Carson Block of Muddy Waters Research appeared on Bloomberg Television earlier today to discuss NQ Mobile, saying that the company will send up like Sino Forest. He said that NQ's reaction today is "typical" and "pretty much standard fraud playbook."
NQ Mobile CEO Omar Khan called in to Bloomberg Television this afternoon to address Muddy Waters' allegations. Khan said, "We have been very busy responding to the nonsense...We are a very transparent company, we have had two independent investment banks validate our cash balances." He said that the accusations show "gross misunderstanding of how the carrier ecosystem works in China."
Block on his reaction to NQ Mobile claiming that everything he has said about the company is false:
"The reaction--this is typical. We've called a number of companies frauds. Four of them have been delisted. Except for one company, everyone comes out and says these allegations aren't true, you don't understand the business, we're going to form a special committee. This is pretty much standard fraud playbook."
Block on how long it's taken him to build the thesis on NQ Mobile:
"We worked on NQ for about two months. We did a lot of on-the-ground work trying to find physical presence of its customers, trying to find retailers that have phones with the apps preinstalled, surveying over 800 people in different parts in China to see whether they have this app on their phone. We did a lot of analysis of government files regarding NQ, its various entities, the companies it acquires and also its largest customer, which we concluded is itself. We did a lot of Internet research. We downloaded the app. We had computer engineers analyze the code of the app. We tried to make payments close to 60 times through their payment portal. So we did a lot of work on this company."
Block on whether he's shorted NQ already:
"Yeah. As we disclosed on the cover page of our report, we had a short position on the stock before publication."
Block on whether he will lose money if the stock does not go to zero:
"The stock was in the 20s just before we published. We don't comment generally on specific trading matters, but the stock is at zero. I think you can infer where the trading price was, we're okay with the progress so far."
Block on CEO Omar Khan:
"We pointed that out of all the China companies, Omar Khan is not a director or officer of any of those companies. But of course he is on the board of the Cayman company, but our point is, this is a guy that sits in the U.S. The company kind of gave some information as to what his geographic responsibilities are--this is something we have tried to get out of the company previously--but it is clear that he is not involved in the oversight or management of any of the China companies. Now I don't know that that exculpates him from anything, but what the company said is not a refutation of the fact, although they certainly spun it that way."
Block on whether NQ's bank statements are not enough to prove that its cash is real:
"That's not enough. We've seen companies defraud auditors numerous times in China with forged bank statements. One of my team members tells a story of reviewing a bank statement dated February 31st once in their work in the China investment world. Anyone who has an Inkjet can forge statements. The questions we really have are why is all of your cash--not just the term deposits--why is all of your cash level 2? We have not seen that elsewhere. The company cited certain companies from China as having all cash as level 2. One of the questioners who called in after that said, no, that's not the case. These companies have some level 1 cash. So this is a major red flag, but yeah, we expect the company to be able to print out some statements and maybe even set up a website--as Longtop Financial did--that show fake cash balances. This is nothing unusual."
Block on how NQ compares to his call on Sino Forest:
"Sino Forest--five former executives in the company are being sued by the Ontario Securities Commission for securities fraud. The auditor who resigned refused to certify 2011 financial statements. The company was delisted by the Toronto Stock Exchange. We expect a similar outcome here. Sino Forest--whatever business it had that was real--it was a tiny fraction of what it claimed. This is similar. The market caps and enterprise values of the company are different, but when you talk about the percentage of the business that is real, this is very similar to Sino Forest. Our expectation is that the regulators will act against this company aggressively. We certainly think that there is a good chance of auditor resignation. Auditors don't like to do that, but in this case I think it is going to be hard not to."
Block on how NQ's conference call has changed his perception on its operations:
"A lot of the response is pretty standard playbook. The interesting part was the questions and answers. They were asked repeatedly about how they couldn't even have one dollar in operating cash classified as level 1 and the company failed to respond to that. I think one of the management members called me and my team racist and I think that's typical of the strength of their response. There were some interesting moments where management had very difficult times answering investors calls about key points...There is some interesting stuff there."
Block on whether he's shorting any other Chinese companies right now:
"At this point there's nothing that we are prepared to discuss that we are doing."
Block on whether he's in conversations with NQ's management:
"Yes, we have done that previously. We have done that not as Muddy Waters though."
Khan on Muddy Waters' allegations:
"We were very busy earlier responding to this nonsense. We take these allegations very seriously. They are all completely false. We approached it with transparency and we hosted a conference call with our investors and analysts this morning, nearly 400 people dialed in, for two and a half hours. We transparently and openly addressed their questions until the last question was answered. We are building an extremely amazing business globally, not just in China. We are a global internet platform company. Muddy Waters showed gross misunderstanding of not just our business but our industry as well as businesses that we are in."
Khan on Carson Block arguing that at least 72% of NQ's 2012 reported China security revenue is fictitious:
"We have multiple billing channels. We have partners in greater China that are not just direct to consumer. We are part of a broad ecosystem. We have partnerships with OEM distributors that preload our software, partnerships with billing providers and carriers. We operate in a mobile ecosystem that has many tenants in it and many parties. It is not something that we are just involved in by ourselves. We support our carrier partners, billing partners, we support our OEM partners in terms of how we operate our business. In China also, obviously we have a thriving gaming and advertising business. 20% of our revenues comes from enterprise mobility where we have very large partners that we work with, such as GE Healthcare, such as Shell. We have an extremely thriving business in greater China and around the world."
Khan on how NQ's business works:
"Our business is split up into two pieces, consumer and enterprise. We are a mobile internet platform company. We monetize the connection between our consumers and the partners and applications that we bring to market. Our platform allows us to acquire, engage, monetize and retain users. The way we do that on the consumer side is really built up through three pieces. One is consumer security. We have eight years of experience in that industry. We were the pioneers in that industry globally. It allowed us to build applications and build a technology that is truly world-class. That is one part of the business. The second part of the business is gaming. We are one of the largest operators of mobile games in greater China. The final piece of the business on the consumer side is advertising. We have a very significant business model where we monetize our active user base through advertising, connecting them with our users and connecting them with advertisers and merchants to help monetize that connection. On the enterprise side of the business, we have our own proprietary mobile device management and managed mobility services platform. We work with large enterprises to help mobilize their workforce. In markets like greater China, we are skipping the PC revolution. Enterprise is going direct to mobile. There is a huge opportunity to work with large enterprises to get to mobile devices."
Khan on NQ's number of paying customers:
"On the consumer side of the business, we have in greater China we have 6 million paying users. That is correct. Globally we have 11.3 million premium users which also includes users that we are monetizing through advertising and gaming as well."
Khan on the discrepancy between NQ's claim of 11.3 mobile customers and Block alleging that the company only has 250,000 subscribers:
"I do not know exactly his methodology. Obviously, we work directly with large partners around the world. We are a channel friendly business model. Much of our business comes from preloading on devices. Obviously, he is looking at some digital channels that he can access publicly. He's missing very large portions of our business. Obviously, we work with our partners to recognize that revenue. Remember, it is not just revenue we recognize. Our partners recognize this revenue. We are building relationships. Here is a perfect example. When we sell a game, an application, on the iOS platform, Apple keeps 30% of the revenue. We have other partners in the ecosystem that collect part of our revenues. We recognize net revenues as an example."
Khan on the timing of net revenue recognition:
"It actually depends. We recognize revenue on a very conservative basis. For a long-term contract that is a 12-month subscription, we recognize that revenue not based on cash collection, but on an amortized basis over a 12-month contract cycle where we recognize it on a monthly basis. It really depends on the billing model. We actually take a conservative revenue recognition policy when it comes to recognizing net revenues."
Khan on why Muddy Waters is targeting his company right now:
"Honestly, I do not know. We welcome him. We are a very transparent company. Our cash balance is one example. Just in the last 24 hours, in response, we have had two independent investment banks validate our cash balances on hand. We welcome him. He has not contacted us."
Khan on whether Carson Block has contacted him to verify the numbers:
"No, he has not. We welcome him to. We are an open book. That is why we had a conference call this morning with our investors and analysts."
Khan on Carson Block alleging that NQ controls its largest debtor:
"That is completely false. They are an independent company that has no relationship with the company whatsoever. We have no related parties. Actually, it shows the gross misunderstanding of how the carrier ecosystem works in China. In order to do business with carriers in China, you have to work with these parties called service providers. Yidatong is one of the largest SPs that we work with, and that is how we -- when you are in an app and you say I want to buy the green sword or the red balloon, the way that you add that to your bill is we have to build that through an SP. They collect money from China mobile. We collect net revenue from them, once they keep their share. It just shows the gross misunderstanding of the carrier ecosystem and how it works in greater China."
Khan on the company's shift into gaming and advertising:
"I use this analogy a lot. We have proven over the last eight years that we know how to acquire mobile users and engage them. A similar analogy -- when I look on the outside -- to what Amazon has done. They started Amazon by revolutionizing the book selling industry. As they engaged their consumers, the natural question they asked was what other types of merchandise or offers would consumers be interested in? How do I expand the shopping cart and monetizing relationship with our customer and make the experience broader? That is the same question we asked ourselves. It is not a shift but a broadening of our business model. As we have these consumers that are engaged with us, what are the natural next offerings for these customers and open up our platform to third parties to help them connect with our customers? That is where the gaming came from. Gaming is still one of the largest monetary engines on mobile. When you ask yourself what else customers might be interested in remember, 90% of the customer that we operate are free customers. We have to find other opportunities to monetize other than a subscription. We are in the mode of expanding this monetization relationship with our customers. Advertising and gaming does that. It is the same thing that Amazon went through when they added more content and merchants to their platform."