"Three things cannot be long hidden: The sun, the moon, and the truth." - Buddha
If you've arrived at this post you've at least overheard the noise bellowing from the recent fight between Muddy Waters (MW) and NQ Mobile (NQ). Both sides have delivered blows via long-winded reports, and other third party sources have shoved their way into the skirmish and followed suit. Amidst the chaos, the most important issue has been given far too little attention: The true nature of NQ's relationship with Yidatong (YDT) -- the entity responsible for processing more than 22% of NQ's revenue. Our purpose in writing this is not to make accusations, but rather to help uncover the facts.
We strongly encourage all stakeholders of NQ -- shareholders, management, and customers -- to help settle this issue once and for all. Although we currently maintain short exposure, we would have no problem exiting our short position and going long if NQ would present the details and come clean (assuming the facts lead to a bullish conclusion of course). In essence, we have no ego or emotion involved in our thesis. Our goal is to find the truth and make money for our partners.
We believe that the answers to the following three simple questions will help us get to that truth.
1. Why does NQ need YDT, a payment service provider?
"If you're not confused, you're not paying attention." - Tom Peters
It's easy to believe management when they say, "NQ has found that it is simply more cost and resource efficient to work with third party service providers over building [our] own billing services." It also seems logical as to why they would use YDT, a company that offers "a lower fee rate than other mobile payment service providers." But the logic stops there.
NQ Mobile has its own service provider license and infrastructure in place to process payments in-house. They don't need to "build [their] own billing service" because it's already built. In fact, NQ uses its own service provider license in almost half of their transactions. Why almost half but not all? If NQ already has the license (which are difficult to obtain) as well as the framework necessary to process payments, why pay a 6%-8% fee to YDT?
To add insult to injury, the service YDT provides isn't as efficient as NQ claims. YDT has repeatedly breached their payment covenants with NQ. At the end of 2012, NQ's days of receivables with YDT were 167 -- this should never be more than 120 days (according to the contract). Not only is NQ allowing YDT to rake off between 6% and 8% of their gross revenue, YDT is delinquent on its debts.
There has to be some reason NQ is outsourcing payment processing: Maybe NQ is legally bound to use third party service providers? Or, maybe this is standard industry practice? The answer to both questions is no; NQ is not legally required to use a third party service provider, nor is this standard practice.
In fact, NQ's top six competitors (as listed in NQ's most recent 20-F) all process payments internally. None of these companies (Qihoo, Tencent, Kingsoft, AVG, Trend Micro and Symantec) make note of working with third party service providers in their most recent annual reports. These companies either bill directly through carriers, sell hard copies of their product through retailers, or process payments via their own internal billing applications. NQ is oddly unique when it comes to paying third party service providers to process payments.
2. If Yidatong is a growing company providing value to many customers, why can't they be reached?
"You can't catch fish when your line's in the boat." - unknown
YDT's website states that they're a payment service provider whose role is to act as a bridge in transactions between content providers (e.g. NQ Mobile) and wireless carriers (e.g. China Mobile). The company is owned by Xu Rong, a former NQ employee (more on her later). They reportedly operate in 30 countries throughout Asia, Europe, the Middle East and South America, and work with more than 50 telecom operators -- quite an impressive channel. Yet, of the $36MM worth of transactions that YDT claims to have processed in 2012, more than 60% were processed for NQ's China business alone.
Even more curious is YDT's lack of online activity. For example, The "Recent Activities" tab of YDT's website has not been updated since March of 2012. Not only that, their "Promotion Solutions" page cites a trend from 2009 -- isn't it almost 2014?
It might be time for YDT to update their website; we recommend they start by posting accurate physical addresses. When MW attempted to visit all ten of YDT's publically documented physical locations, five of them were not inhabited by YDT staff and the other five weren't even real addresses. Only after MW issued their first strike on NQ was YDT's true physical location revealed. In NQ's 97 slide report management finally disclosed the location of YDT's main operating facility.
The layout of this location, as we later discovered, is not only unorthodox, it's suspicious. YDT operates in a shared headquarters with a company called 9H, an online game producer. Guess who owns 9H -- an NQ Mobile insider, Xu Zhou.
So, taking a step back, YDT is owned by Xu Rong, a former NQ employee, and 9H is owned by Xu Zhou a current member of NQ's board of directors. Is this a case of friends helping friends by providing free office space? Even in that case, why wouldn't YDT, a reportedly independent and growing company not feel the need to post a public address? Do they not want more customers?
3. Why has NQ issued four contradicting stories on Xu Rong's relationship with NQ?
"No man has a good enough memory to be a successful liar." - Abraham Lincoln
As we alluded to above, Xu Rong's affiliation with both NQ and YDT presents a problem. Prior to NQ's IPO, Rong was a listed Director. At the same time, Rong was also an Executive Director for YDT -- eventually becoming majority shareholder in 2007. This makes YDT an "undisclosed related party," as Rong was majority owner of YDT at the same time she worked with NQ. However, NQ did not disclose this relationship truthfully. In fact, NQ has issued four separate accounts on how Xu Rong was an affiliate:
- Xu Rong was a consultant to NQ in 2006 and 2007 - NQ's May 2011 prospectus.
- Xu Rong consulted for NQ for less than six months in 2007, and bought 75% of YDT at the time she left NQ - NQ's response to J Capital report, August 1, 2013.
- Xu Rong was an employee of NQ from September 1, 2006 to December 31, 2008. She bought 75% of YDT after she left NQ - conference call, October 25, 2013.
- Xu Rong was an NQ consultant from spring 2007 until the end of 2007; she was then an NQ employee (Director of Marketing) from December 2007 to August 2008 - a narrowly circulated email to investors from Matt Mathison, November 2, 2013.
Is it possible that NQ wanted to avoid a higher level of scrutiny by not disclosing the true details of the relationship?
What we know for sure is that NQ has been inconsistent. This inconsistency has caused us and others to suspect that they might be hiding more. Dear NQ Mobile, help us help you by truthfully answering the questions we presented.