1. 4
  1.  

  2. 3

    Very interesting interview with Carson Block (founder of Muddy Waters) where he discusses this short position, among other things.

    On the possibility of the stock price going upwards:

    Now, why didn’t the stock continue to go down? If you look at most of the page one holders, and this goes back to what I was saying earlier. I think they felt that the report was correct. They just felt it didn’t matter. You’ll have these large, sophisticated hedge funds say, “Yeah. It’s a fraud. It’s a big fraud. But whatever. We should still own it.”

    So these are decisions that are made by large allocators on a macro basis. “We’re going to be X percent US, Y percent Europe, Z percent China.” Ok, so now they’ve got Z amount of money going into China. Well, “we need things that are large and liquid.” So that crosses off a lot of names. “We don’t want to be in state-owned enterprises.” So that crosses off even more names. Ok, “What are we left with?” You’re left with a handful of companies that are just going to, no matter how problematic those companies are, I shouldn’t say no matter how problematic they are, but absent a showing of enormous problems, I guess, they’re going to continue to receive capital flows, at least in the environment that we had been in where central banks are just globally trying to force up asset prices as their economic playbook.

    So the question really becomes, “Do investors think it matters?” That’s what we’re trying to figure out. Even outside of the world of China fraud, this is a question that we have to constantly answer. Because when we look at our bread and butter type of shorts, highly misleading accounting, etc. The bar has gotten higher each year because investors are just more and more unconcerned, just more and more oblivious, or deliberately oblivious to, risk.

    On investment banks participating in coverups:

    What’s their role? Years ago, right after we published Sino-Forest, I spoke with the credit analyst at one of Sino-Forest’s investment bankers. This analyst told me, “I figured out that Sino-Forest was a fraud over a year ago. I went to my boss, and I said that.” And my boss said, “Listen, you just be quiet. You don’t have to cover the company.” But, that’s it.

    On the failure of the big 4 audit firms:

    Every year, every one of the big four will have a major blowup. And yet everybody thinks the big four brand means something. Every time we short a company, especially if we say it’s a fraud, I just see all of the responses on Twitter. And it’s all “Oh, but it’s audited by so and so.” Like, come on man. So and so last year had three major audit failures.

    1. 2

      Word on the street is that there’s about 30% topline fraud tolerance from the CCP. So yeah these are legitimately very large companies with thousands of employees providing a real service. They fudge their numbers some and the government turns a blind eye as long as its not too egregious. See also this thread where sell side Chinese analysts are, shall we say, strongly discouraged from giving sell recommendations to domestic firms.

      Will be very interesting to see how this dynamic plays out over the next few years…

    2. 2

      Even assuming this company is not a fraud, the company’s competitive positioning isn’t great either. Tencent has around 25% market share of the china video market, Youku backed by Alibaba has over 20% share and IQIYI has over 20% share as well. The two competitors are backed by larger platforms that can push the video service on their platform. So IQ’s position in China isn’t as formidable as Netflix’s position in the US. At 3.28 times EV/Sales, the stock isn’t really incorporating any impact from competitive threats as well as potential for accounting issues.

      Also, Baidu’s ex employee was recently charged with corruption. See the news piece below.

      Baidu VP Wei Fang Suspected Corruption and Sent to Police Department

      April 21, 2020 5:17 pm Baidu has accused Wei Fang, its former VP, of corruption while in position. Wei was arrested by police on Tuesday, pending further investigation.

      A statement issued by Baidu’s Moral Committee claimed that his illegal activities had violated the company’s culture of honesty.

      The company went on to say that it stands resolutely against all illegal and criminal activities, and warns its employees that these activities will be met with zero tolerance.

      Wei served as a director of finance at the company prior and was promoted to VP Finance in 2018.

      Baidu established its Moral Committee in 2011 as an employee behavior watchdog and interior anti-corruption task force. Members of the committee are required to have deep legal backgrounds, with some of them ex-lawyer and police officer. Since establishment, the committee reported about twenty cases with a total number of 116 employees reported, among which the most are corruption cases.