China’s NQ Mobile Sinks as Muddy Waters Calls Company ‘Massive Fraud’

October 24, 2013

Muddy Waters Initiates Coverage on NQ Mobile Inc. (NYSE: NQ)

Muddy Waters rates NQ Mobile Inc. (NYSE: NQ) shares a Strong Sell. In this latest report Muddy Waters highlights:

• NQ is a massive fraud. We believe it is a “Zero”. At least 72% of NQ’s purported 2012 China security revenue is fictitious. NQ’s largest customer by far is really NQ. Our research estimates that NQ’s real market share in China is only about 1.5%, versus the approximately 55% it reports. We estimate that its China paying user base is less than 250,000, versus the six million NQ claims.
• NQ’s Antivirus 7.0 is unsafe for sale to consumers, and we consider it to be spyware that makes users’ phones vulnerable to cyber attack. NQ makes a weak attempt to protect users’ private data as it’s uploaded through the Chinese government’s firewall to NQ’s server. Phones are vulnerable to MITM attacks because NQ fails to adhere to basic security protocols. MW engaged top-flight security software engineers to analyze this product.
• NQ’s purported international revenue of $36.5 million is likely less real than its PRC revenue. NQ claims to generate international revenue in obscure markets, and through mysterious counterparties that seem to seldom pay.
• NQ’s future is as bleak as its past. The recent pivot to advertising and gaming is merely an attempt to change to a fraud that NQ hopes will be less obvious. NQ cannot monetize users that it does not have.
• NQ’s acquisitions are highly likely to be corrupt.

NQ’s cash balances are highly likely to not be real. In NQ’s 2012 20-F, PwC classified all cash and term deposits as Level 2 assets (slightly hard to value), which is the first time we have seen this. NQ’s purported movements of cash from its IPO almost certainly did not occur due to PRC FX controls. We therefore believe the term deposits are likely forgeries.

NQ Mobile Sinks as Muddy Waters Calls Company ‘Fraud’

NQ Mobile Inc. (NQ), a Chinese mobile-security service provider, sank the most on record after Muddy Waters LLC called the company a “massive fraud.” NQ Mobile dropped as much as 63 percent to $8.46 in New York, the most since the company’s initial public offering in May 2011, before trading was suspended. Shares were up 279 percent this year as of yesterday.Muddy Waters, a research firm founded by short seller Carson Block, initiated coverage of NQ Mobile with a strong sell rating, saying the company inflated sales. NQ, whose co-Chief Executive Officer is Omar Khan, a former Samsung Electronics Co. Chief Strategy Officer, raised on Aug. 12 its 2013 revenue estimate to as much as $188 million from the upper limit of its prior forecast of $184 million. The company’s second-quarter adjusted profit more than doubled.

“We believe it is a zero,” Block, wrote in an e-mailed report today on NQ Mobile. “At least 72 percent of NQ’s purported 2012 China security revenue is fictitious.”

NQ rejected the allegations, saying the company will respond with more details before the open of the U.S. markets tomorrow, according to a PRNewswire statement.

Block gained fame for his short-selling calls after regulators halted trading in four of the first five companies he targeted starting in June 2010.

‘Seldom Pay’

NQ’s market share in China is about 1.5 percent, versus the approximate 55 percent it reports, Block wrote. The company’s China paying user base is less than 250,000, versus the six million NQ claims.

The company, which has added online games and a music search application to its services, released NQ Live, a mobile Internet platform that can be customized, Jun Zhang, an analyst at Wedge Partners Corp., wrote in a report this week.

“NQ claims to generate international revenue in obscure markets, and through mysterious counterparties that seem to seldom pay,” Block Wrote.

The majority of NQ’s China revenue is exagerated or non-existent, according to Muddy Waters. Yidatong, described by NQ as an independent company that accounted for $20.2 million of the NQ’s $27.9 million in carrier billing revenue in China last year, doesn’t exist, it said.

Muddy Waters said in June 2011 that Sino-Forest Corp., a Chinese plantation company listed in Canada, exaggerated its revenue. Sino-Forest filed for bankruptcy protection the following year.

Shorts Double

Short interest in NQ has doubled since July to a record 11 million shares at the end of September, according to exchange data. Beijing-based NQ said in December that a report by short seller FJE Research claiming the company inflated its user based was incorrect.

Gotham City Research said that as much as 25 percent of NQ’s business is overstated, according to a post on Twitter.

Morgan Stanley and Deutsche Bank AG helped NQ Mobile raise $173 million in a private placement of convertible bonds on Oct. 9. The conversion price was about $25.61 per ADR.

“With the debt, that’s not a good position to be in,” Daniel Yu, the director of research at Gotham City Research, an investment research firm, said by phone from New York. “Once you have debt, you have covenants.”

NQ’s co-founder and co-CEO Henry Lin started the company in 2005 with $15,000 he and a high-school classmate cobbled together. He scored investments from Sequoia Capital, Qualcomm Inc. (QCOM) and Fidelity en route to an $89 million initial public offering in 2011. To expand the company outside China, he recruited Khan, who had just joined Citigroup Inc. to run the bank’s worldwide mobile business.

The company has two global headquarters, in Dallas and in Beijing. NQ Mobile was the third-best performer on the Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. as of yesterday.

To contact the reporters on this story: Belinda Cao in New York at lcao4@bloomberg.net; Matthew Kanterman in New York at mkanterman2@bloomberg.net