How Easy Is It To Create A Scandal?

| About: NQ Mobile (NQ)

There has been much talk about NQ Mobile (NYSE:NQ) thanks to a bearish Muddy Waters report from last week that has caused the stock to shed about two-thirds of its price in the matter of days. Before diving into the issues I have with their analysis, I must compliment the abilities of Muddy Waters to have such an effect on a stock. As someone who has written short-biased articles in the past, I understand what they understand. Trying to win on a position in the stock market in the social media world is a lot easier on the short side than the long side. If you write a positive article on a certain stock, you are telling people what they want to hear. They will agree with your stance and continue to hold their position. Some may buy more but it's unlikely that you'll change market sentiment as a whole just on that. The only way you could materially positively affect market sentiment on that stock is if your article gained traction in the investment world outside of its own news feed.

To try to negatively impact a stock's sentiment is much easier. Writing something like "Initiating Coverage on NQ Mobile" is going to get the eyes on it that you want - longs on NQ. If you convince them to sell, that'll create a snowball effect like what we have seen in the past couple of days where thousands of momentum traders who never heard of NQ will investigate and comment upon the state of the firm.

This leads me to my first criticism of the MW report. They use a lot of potentially libelous terms in their report to describe NQ such as "massive fraud" and claims that the management team and auditors were very sloppy. Well, if that was the case and this "massive fraud" was so easy and apparent to find, why didn't they expose it sooner? This stock has traded in the US for over two years. Instead of spending all that time hitting blanks on QIHU, why didn't they take this easy, low-hanging fruit of a fraud case? They could have saved even more investors by doing us this service over a year ago and really build their credibility on the heels of their Sino Forest exposure.

Two potential answers to that - this isn't nearly the massive fraud that was so easy to expose as they claim and they waited to pick their spot when the stock price was high to try and maximize their short position. I can understand that. When I wrote bearish articles on YRC Worldwide over the summer, I did so after the stock price had risen as I knew it was unsustainable. I took a lot of heat from those bullish on YRCW who have conveniently slinked back into shadows after their laughable price targets on it look ridiculously bad considering where the stock sits today.

That's where the similarities between my bearish articles and MW's analysis ends. While I used YRCW's own financial reports to pick apart some bullish arguments - I was using claims made by management themselves to support my analysis - Muddy Waters uses a mix of potentially excellent research with potentially shady research and adds in a ton of assumptions and hearsay to come up with an 81-page report completely condemning NQ and everything associated with their business. And a drawing of a clown.

Muddy Waters makes assertions about NQ's cash balance being a lie and the illegitimacy of its revenues thanks to a relationship with a potentially made up company called YDT. It is NQ's responsibility to prove the company's cash balances are real and trying to debunk MW's claims such as YDT's office locations being fictitious would take a lot of time and effort. So I can't say anything disprove them. But what I will do is take a look at the claims which are very easy to challenge so we can question just how easy is it to create a scandal - not just on NQ but on any company out there - with the right amount of anecdotal data and a few pictures.

MW claim challenge #1: NQ's Antivirus 7.0 is unsafe for sale to consumers, and it is spyware.

There's a lot of material out in cyberspace that can challenge this dubious claim. Doing a Google search on NQ Antivirus 7.0 links you directly to the Google Play result for NQ Mobile Security & Antivirus. As of this writing, there is 8,018 1-star reviews for the app. Seems like a lot of anecdotal material to gather if you wanted to rip apart the app as something substandard. However, those 8K negative reviews seem quite miniscule in comparison to 114,872 5-star reviews along with the 23,328 4-star reviews. If you scroll down to the "Additional information" section you will see that there have been between 10 million and 50 million installs of this app. If NQ's products were really that horrible and unpopular as claimed in the report, don't you think these Google Play numbers would reflect that? Instead they show that NQ's app is widely used, well-respected and popular.

Muddy Waters' specialty is as a short-biased research firm. They are not known for their expertise in software development and analysis. And yet their claims of NQ's software being malware is getting more attention than qualified opinions. This site offers a much more unbiased opinion on the performance of NQ's software - an effective product with some downsides but no mention of it being malware.

MW claim challenge #2: CCTV caught NQ in a malware scandal, and therefore the company and its products cannot be trusted.

This is really where going back to the title of this article makes sense. What MW says about this situation could be completely true. But how does that make NQ any worse than any other company out there that has ever been involved in a scandal? Reading this article titled "Microsoft Responds to Growing NSA Spying Scandal" which also has Facebook, Apple and Google battling allegations of privacy breaches shows that a lot of large companies have been accused of wrongdoing. This is just one recent example that I took from a few moments of a Google search but there are many more out there. While NQ may be guilty of past shady activities, how is this any different from any other company, Chinese or American, which has either been convicted or accused?

Doing a Google search on the term "Do antivirus software developers create viruses" brings up many interesting items. The first result was from a CNET forum where many users philosophize over the question. One of my favorite responses came from a user who suggested that they would have to develop a myriad of viruses in order to develop an effective and proactive anti-virus to stop them. Then all it takes is one slip up or a move from a malicious or inept employee to take that virus widespread.

I'm not suggesting that for sure NQ is 100% innocent except for one person. The company could very well have tried to pull some sort of scam and got caught doing so. I'm not going to come to the most positive conclusion on NQ to support my bullish position unlike Muddy Waters which doesn't even suggest a possible explanation other than malicious and sloppy fraud perpetuated by the company's management team. But the fair thing to do is to consider both possibilities and consider that the truth probably lies somewhere in between.

If every company on the DOW, NYSE or NASDAQ was held to the same scrutiny as what MW does with NQ, we might be at lower levels than the 2008 financial crisis. Investing comes with a certain basic level of trust that the companies are led by competent people who are generally trying to do the right thing. When I wrote my bearish articles on YRCW I never suggested that its management team was a bunch of manipulative, evil fraudsters. That's the weakest part of MW's analysis. They don't even suggest anything other than that as a possible explanation for any issue that they brought up.

MW claim challenge #3: NQ's China prepaid card channel is questionable in size and materiality to revenue.

This one is a somewhat of a subset of #1, but I felt the need to mention it because Muddy Waters did a very smart thing to promote their cause which was to take pictures of NQ's points of distribution. My favorite picture was the one on page 22 of the report where they showed the kiosk displaying cards with the new logo beside cards with the logo from a couple of years ago. Their conclusion was that NQ's merchandise is old and not moving.

This is another great way to create a scandal where there might not be one. Their assumption could be true and it looks great in their report. However, if you go to any kiosk at a flea market, a pawn shop or even a discount bin at a large department store what will you see? A large amount of older goods, possibly next to new items. A challenge to anyone reading this would be to go to one of those independently-run kiosks and try to find an iPhone 4 alongside newer Smartphones. My guess is that it wouldn't be too hard. You could upload a photo of what you saw then write a report about how iPhones aren't selling.

I can't say for sure how legitimate and honest Muddy Waters is with this claim along with the others I haven't touched upon. All I can say is given the context of the first two points I made, we know where MW's biases lie and that they have been shown to not tell the full story if a piece of that story doesn't support their cause. I'm not throwing out any accusations but it wouldn't be a stretch to think that they bent the truth to fit their needs as much as possible.

I'll conclude with something that isn't directly pointed at the Muddy Waters research but at other bearish articles against NQ. A theme that seems to keep coming up is that on Chinese tech-related message boards and chat rooms, NQ is generally seen in a negative or insignificant way. On North American message boards, how often do you see critiques that are overwhelmingly positive? I work in the Canadian Telecom industry and I have seen my fair share of articles and message boards on the industry. If the angry rants that I see in the comments section of these articles were to be any indication of the stock prices of the members of the Canadian Telecom industry, they would all be priced at 5 cents each. And yet, Bell, Telus and Rogers are three of the strongest companies in Canada and a staple of the TSX and Canadian economy. I can take any negative comments I see on NQ products in China with a grain of salt.

This pullback in stock price provides strong-willed investors an opportunity for great gains

Since the Muddy Waters report, Macquarie, among others have defended the company and their stock price targets above $20 per share. I would have to agree that this provides an opportunity for strong-willed investors who can tolerate the risk and volatility. At a $9 stock price, the market cap is below $500M and their forward Price to Earnings estimate is less than 7. Compare that to the much more mature Symantec Corporation (NASDAQ:SYMC) which has a market cap of over $15 billion and a forward P/E of over 11. Early last week you would have had to pay for a P/E multiple of over 20 on NQ. Now that it has had its business practices questioned at every possible angle, the stock is on sale.

The PEG ratio tells an even more bullish story. Because of NQ's high growth potential the 5-year expected PEG ratio is down to a little over 0.2. SYMC's is nearly seven times higher at just under 1.4. One has to wonder how far SYMC would drop if a firm decided to do a short-biased report on its business practices and make a big deal over "The Symantec Hacking Scandal". But then again it's probably too hard and not profitable enough to try to destroy such a large American company based on the some of the miscues that they have done in the past as a firm with thousands of employees.

Disclosure: I am long NQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.