- After three months, Montage Technology still has not responded in any kind of detail to the allegations by Gravity Research.
- Montage Technology's 10-K is more than 45 days late.
- Montage might be suspended from trading or de-listed by the Nasdaq, perhaps as soon as June 2.
- Any one of a number of events could cause Montage shares to fall by 50%.
In recent weeks, many investors have been riveted by the ongoing saga at NQ Mobile (NYSE:NQ). The big news out of NQ Mobile in the last couple of days has been that the company is delaying its filing of its 20-F, an SEC filing submitted by foreign private issuers to the US Securities and Exchange Commission. Much of the big price move at NQ Mobile seems to have already occurred this week.
However, shorts who have been following that saga might also want to consider a similar play with Montage Technology (NASDAQ:MONT), a Chinese semiconductor company which designs, develops, and markets analog and mixed-signal semiconductor solutions for the home entertainment and cloud computing markets. Montage sells both set-top box technology and also memory interface technology. The case against Montage has been well-researched by Gravity Research and also by Aristides Capital, on a couple of occasions: February 20 and March 20. The gist is that Montage is egregiously overstating its revenue and that its largest distributor, the LQW Technology Company Limited, is in fact a shell company by means of which MONT fabricates its financial information. The initial allegation by Gravity Research was that LQW is in fact secretly owned by the Shanghai Montage Microelectronics Technology Company, Ltd. (OTC:SMMT), a business entity established for fabrication purposes by MONT.
In response to the allegations, Montage has authorized forensic auditors to inspect the company's books. Montage even announced recently in an April 22 press release (the same day that it received its notice of non-compliance from the NASDAQ) that the internal audit committee had not found any issues.
I am an independent investment professional and I do not have at my disposal the resources of one of these groups to visit China and unpack the details of Montage's company practices. I am also not sure that the short thesis is correct. However, I do think that there several things about Montage's recent actions that are suspicious. In particular, there are several troubling facts that I think are worthy of better publicity here on SA.
Fact #1: As of May 15, Montage is now over 45 days late on their 10-K filing.
This is, on its face, suspicious. At least two sets of auditors have supposedly been clearing the books. Jones Day and FTI - both reputable companies - are involved in this process. PricewaterhouseCoopers is completing the 10K. But if CFO Mark Voll is right and the forensic auditors have given the company a clean bill of health, why is the 10-K so delayed? The unaudited Q-1 report was released recently. But the company still has not released the 10-K.
Fact #2: Montage's April 22 press release update on the audit process was phrased in a way that was incredibly broad and could be interpreted in a variety of ways.
For instance, it said at one point in the press release that "Based upon the audit committee's report, the Company continues to believe that the allegations by Gravity Research lack merit, and the Company therefore does not anticipate any changes to its previously reported financial results." This statement is based on an internal company assessment - conducted by forensic accountants and lawyers employed by the company - and it could be interpreted in a variety of different ways. There has been no independent release of verification confirming the company's financial position. The company's internal statement is just that - an internal statement. The company has never been financially audited, apart from its initial prospectus.
Fact #3: Intel Corporation (NASDAQ:INTC), an early investor (2006) in Montage and a major reason why many US investors have continued to trust the Montage story, recently sold 80% of its 1.7-million-share stake in the company. This is capable of being confirmed from its Q4 2013 and Q1 2014 SEC 13F filings. It might be coincidental or it might not be.
Fact #3: LQW has been acknowledged by Montage executives to have no website and also to have the kinds of employment numbers (one full-time employee) which made American analysts initially so suspicious.
Executives at Montage have admitted also that LQW consisted of parties known to insiders, and that they did not disclose this in their initial S-1. According to MONT's financial statements, business with LQW makes up more than 70% of MONT's accounts receivable. Montage's other clients do all have credible websites, so LQW's lack of one is singular.
Fact #4: Montage reports earnings margins that are significantly higher than the industry average.
Its gross margins in 2013 were 63%, even as its competitors with greater market share in SoC averaged under 40% (and none had higher than 45%). This is more easily explainable in my view if Montage is cooking its books than if it is in fact doing legitimate business.
Fact #5: There is no binding offer right now for Montage that has been initiated by a credible buyer.
The main reason why Montage does not seem to have sold off yet is because there is currently on the table a non-binding offer for the company at $21.50 from PDSTI. According to a recent press release, PDSTI is "a wholly state-owned limited liability company directly under Pudong New Area government of Shanghai." Its business "currently covers a broad range of areas, including venture capital and private equity investments, mergers and acquisitions, management of fund of funds and private equity funds, and debt investments." What is this offer and what does it mean? One possibility is that the bid could be aimed in fact at RDA Microelectronics (NASDAQ:RDA). Right now PDSTI seems to be involved in a semi-hostile bid to take over RDA. PDSTI could be attempting to assemble a large company made out of semiconductor manufacturers and other companies, perhaps to rival Qualcomm, Intel, or similar western companies. Maybe the Montage offer is an attempt to negotiate with RDA by turning in another direction. This conjecture seems to be supported by the fact that PDSTI has initiated numerous press releases vis-à-vis RDA, but few to no press releases vis-à-vis Montage.
Now if the Gravity allegations are correct, then any sane Chinese businessman involved with the Shanghai government would know that it makes more sense to buy RDA than it does to buy Montage. As pointed out by SA contributor J Mintzmyer, Montage trades at approximately 90% of its proposed bid by SOE. This is remarkable, especially in comparison to other recent buyout bids for American companies BBY, which once traded for only 70% of its bid, and BBRY, which traded for 85% of its bid. Perhaps it could be said in response that the fix is in and perhaps that a Chinese SOE does not care if the numbers at Montage are goosed or not. Maybe government officials in Shanghai would get a substantial kickback from an SOE Montage purchase. Maybe there are quid pro quos going on in Pudong that are opaque to western investors.
But I am not sure that there are. Supposing that Montage is a short a bet on the honesty of Chinese SOE executives, in 2013 this bet might have been a bad one. But the business climate in the China of 2014 does seem to be changing, as the government cracks down on the bad debts and the shadow banking industry. My own view is that the executives in PDSTI can probably see the writing on the wall and that there will not be any buyout of Montage by PDSTI. I think in fact that the non-binding buyout offer is just a negotiating tactic.
Fact #6: Time is passing.
More than 65 days have now passed since the non-binding letter offer, without an answer. And over three months have now passed since the original allegations, without a credible and detailed response by the company. Every day without a response, just like every day without a 10-K, and every day without a response from the company or its sell-side supporters to the Gravity allegations, gets louder and louder. The company right now seems to be continuing to conduct business as usual in an effort to sooth the worries of its foreign investors.
Fact #7: Montage is much less-well-known than NQ Mobile to the American investment community.
The company's market cap as of earlier this week was $520 million, larger by about $100 million than NQ Mobile. When the news about the delayed 20-F at NQ Mobile first broke, the share price of Montage, a company facing similar allegations, moved hardly at all. NQ has over 6000 Seeking Alpha followers, whereas Montage has only about 360. This suggests that American investors are neglecting this play and that one of the main reasons MONT has not fallen in recent days is simply because of a lack of publicity.
Nevertheless, a few Americans do in fact seem to be paying attention. Prominent American investor Whitney Tilson has shorted both NQ Mobile and Montage. He has stated in an email to ValueWalk that "It's amazing how little things change and how little investors learn, as dicey Chinese companies are all the rage once again." Tilson has said earlier, speaking of the Chinese affiliates of the accounting firms that inspected the books at companies like NQ and Vipshop Holdings (NYSE:VIPS), that "It's jaw-dropping what these accounting firms are doing - they're utterly complicit in the fraud. It is an absolute disgrace that the big-four firms are willing to so completely sell out by allowing their affiliates to continue using their good names in the face of overwhelming evidence of being complicit in such widespread fraud." It is in my view imperative that the accounting companies that are involved in inspecting the books at Montage do the right thing. My fear is that they will not.
Alongside the Whitney Tilson mention, it does bear mentioning also that Jim Oberweis is, to my knowledge, still a MONT backer. His Oberweis Asset Management has also recently been a backer of NQ Mobile.
In summary, in my view Montage is a live and compelling short opportunity and will remain so until a 10-K is filed without a serious restatement of the company's revenue and earnings, and/or a binding offer is made by a legitimate buyer. Montage longs should do their investigative diligence and consider their positions. Potential Montage shorts might want to consider this play before it gets expensive.