Based on our research, Exceed Company Ltd. (EDS on the NASDAQ) is falsifying its financial statements. EDS portrays itself as a market leader with nearly $400,000,000 in sales under the "Xidelong" brand name.
In reality, we believe Exceed's actual revenue is less than $40,000,000 and that the company is a boutique player masquerading as a giant. A concise summary is below; however, our full 28 page report including all source documentation is available here.
- Local Filings in China Do Not Match SEC Financial Statements: Filings from the SAIC show that the company generated 1/9th the revenue and net income reported to U.S. investors. They also show the company's claimed cash balances as fabricated. We then caught management swapping the original SAIC documents out for fabricated filings designed to mirror SEC filings.
- Independent Industry Analysts and Government Data Confirm That Exceed Is Not a Sizeable Player in the Chinese Sports Apparel Industry: Multiple independent market research reports and government data classify EDS as a small player in its respective industry, contrary to management's claim that EDS is a market leader.
- EDS's Failed IPO in Hong Kong Was a Grave Warning Sign: Due to the Beijing Olympics, companies in the China sports apparel industry were hot commodities, in which their offerings were generally priced in line with peers and oversubscribed. EDS's Hong Kong IPO failed despite pricing at half the valuation of public competitors. EDS then turned to U.S. investors in a deal which valued the company at a P/E ratio between 2.01 and 3.02, depending on potential earnouts.
- Media Reports and Lawsuits in China: Chinese press implies the firm only listed in the U.S. after failing its Hong Kong IPO amid rampant fraud allegations.
- A Top Chinese Forensic Account Expert Has Provided Evidence That the Company Is a Fraud: Leading financial investigator Zheng Chaohui (Summer Grass) has provided supporting data that Xidelong is defrauding investors.
- Where's the Cash?:EDS claims a large cash hoard, yet refuses to buyback shares, warrants, or pay a dividend. Despite reporting large amounts of cash, EDS behaves as if it is in dire need of capital.
- Advertising Expenses Seem Massively Overstated:A detailed breakdown of advertising and promotion expenses and sponsorships seems to confirm that EDS is massively exaggerating its size to U.S. investors. We compare EDS to the comparable companies China Dongxiang (Group) Company Ltd. and Peak Sport Products Co., Ltd. to demonstrate this.
Local Filings in China Do Not Match SEC Financial Statements
EDS has two subsidiaries that conduct all operations: Fujian Xidelong Sports Goods Co., Ltd and Xidelong (China) Co. Ltd. A corporate structure diagram is below (click to enlarge image):
Fujian Xidelong is a very small company which accounts for about 4% of revenue/net income, while Xidelong (China) accounts for 96% of the consolidated company's revenue/net income, according to Claire Zheng of Investor Relations and Vivien Tai, a former CFO who is currently Vice President of Finance. Fujian Xidelong and Xidelong (China) are both Foreign Investment Enterprises because they are owned by a Hong Kong company.
Chinese corporate law applies higher standards of scrutiny to Foreign Investment Enterprises (FIEs). FIEs are legally required to file audited annual financial statements with the Chinese government and they must file the same audited figures to both the SAIC and the SAT.
An initial joint inspection involving the SAIC and SAT ensures the financials are identical. The SAT is the official taxation bureau of China and there are serious repercussions for submitting incorrect information. Accordingly, the SAIC documents originally filed are identical to a company's official tax filings and are very accurate.
Below is a comparison of the SAIC filings for Xidelong (China) as compared to the SEC numbers for EDS.
|Income Statements (000's RMB)||Chinese Audited Numbers||SEC Numbers|
|Cost of Sales||141,344||1,323,262|
|All other Expenses||44,423||328,492|
Since Xidelong (China) accounts for 96% of the consolidated company's total revenue and profit, it is clear that the company's Chinese government filings show a far smaller business than the SEC filings.
We believe that through an amendment process, a fraudulent company can go to the local SAIC office and remove the original audited SAIC filings, which are identical to the official tax filings, and replace them with fabricated filings designed to fool investors. Since the SAIC filings are only checked to match the SAT filings during the initial joint inspection between relevant government agencies, it is easy to swap the filings subsequent to these inspections.
To clarify, after the joint inspection, the SAT will not check the SAIC filings to ensure they are identical; it is only the original filings which have been verified by the SAT. We caught management doing exactly this with Xidelong (China) when we accessed the company's 2009 financials; management had replaced the original 2008 audited filing with a fabricated version designed to mirror SEC filings.
The next table compares the original filings with the amended version that management swapped in.
|Income Statements (000's RMB)||Chinese Audited Numbers||Amended Numbers|
|Cost of Sales||141,344||1,294,675|
|All other Expenses||44,423||264,834|
Independent Industry Analysts and Government Data Confirm That Exceed Is Not a Sizeable Player in the Chinese Sports Apparel Industry
Just as Citron pointed out with CCME, the notorious RTO fraud, EDS is missing from all independent industry analysis as the reports below dictate:
Report 1: This report by Everbright Research shows competitors in China's sports apparel industry, yet nowhere is EDS mentioned, even though EDS claims to be exponentially larger than some of the companies profiled.
Report 2: This thorough analysis of the Chinese shoe market by the Italian government discusses the largest competitors in Chinese footwear. It has an analysis of top competitors, but once again, EDS is missing.
Report 3: This detailed report by Gao Hua/Goldman Sachs covers the sports apparel/footwear segment. Once again, there is no mention of EDS anywhere.
Report 4: This report is only available after purchase. This report details textile footwear revenue for FIEs by geographic areas. According to Claire Zhang, EDS has almost exclusively textile shoes. In Quanzhou prefecture-level city, which includes Jinjiang, all FIE producers had total footwear sales of $43,480,000. EDS's operating subsidiaries are FIEs located in Jinjiang; curiously, EDS claims that footwear revenue aer three times as large as all sales generated by all producers in the area.
|Total Quanzhou FIE Textile Revenue||EDS Claimed Footwear Revenue|
While we are unsure of the specific year that Quanzhou FIE revenue totaled $43,480,000, it's important to note the report was compiled solely using 2008, 2009, and 2010 government data, and therefore EDS's claims would seem impossible.
Report 5: This report has a pie graph of the largest sportswear players and, as always, EDS is missing. Yet based on SEC-reported numbers, the company claims to be bigger than several of the companies shown below (click to enlarge image):
EDS's Failed Hong Kong IPO Was a Grave Warning Sign
During the 2007, 2008 and 2009 timeline, Chinese sports apparel companies were hot commodities due to the Beijing Olympics. Institutions and retail tranches were usually exponentially oversubscribed and pricing was in line with peers.
In June of 2008, two competitors attempted to go public: EDS and Xtep. Xtep successfully went public at 17.1x current year EPS estimates and demand was high enough that certain investors only received 33% of the shares they requested. EDS's IPO was priced at 8.5x earnings, roughly half the valuation of Xtep and other publicly traded peers, yet investors were not willing to participate. EDS claimed that the failure was due to market conditions; however, after examining 361 Degrees' IPO, this seems implausible.
361 Degrees went public after the Hang Seng Index dropped another 3,350 points, raised money at a 35% premium to EDS's proposed price, and had its retail tranche 40x oversubscribed. 361 Degrees raised money in far worse market conditions, at a substantial premium to EDS, and still had an exponentially oversubscribed offering. There was clearly a reason why investors refused to participate in EDS's offering. EDS then turned to U.S. investors by merging with a Special Purpose Acquisition Company ("SPAC"). The SPAC acquisition valued EDS at a price-to-earnings ratio of between 2.01 and 3.02, depending on potential earnouts. A detailed methodology can be found in our full length report. Clearly there is something gravely wrong when a supposedly thriving company is selling equity at 2-3x earnings.
Media Reports and Lawsuits in China
National Business Daily published a series of articles about the failed Hong Kong IPO. The initial July 8th article discuses rumors that the company had falsified loan documents. The second article, from July 23rd, discusses an interview with a corporate insider who advises PRC companies on listing. He implied that the IPO failed due to "objective factors," such as failing the financial audit. The newspaper also proudly proclaims that it was among the first to challenge EDS on its claim the IPO failed due to market conditions.
In addition to the National Business Daily articles, there have been additional allegations from more informal sources. In these more harsh allegations, EDS's China rap sheet includes theft, brand infringement, submitting falsified financial information and bribery. The company was also sued by its Hong Kong underwriter, KGI Capital Asia, for refusing to honor contractual obligations. All of these articles can be found translated here.
Where's the Cash?
Exceed claims to have an unusually large cash hoard, yet refuses to buy back shares, warrants, or pay a dividend. This has long been an excellent indicator in finding RTO fraud: Look for the companies who claim in SEC filings to have large cash positions, yet behave as if they have no cash. Due to this refusal to buy back shares, warrants, or pay a dividend, analysts turned the Q4 conference call into a circus, as they couldn't fathom why EDS wasn't proceeding with these options. One analyst even blatantly asked if the company is a fraud.
In reality, we believe there is a clear reason why management doesn't pay a dividend: We believe the cash is not real and only exists in the company's falsified SEC filings. The below table compares cash and AR between the real audited Chinese numbers and the amended numbers.
|Balance Sheet (000's) RMB||Chinese Audited Numbers||Amended Numbers|
A Top Chinese Forensic Account Expert Has Provided Evidence That the company Is a Fraud
Zheng Chaohui, a leading Chinese analyst, was one of the first to question Xidelong's financial statements. Mr. Zheng has been hailed by the media as one of China's greatest financial detectives for his work exposing dozens of frauds. His techniques can be found in KPMG, Ernst & Young, & Deloitte & Touch internal training manuals. Mr. Zheng wrote about Xidelong here. In this article, he suspects Xidelong's financial results as "being made out of thin air." He also alludes to fictitious revenue and discusses how Hong Kong investors didn't believe in Xidelong's financial results.
Advertising Expenses Seem Massively Overstated
The table below compares advertising and promotion expenses for EDS and two prominent China footwear manufacturers: China Dongxiang (Group) Co., Ltd and Peak Sport Products Co., Ltd.
|A&P Expenses (Million RMB)||2008||2009||2010||Total|
Based simply on percent of gross revenues, these numbers seem reasonable. But when the details related to these aggregated totals are more closely examined, it becomes apparent that EDS should not be claiming expenses in the ballpark of China Dongxiang or Peak.
China Dongxiang sponsors the China Open Tennis Tournament, World Golf Championships, Olympic Skiing, Travel Channel Golf programs, top professional Soccer Teams, a racing team, an art show, Bazaar Fashion Image, and many other events. Peak sponsors 13 NBA players, an Australian basketball team, a cycling race, numerous NBA events, an Olympic Team, various basketball events, and 6 Chinese soccer teams. Both also engage in vast TV advertising. EDS, in contrast, sponsors no sports teams, professional athletes, or Olympic Teams. Instead, its sponsorships comprise of a teenage pop group and magic shows on TV. A detailed listing of Peak and China Dongxiang's other sponsorships can be found in our full length report.
Based on our methodology, detailed in our report, we derive a $.95 price target in comparison to the stock's current $4.45 price. This valuation is also the bull case considering we assume high growth rates and margin expansion.
Disclosure: I am short EDS.