How common is level 2 cash.

[vermut]

I decided to check with other companies and verfiy the claim made by the Muddy Waters and the Barrons article that Level 2 cash is extremely uncommon and is a sign of fraud. I decided to do that because I saw a post on yahoo boards of a person claiming that he was a CPA and that it was not so uncommon. I checked 20-F statement (Annual report) submitted to SEC from the following companies: NQ, QIHU, BIDU, YY, SOHU, PWRD, CYOU. Not all of them have identical business model but still they operate in the same industry. NQ's business model has esepecially very high resemblence to SOHU, CYOU and PWRD. And probably to a surprise of many: THESE 3 COMPANIES HAVE ZERO OR ALMOST NO LEVEL 1 CASH

I acquiered all this information from money.msn.com. You enter the stock symbol and on the left tab look for "SEC filings". And choose 20-F report. The search for "level 2" there. Here are the screens from their statements where they disclose their cash positions:

NQ

As you can see NQ has no level 1 cash. And Muddy Waters report claims that a company cannot function without level 1 cash as there is no cash for operational purposes such as workers salary, electricity bills, office rent and so on. There was also a Barron's article where the author claimed that reputable sources in Hong Kong confirmed that: "NQ Mobile did shoot itself in the foot: its cash was classified as level 2 assets, which is very, very rare."

Let's see if it is rare indeed. Here is a screenshot from SOHU's statement:

SOHU also has no level 1 cash. Next example is PWRD. The company has some LEVEL 1 cash. But it's only 1% of its total cash. 99% is LEVEL 2 cash.

And another one is CYOU. No LEVEL 1 cash at all:

So obviously the claim that Level 2 cash is "very, very rare" sounds very strange. As 3 other companies in the business of selling games and apps also have no level 1 cash. You either have to assume that they are fraudulent as well or the claim that it is not possible to function without level 1 cash is false. I personally think it is the latter.

To make the comparison complete not all the Chinese internet companies have no Level 1 cash assets. BIDU for example has mixed assets with LEVEL 1 and LEVEL 2 almost equally distributed:

QIHU reports all cash strictly as LEVEL 1 (the only company in the list that doesn't have LEVEL 2 assets):

There are some companies which do not even disclose what is what. Here is an example of YY. They did not provide any table just a discription:

[admin]

Thanks for that extensive DD, Vermut. So apparently it's not that uncommon..

I think there is a good chance we'll recover when more independently information will be brought to light.

[quantumvibes]

Unless I'm mistaken, I think the supplementary tables you've displayed list "cash equivalents" among other financial instruments, but if you go to the consolidated b.s., there's a line item for "cash and cash equivalents". As a result, to me at least, it looks like SOHU, for example, carries a blend of level 1 & 2 financial instruments in the "cash and cash equivalents" line, where the "cash equivalents" are all deemed level 2 in the acct. hierarchy.

The key takeaway still being, however, that level 2 is still considered "cash equivalent".

Anyone feel free to point out if I'm not reading the financials correctly.

[vermut]

Unless I'm mistaken, I think the supplementary tables you've displayed list "cash equivalents" among other financial instruments, but if you go to the consolidated b.s., there's a line item for "cash and cash equivalents". As a result, to me at least, it looks like SOHU, for example, carries a blend of level 1 & 2 financial instruments in the "cash and cash equivalents" line, where the "cash equivalents" are all deemed level 2 in the acct. hierarchy. The key takeaway still being, however, that level 2 is still considered "cash equivalent". Anyone feel free to point out if I'm not reading the financials correctly.

You are correct. I have checked NQ, SOHU anc CYOU. In the case of NQ this supplementary table states: "Cash and Cash equivalents" while SOHU's and CYOU's are called just "Cash equivalents". And by checking the balance sheet NQ has only level 2 assets. While for SOHU and CYOU "Cash and Cash equivalents" ia always larger than just "Cash Equivalents" meaning they have hard cash on their accounts.

Well, I admit I am confused here. It indeed looks like all the NQs cash is on the bank deposit as they claim. I guess we need somebody with an accounting background to explain if the company can function with no hard cash at all.

[quantumvibes]

The management addressed this point on the cc in several ways as far as I know, but will probably still have to provide additional details to dispel concerns:

They said the b.s. was a "snap shot," which it is, and I guess by that implied that at other times they might have level 1 cash on hand. In addition, they explained that there's sufficient cash flow from operations to manage operational needs and that in the event they do require cash, they can readily tap into a term deposit. I also see that the schedule of term deposit maturities are staggered to come due pretty regularly, thus providing ongoing liquidity even if they couldn't be accessed, which they can. I believe "tradestar" may have also brought up the possibility of a sweeping mechanism, which would automatically divert excess cash into interest bearing term deposits in order to maximize interest income, rather than let the cash languish at virtually no return.

At any rate, I imagine they'll be supplying additional details regarding this point, along with others.

[kshen]

Refuting the Barons Article

In NQ’s 2011 20-F they classified all their level 2 as cash and cash equivalents and term deposits. Their issued bank information is with CiB. If you look on their website for time deposit and call deposit, it is consistent with NQ’s press release. Thus they are not investing in shady wealth management products

Also, in regards to their comment about NQ not notifying anyone of their change and shooting themselves in the foot, please find the below statement on their 2011 20-F
“aa) Recently issued accounting standards

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This results in common fair value measurement and disclosure requirements in US GAAP and International Financial Reporting Standards. Including which, the amendments clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements, such as the application of the highest and best use and valuation premise concepts being only relevant when measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets or of liabilities. The amendments also change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. This update is to be applied prospectively for public entities during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted.

The Group will adopt this amendment at the beginning of 2012 but expects no significant impact on the consolidated financial statements of the Group. ”

This seems to suggest that not only are using correct accounting procedure, but also did notify their intent to switch over their assets in accordance with the new law.

[vermut]

Refuting the Barons Article In NQ’s 2011 20-F they classified all their level 2 as cash and cash equivalents and term deposits. Their issued bank information is with CiB. If you look on their website for time deposit and call deposit, it is consistent with NQ’s press release. Thus they are not investing in shady wealth management products Also, in regards to their comment about NQ not notifying anyone of their change and shooting themselves in the foot, please find the below statement on their 2011 20-F “aa) Recently issued accounting standards In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This results in common fair value measurement and disclosure requirements in US GAAP and International Financial Reporting Standards. Including which, the amendments clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements, such as the application of the highest and best use and valuation premise concepts being only relevant when measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets or of liabilities. The amendments also change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. This update is to be applied prospectively for public entities during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Group will adopt this amendment at the beginning of 2012 but expects no significant impact on the consolidated financial statements of the Group. ” This seems to suggest that not only are using correct accounting procedure, but also did notify their intent to switch over their assets in accordance with the new law.

I am getting an impression that both CEOs are probably very bad at accounting. I think the main issue everyone is pointing to is that they did not emphasize this change iduring one of their conference calls. And I think it was because they do not understand how one representaiton is different from another. And probably thought of it as a non-issue. They are more excited to speak about the business development every CC.

If it is so it is probably a good thing. It will mean they do not have enough skills for creative accounting. And there is nothing to worry about.

[tradestar2012]

I dont think you can lay blame on the CEOs. Those types of questions are for the CFO to answer. The issue was that NQ was transitioning between CFOs. The old CFO was not on the call (he should have been) and the new CFO has been on the job for just a few weeks. Matt however did answer the questions, but I think some of the conference call participants were as confused as the rest of us and confusing the issue for everyone.

Also, Omar has an MBA from MIT. Hes not a CPA. MIT a good school for MBA level accounting. But, Omar's primary background is in technology, so its unrealistic for investors to expect Omar to know every accounting intricacy. To put this into perspective, I have an MBA from a comparable school to Omars and I worked on wall street and have a finance background. Even that lvl1 vs lvl2 rule was surprising and not terribly clear to me until I had a chance to spend the last 48hrs reading up on all this garbage. Thanks Carson Block for the accounting lessons. I'll be sure to bill you for my hours during the class action against MW. I hope you are reading this forum. You've pissed off the wrong investor.

[SamAdams]

Refuting the Barons Article In NQ’s 2011 20-F they classified all their level 2 as cash and cash equivalents and term deposits. Their issued bank information is with CiB. If you look on their website for time deposit and call deposit, it is consistent with NQ’s press release. Thus they are not investing in shady wealth management products Also, in regards to their comment about NQ not notifying anyone of their change and shooting themselves in the foot, please find the below statement on their 2011 20-F “aa) Recently issued accounting standards In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This results in common fair value measurement and disclosure requirements in US GAAP and International Financial Reporting Standards. Including which, the amendments clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements, such as the application of the highest and best use and valuation premise concepts being only relevant when measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets or of liabilities. The amendments also change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. This update is to be applied prospectively for public entities during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Group will adopt this amendment at the beginning of 2012 but expects no significant impact on the consolidated financial statements of the Group. ” This seems to suggest that not only are using correct accounting procedure, but also did notify their intent to switch over their assets in accordance with the new law.

I am getting an impression that both CEOs are probably very bad at accounting. I think the main issue everyone is pointing to is that they did not emphasize this change iduring one of their conference calls. And I think it was because they do not understand how one representaiton is different from another. And probably thought of it as a non-issue. They are more excited to speak about the business development every CC.

If it is so it is probably a good thing. It will mean they do not have enough skills for creative accounting. And there is nothing to worry about.

Pleas keep the discussion rational.  This is a Yazoo type post and does merit to be included with the solid information othe SHU mmbers have posted.

[admin]

If it's a non-issue, like it now very much looks like, I'm sure the shares will recover. It might take a while for them to recover in full, and many might have sold (although some of them might be able to buy back below that). I'd like to hear from PWC though, that will probably put the question beyond reasonable doubt. The Barron piece wasn't helpful