Shorting China's Cogo Group: Nonfunctional B2B Website Raises Serious Red Flags

In this report, we elaborate on why investors in Cogo Group, Inc. (“COGO” or “the company”), as well as its auditor and the SEC, should be especially cautious.

Specifically, a thorough analysis of the company’s accounts and filings reveal numerous red flags, ones consistent in nature to those exhibited by other troubled Chinese RTOs we’ve assessed in the past, including:

• Declining quality of earnings
• A history of making acquisitions with a lack of transparency and a low proportion of tangible assets
• A record of apparently exaggerated claims
• An egregious transfer of wealth out of the pockets of shareholders and into the hands of an unnamed executive

Previous articles on Seeking Alpha, including the ones here and here, have done an excellent job documenting COGO’s suspicious related party transactions, unusual accounting, and questionable acquisition history.

In this report, we’ll shed light on dubious claims made by management regarding a website they’ve portrayed in press releases as a central component of the company’s new online strategy: www.cogozon.com. The red flags in this case are clear, and most investors should have an easy time understanding them.

Historically, COGO's business model has been described as the provision of “customized module design solutions for a diverse set of applications and end markets, serving as a gateway for [the company’s] technology component suppliers to access leading electronics manufacturers in the PRC.” It’s not very clear what is exactly meant by this and a visit to the company’s main Comtech subsidiary website at www.comtech.com.cn appears to describe a simple re-selling business. Comtech’s “products” section is little more than hundreds of links to other manufacturers’ websites. We'd add that a number of those links are broken.

Recently, however, in light of the numerous high-flying Chinese internet businesses that have gone public in the US, COGO has attempted to present itself as a dotcom growth story.

In a May 5, 2011 press release, COGO CEO Jeffrey Kang announced the company’s new online strategy:

“Today, I am announcing our new online strategy, called "COGO 3.0", which will launch later this quarter. COGO 3.0, which will be divided into two distinct but intertwined subgroups, focuses on applications and products. It will utilize the Internet to enhance our push into the SME market by accelerating our SME customer growth and significantly lowering our SME acquisition costs. We will launch a number of websites, blogs and social networking sites aimed specifically at leveraging our already powerful position within the massive and influential China engineer community, numbering in the range of 50-100 million.”

The company has reconfigured its business description in its most recent press releases. For example, below is the business description from the most recent press release on the COGO investor relations website (emphasis added):

“Cogo Group, Inc. (Nasdaq:COGO) is the leading online platform of Core Technologies for the 42 Million Small and Medium Enterprises ("SME") in China. Cogozon.com, currently serving Cogo's 1,500 SME and 100 Blue-Chip customers, is an e-commerce platform for customers in tech manufacturing sectors (Smart Meters, Alternative Energy, Autos, Healthcare, Tablets and HDTV), offering designs, product, applications and technical support. Cogo's transaction-based online revenue model centers on its Application Store, offering design solutions and embedded software, and its Product Store, which sells standardized Electronic products. Cogo operates Cogopedia.com, a unique web-based business networking platform to engage with 50,000 electronic and software engineers, collecting one million data inputs daily. Cogo offers technology from 400 suppliers, including 50 global players like Broadcom (BRCM), Xilinx (XLNX), Freescale (FSL), Microsoft (MSFT) and Atmel (ATML). Cogo has 600 employees, with 300 in engineering and 200 in direct sales and 15 service centers across China.”

COGO's CEO further promoted the company's new online strategy in the most recent conference call, a transcript of which is available here. In addition to comparing his sites to the widely known Alibaba.com, the CEO called COGO the "clear leader" in "transaction based online B2B platform[s] of technical solutions". Here is an excerpt discussing the company's online presence [excerpt added]:

"Now, I would like to further discuss our exciting new business initiative. I believe this is the most exciting new strategy that we have announced in the history of Cogo and it will be the basis for our next phase of growth in the next five years. We have both planned to create a transaction based online B2B platform of technical solutions that have no peer in China marketplace. We are the clear leader. A key point to understand then is that other companies like Alibaba have created the B2B e-commerce platform in China, however, those revenue models are based on membership. Our model is based on transactions."

This company description from recent press releases seems to indicate that cogozon.com is a central piece of the online business and serves more than a thousand business clients. Given that COGO "is the leading online platform of Core Technologies for the 42 Million Small and Medium Enterprises ("SME") in China", we would expect cogozon.com to be quite a powerful site.

However, our research shows that cogozon.com has only been in operation for a few months, and is a deficiently designed site with minimal online traffic. I’d like to credit some of the excellent research discussed on walrusvalue.blogspot.com, which has given us permission to use some of its arguments on COGO in this article. The creator of that site also made an excellent video discussing cogozon's deficiencies in the following embedded video.

To begin, here is a screenshot of the site:

click to enlarge

As a first point, the site itself looks generic and low-budget and did not appear to us to have the robust functionality one would expect from a leading business-to-business electronics platform.

That aside, we next looked at independent traffic data for the site. There are numerous third party websites, such as Alexa and chinarank, that calculate traffic to sites on the Internet and provide website rankings. Given that cogozon claims to be a leading online platform for 42 million Chinese SMEs, we would expect high rankings on third party traffic ranking providers.

Instead, what we found is that Cogozon registers so few hits that Alexa doesn't even contain data for the site.

First, here is a screenshot of what we saw on Alexa when searching for cogozon.

Alexa tells us that cogozon.com experiences so few hits that Alexa does not even “have enough data to display the traffic metrics for cogozon.com.” Alexa typically has a substantial amount of data on Chinese websites, as can be seen by its listing of the top 500 Chinese companies by web traffic here. And Alexa typically has data on smaller sites, as can be seen by Alexa’s information and ranking of our website, www.presciencefunds.com:

As a result, we can reasonably conclude that Alexa’s lack of data on cogozon.com indicates that cogozon.com receives shockingly low traffic to its website, despite “currently serving Cogo's 1,500 SME and 100 Blue-Chip customers.”

Next, let’s look at the number of results that come up when we searched for cogozon.com on China’s leading search engine, Baidu (BIDU). Given that COGO is “the leading online platform” for its wide suite of electronics products, and that cogozon.com is the first site the company mentions in its business description, we’d expect a substantial number of references to cogozon on Baidu. Instead, we find only three pages of results. See the following screenshot:

Next, given that cogozon.com is supposed to be a leading online business-to-business sales platform, we would expect to be able to purchase products through the site. Instead, our attempts to purchase products were unsuccessful. When we attempted to put an item in our cart and check out, we were taken to a contact information window that stated "our business staff will contact you as soon as possible". See the screenshot here. Despite COGO’s claims to have a leading electronics website, we could not complete our orders online. The walrusvalue.blogspost.com video which I link to above does an excellent job demonstrating that goods could not be purchased online during repeated attempts.

Also, when customers attempt to download instruction manuals for certain products, a number of the links are broken. I’ve tabulated a list of broken links in this chart.

Finally, we’ll point out that the currency for most of the items that we searched for on the website was in U.S. dollars, not Chinese yuan. Given that cogozon.com is supposed to be a leading online platform for “the 42 Million Small and Medium Enterprises ("SME") in China”, we’re puzzled why items would be denominated in U.S. currency.

As a last point, it should now surprise no one that cogozon.com is only a few months old, as this link and screenshot from whois.domaintools.com indicates. We seriously question whether COGO is the "clear leader" in "transaction based online B2B platform[s] of technical solutions", as the company's CEO claimed.

Conclusion

COGO has made dubious claims about its emerging web strategy. It has begun referring to itself as “the leading online platform of Core Technologies for the 42 Million Small and Medium Enterprises in China”, citing cogozon.com as an example of its robust e-commerce platform. Our research into cogozon.com shows that it’s a deficient website with minimal web traffic and a conspicuously low web presence based on Baidu searches. Customers cannot purchase products on the site, a striking red flag for a purported “e-commerce platform”, and prices are denominated in U.S. dollars instead of Chinese yuan. It appears to us that cogozon.com is merely a façade to show to prospective investors of the company’s shares, and not to customers of its actual products. Given that this appears to be the case, we’re concerned that other elements of the business are merely facades to show to U.S. investors, and that Cogo’s actual underlying operations are worth substantially less than the company’s current $170m market capitalization.

We hope that investors who own COGO and those considering buying shares at what appears to be a rational valuation familiarize themselves with the risks that we and others have addressed. We also hope that the SEC and COGO’s auditor KPMG take necessary precautions in protecting investors. We encourage KPMG to carefully analyze the evidence that we and other investors have provided, in order to ensure that COGO is accurately reflecting its financial position.

Disclosure: I am short COGO.