NQ in their smartphone bundle product, which bundles prepaid subscriptions for a leading mobile game, a mobile lottery product, and NQ's security product.



Will post further updates as they happen if we do not have a chance to document our findings in a follow-up report.

[quantumvibes]

Thanks for the heads-up! I'm supposing that as IPO lead manager, it's completely reasonable for Piper to suspend its rating on NQ, especially in order to demonstrate impartiality under the circumstances (which include a former PJ employee working as NQ cfo). I'm sure they're gearing up to do more dd and looking to obtain more data before publishing an updated rating.

[admin]

There is an interesting discussion at the end of one of these articles:

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Akram's Razor Comments (938)

 

Since you are on site, I have some questions.

1) How did xu go from an employee to owner of these companies? Seed capital came from whom? Who are the shareholders of these two entities she runs?

2) What's the revenue breakdown from these partners?

3)Why with all the growth ahead do they buy back stock?

4) Why did they choose to hold nothing in level 1? Does their cfo understand they are a growth business and not an asset mgr trying to maximize yield?

5)What exactly is the purpose of a US CEO if he doesnt know the top 4 customers?

Keubiko Comments (423)

 

6) What are the details of the CCTV retraction NQ put in writing occurred the very next day after it aired?

Toro Investment Partners Comments (109)

  1. we are not the company's HR department, so what we say should be taken with a grain of salt, but... Our understanding of the matter is that Ms. Xu was a successful businesswoman with connections to angel investors (including Xu Zhou, who was one of the original angels for NQ, as well as H9 and YDT, later). She introduced Xu Zhou to Henry and Vincent when they needed seed capital for their business. Over time, as NQ became a successful company with more scale, Ms. Xu was asked to help out. We did not verify which exact periods, down to the exact date, corresponded to Xu the employee vs. Xu the consultant because, frankly, we really do not believe such details matter much. We understand others think it's a huge deal, but we don't (and this DD is obviously for us and our investors first and foremost). The shareholders of the two companies she currently runs are herself (majority) and minority angels (e.g Xu Zhou). However, we have not verified the official cap table for those companies because we do not have access to them (nobody but the government and the company does). The SAIC filings show no other NQ insider as shareholder.

2. Revenue breakdown is something we cannot share in detail with anyone not under NDA. We can repeat that we have confirmed that about 1/3 and as much as ~40% of quarterly revenue comes from these offline channel partners in China (varies by quarter).

3. Because it's dirt cheap and they have quite a bit of excess cash, especially after the convert proceeds are factored in. They also do not have an imminent transcation or major investment that would obviate a buyback. We know you are not a believer in these buybacks but many investors, including us, disagree with that view. We have urged the company to do some buybacks with their large cash pile.

4. Read our Part 1. We disagree with your characterization of what levels 1-2 actually mean. We completely agree with Dr. Gillis's interpretation, which we referenced in our report. Furthermore, each Big 4 accounting firm has variance even within their four walls as to how cash is categorized, which explains why different PWC clients have cash assets marked differently. Their CFO understands what you wrote but he also understands that in order to do significant business (not just participate in their app store, but rather either private-label or exclusively power certain parts of their business) with major carriers such as AMX and China Mobile, they need to hold a large net cash balance. It is required. Why hold it in anything other than what yields the most? Also, it is not accurate that they do not have cash at immediate disposal. We checked over $10 million of cash (not equivalents) in local bank accounts in Beijing and Dallas for payroll, rent, etc. How PWC marked that cash is their prerogative, not NQ's, and is a better question for them. A PWC partner told us that PWC will sometimes use a value-based rating system in which, if cash is a small (say 10%) percentage of cash + equivalents, and the remainder is classified as 1 or 2, everything will be bundled as 1 or 2. We're not saying this is the reason why, only PWC knows, but we were told this in no uncertain terms.

5. He does know the top 4 customers but chose not to share (you mean he doesn't know the top 4 cities/regions?), probably for the same reasons we are being asked not to share revenue by partner. We know of no other company in the space that discloses that information, so this is not a surprising request by NQ.

His role? To build the business globally, contribute to and co-lead corporate strategy, contribute to operating the business as a more experienced executive, help govern the company as a director on the board, mentor and manage employees, and, as the co-CEO title suggests, generally co-run the business with the other co-CEO. In our opinion, Omar and Henry have complementary skills, with Henry being the more product-focused and locally connected (obviously) of the two, while Omar is the more financially savvy and global of the two. They do not share each individual duty.

[kshen]

Also note

Thank you Toro. Another question to ask has been raised by Dr. Gillis(your accounting authority) in an newer post:


He writes:

"So, how did that $145 million get there? Given China’s exchange controls I see only one way to get dollars into a VIE. That is to find someone inside China who has a big pile of RMB and who wants to exchange it for dollars. So, you find Mr. Wang who has 650 million renminbi. We won’t ask how he got it. Mr. Wang could go to the bank and exchange $50,000 per year. If he had 2,097 friends help him, each taking out $50,000, he could get the money out in one year. Or, to do it all at once you could offer to deposit $100 million in Mr. Wang’s Hong Kong account if he will deposit his 650 million renminbi in your China account. (You can get a great exchange rate this way as well). There are a number of variations on this approach (Rocky Lee suggested one in the article that has also been used by public companies). There are middlemen who do these transactions. A lot of wealth has left China in this fashion, all in violations of China’s exchange controls.

But perhaps NQ Mobile found a better, legal way to do it. I am all ears."

Any thoughts on this aspect?
5 Nov, 03:44 PMReply! Report AbuseLike0
Toro Investment Partners Comments (109)

We are of course all over it, since that is a topic we agree is important, and will report back as we gain enough of an understanding to address it responsibly. We have a meeting set up tomorrow for this specific purpose.

More importantly than our opinion will be what Shearman and Sterling and Deloitte think of that post, of course. That will come out when the investigation concludes.

But we will share our view shortly, stay tuned.

here is new article by Dr Gillis
http://www.chinaaccountingblog.com/weblo...obile.html

[chenlica]

Also note Thank you Toro. Another question to ask has been raised by Dr. Gillis(your accounting authority) in an newer post: He writes: "So, how did that $145 million get there? Given China’s exchange controls I see only one way to get dollars into a VIE. That is to find someone inside China who has a big pile of RMB and who wants to exchange it for dollars. So, you find Mr. Wang who has 650 million renminbi. We won’t ask how he got it. Mr. Wang could go to the bank and exchange $50,000 per year. If he had 2,097 friends help him, each taking out $50,000, he could get the money out in one year. Or, to do it all at once you could offer to deposit $100 million in Mr. Wang’s Hong Kong account if he will deposit his 650 million renminbi in your China account. (You can get a great exchange rate this way as well). There are a number of variations on this approach (Rocky Lee suggested one in the article that has also been used by public companies). There are middlemen who do these transactions. A lot of wealth has left China in this fashion, all in violations of China’s exchange controls. But perhaps NQ Mobile found a better, legal way to do it. I am all ears." Any thoughts on this aspect? 5 Nov, 03:44 PMReply! Report AbuseLike0 Toro Investment Partners Comments (109) We are of course all over it, since that is a topic we agree is important, and will report back as we gain enough of an understanding to address it responsibly. We have a meeting set up tomorrow for this specific purpose. More importantly than our opinion will be what Shearman and Sterling and Deloitte think of that post, of course. That will come out when the investigation concludes. But we will share our view shortly, stay tuned. here is new article by Dr Gillis http://www.chinaaccountingblog.com/weblo...obile.html

that 50,000 per year limit is for personal allowance like travel abroad, study or simply pleasure visit. im sure the exchange control works differently for companies. these are so many import and export companies in this country, no way each of them using friends' yearly allowance to receive foreign currency!

[kshen]

There is definitely ways to get around that.

Also not enforced that well. I remember going to china and exchanging 60K RMB with someone who was at the bank who wanted USD. He did it through the bank with me where we both went to the teller and had the teller do the exchange for us using his bank account

[chenlica]

China has a large foreign exchange reserve. that 50,000USD limit i believe only applies to individuals who require this money for personal purpose. by enforcing this policy the country effectively prevents unexpected large outflow from its reserve, and maintains the stability of its financial system. That said, if it is for business purpose, like companies sending or receiving foreign exchange, they will need to file with or report to the authorities(State Foreigh Currency Control Bureau or something) before settling the cash. In fact, Chinese government encourages companies to "earn" more foreign exchanges. I would not worry at all if I had in this case 145 millions USD to settle in China, as long as this fund is clean.

[quantumvibes]

I remember when reading MW's report this issue regarding the vie had piqued my curiosity and so I was hoping there'd be a corresponding question on the cc. Good to know Toro is on the case and intends to report back. In the meantime, any other ideas, opinions?