China Finance Online's (NASDAQ:JRJC) stock soared on Monday on the news that it was launching China's first "Integrated, Web-Based Securities Trading Service Platform." The product is the result of a strategic partnership with CITIC Securities, the largest brokerage firm in China. The press release, combined with the rapid appreciation in the stock price caused me to look a little bit deeper.
JRJC was incorporated in Hong Kong in November 1998. In April 2001, JRJC launched its online financial and listed company data and information services. In April 2000, JRJC acquired www.jrj.com. In October 2004, JRJC went public and listed its ADSs on the Nasdaq. In 2006, JRJC acquired www.stockstar.com. In 2006, JRJC also acquired CFO Genius, which is a financial information database. The rest of its corporate history from the 20-F:
In 2007, we acquired Daily Growth Securities Limited, (renamed iSTAR International Securities Co. Limited by February 2013), a licensed securities brokerage firm incorporated in Hong Kong, and therefore established our business outside mainland China. We currently hold 85% of the equity interests of iSTAR Securities (formerly named Daily Growth Securities), iSTAR Futures (formerly named Daily Growth Futures), iSTAR Wealth Management (formerly named Daily Growth Wealth Management), and iSTAR Investment Services Co. Limited (formerly named Daily Growth Investment Services Limited), or iSTAR Investment Services, all of which are companies incorporated in Hong Kong and held indirectly by iSTAR Financial Holdings Limited (formerly named Daily Growth Financial Holdings Limited). We intend that all the equity interests held or to be held by CFO Hong Kong in a financial service related business will be integrated into iSTAR Financial Holdings Limited, thereby making iSTAR Financial Holdings Limited our platform to develop financial service related business outside mainland China. On February 10, 2012, we incorporated another Hong Kong subsidiary under iSTAR Financial Holdings Limited, Daily Growth Credit Limited, which was renamed iSTAR International Credit Co. Limited by January 2013.
Where Is Revenue Coming From?
In response to a downturn in Chinese equity markets, JRJC has been diversifying its revenue sources. Again, from the 20-F:
In 2013, in order to address the market demand for alternative investment opportunities, the Company established Zhengjin Fujian, Zhengjin Tianjin and acquired Henghui to help clients invest and trade precious metals. As a PRC-affiliate of the Company, Zhengjin Fujian is a member of the SAIC (State Administration for Industry and Commerce)-approved Haixi, while Zhengjin Tianjin and Henghui are members of TJPME. Our precious metals trading affiliates' intended scopes of business include precious metals spot trading, silver product sales and financial investment advisory services. Currently, they are focused on online silver trading on Haixi and TJPME on behalf of their clients.
We earn commission income from our clients' trading. In addition, we act as one of the market makers in Haixi and TJPME. As a market maker, we commit to accept all the trade executions by offering to buy or sell trading products from/to our clients. As a result, we also recognize trading gains/losses in our net revenues. In 2013, our net revenues derived from precious metal trading business represented approximately 57% of our total net revenues.
In 2012, JRJC did not derive any revenues from precious metals trading. In 2013, JRJC derived 57% of its revenue from precious metals trading. Despite this tremendous shift in business, the gross margins actually increased by 7%, from 73% to 80%.
So why are these margins almost unbelievable? Well, precious metals trading is an incredibly low-margin business. Compare this to another publicly traded company that does only does precious metals trading, AMRK, and one sees an interesting picture.
Given that precious metals trading is such a low-margin business, it is remarkable that JRJC managed to actually increase its margins, when 57% of revenue came from a segment that it previously did not have and has generally low margins.
Websites - Different Name, But Same Content
According to the 20-F, the two websites (jrc.com and stockstar.com) have the same content, but different names:
We acquired the financial information website jrj.com.cn in April 2000 and the domain name jrj.com in October 2004, and commenced operating our subscription-based financial information business in March 2005. We maintain the same content under both domain names.
This makes sense, as it keeps the cost of creating content down. However, if the content was the same, it would also be logical that the users are getting to the websites in a similar manner. According to Alexa, however, the keywords that are driving users to each site are radically different.
Using information from Alexa.com, these are the main search keywords which drive traffic to each site, translated into English.
While jrj.com has keywords that seem reasonable for a finance site, stockstar.com certainly does not.
JRJC's Material Weakness
In its most recent 20-F, JRJC mentioned it had a material weakness in its internal control in financial reporting. The 20-F reads:
We had a material weakness in our internal control in financial reporting for the year ended December 31, 2013, which could result in our financial statements not being prepared properly. Our management identified a material weakness and concluded that our internal controls over financial reporting were not effective as of December 31, 2013. A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal controls over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The Company's management determined that the Company's oversight of complex transactions is not effective. Specifically, management lacks the expertise to evaluate the accounting requirement of certain non-routine and complex transactions. From time to time the Company will encounter non-routine accounting transactions that require a high level of technical accounting expertise. Non-routine accounting transactions will likely increase in frequency as the Company continues to grow and expand its operations.
A material weakness makes it a reasonable possibility that a material misstatement of our company's annual or interim financial statements will not be prevented or detected on a timely basis. In the event that the material weakness described above led to our financial statements not being prepared properly (which we currently do not believe to be the case), we would be required to restate our financial statements, which could result in a decline in our stock price
Alone, this is not necessarily a red flag, although given the company's seemingly remarkable margins, it is a risk that investors should consider.
Which brings me to my last and final point. The stock is up 85% in the last 5 days. Just three months ago, JRJC was a $3 stock. Now, it's an $8 stock with a $175 million market cap. Why has it gone up so much? This press release:
China Finance Online Co. Limited ("China Finance Online", or the "Company") (NASDAQ GS: JRJC), a leading web-based financial services company that provides Chinese retail investors online access to stocks, commodities and wealth management products, today announced that it has launched China's first independent web-based securities trading platform, "Zhengquantong ("Securities Master")", on the leading financial portals it operates, www.jrj.com and www.stockstar.com. Securities Master is the product of a new strategic partnership China Finance Online has entered into with the largest brokerage firm in China, CITIC Securities Co., Ltd. (SHA: 600030) ("CITIC"), to seamlessly integrate China Finance Online's state-of-the-art, web-based architecture with CITIC's robust trading and settlement system.
While JRJC may want to claim that it has the first web-based securities trading platform, that is simply not the case. Tencent (OTCPK:TCEHY) has beat it to the punch. From an article on February 21st:
Tencent (0700) has partnered with a mainland brokerage firm to launch an online stock trading service with the mainland's lowest commission fee, even as China's central bank warned on the risks of internet finance. The new trading service appeared on the websites of both Tencent and the Shanghai-listed broker Sinolink Securities yesterday.
JRJC hosted a conference call on Tuesday morning to address this development; what was unfortunate was just how light on details it was. While there is no transcript of it, one can listen to a recording of it by calling +1-855-452-5696 and using the conference ID #89855480. What was particularly troublesome was that JRJC was unable to give any guidance on how this deal would affect its guidance, and when asked about the commissions for the venture, management was unable to provide an answer, instead saying that this call was only to address the platform.
When Tencent announced the deal, it was able to immediately disclose the commissions on the platform.
Users can register for the new account or apply for transfer from other brokers for a commission fee of 0.02 percent and are offered a consultant service worth 6,888 yuan (HK$8,780) a year, according to the website. Huatai Securities announced a commission of 0.03 percent for online users last month. Most brokerages now charge 0.08 percent commission.
JRJC has been hyped up immensely by this deal. I am not suggesting that JRJC is worthless, but rather that the stock is over-hyped right now surrounding this deal. Combine that with the lack of clarity provided on the conference call, and you have a recipe for a sharp pullback.
Note: I am long puts on JRJC. I have contacted management with several of my questions, but have not received a response. The information presented above is correct to the best of my knowledge; however, if there are any errors, I will correct them immediately.
Disclosure: The author is short JRJC.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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