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Small time portfolio manager trying to make sense of a crazy world.
  • post citron, post conf call 8 comments
    May 6, 2011 11:14 AM | about stocks: LFT
    What exactly are the issues with LFT? (sorry if this is kinda long)
     
     Nobody seems to question, even Citron, that LFT is a large software provider and that the relationships with the big Chinese banks, specifically CCB, are real. So people are wondering about the margins, I think 60% gross margins on software development with a large support staff to do customization and integration makes sense. CY 2010 they had roughly 3,200 software engineers (averaged over the year), paying them $20k each (which seems reasonable, this year it is up to $25k and wage inflation for 2011 has come down to 15%). So call it $64MM? Company reported $63.35MM in COGS last year... seems largely in line to me. My back of the envelope numbers are certainly in the ballpark, I don't see anything glaring there. 
     
    So then are they inflating revenues? We know they are a large software provider to CCB among others (CCB says as much) but how big? Hard to prove one way or another as no one is going to do channel checks across the whole organization. I'd be willing to bet neither the Wall Street analysts nor Citron has any special insight into this. But if we take our 3,200 software programmer number and divide it by 2010 reported revenue: $169MM, we get roughly $53k in revenue/employee, even less if we look at their total employee count, which strikes me as plausible. A tech company in the US might get $150-$200k per employee and pay roughly $60k-$75k, so the ratios are pretty consistent in the 2.5x range. So I'm not sure what type of fraud this is? Are they underreporting expenses or claiming extra workers just to make the inflated revenue numbers look feasbile? I dunno, nothing pops out at me here.
     
    So then there is this whole Xiamen employment agency link. The company did say, prior to any of this Citron stuff coming out, that they were cutting out the 3rd party and employing people directly through Longtop and that there shouldn't be any margin impact so does it even matter? I've certainly received checks made out from entities other than what my business card said... really isn't that uncommon. Also if you look at the CC transcript from the Giantstone acquisition last year dated March 30th 2010 they really did address this same issue seemingly in response to allegations of impropriety, which does make me wonder about the timing of the Citron short report. A real concern seems to be the wage inflation they are experiencing. I'd be interested to know how their contracts make allowances for that and what part of their growth is pricing escalation vs volume. But that wasn't Citron's beef so we'll save that for another day.
     
    The chairman's generosity with the stock gifts is an interesting point. Now if the gifts were promised as a way to retain employees then it is really a form of compensation. The accounting actually looks at this the right way as they did report a significant loss in connection with the gift. The problem is what if the gift is ongoing and they need to give these employees stock every year. At some point the chairman's generosity or his shares runs out and the share grants become dilutive. This isn't illegal or anything, pretty much every single company in the US does exactly this to varying degrees, but it would lower GAAP margins going forward.  

     As for why they haven't bought any stock back yet the quiet period argument is valid. Quiet periods generally run from 1 month before to 3 days after major releases. Usually you see companies set up buyback programs as 10b5-1 plans in order to avoid exactly this type of problem but if Longtop hasn't done that, ie they retained the timing decision making, then they can't do it now. As for what the big news is going to be, it seemed from the conference call that the material information was the earnings release. I guess he was hinting that they knew they were going to come out ahead of guidance but utlimately any earnings release is generally considered material non-public.
     
     
    As for Palaschuk, he worked for eLong and Sohu.com both of which are large Chinese Co's with ADR's listed in the US and are still up and running (haven't been blown up by short research reports yet). Looks like he was hired in 2006 to help prepare for LFT's IPO in 2007. I've actually met him, he's Canadian, seemed like a decent guy. Seems like he's made a career out of being a respectable white face to put in front of Chinese companies. Not sure why he'd stick around LFT if he knows its a fraud, seems this guy would have other options. Also not sure why LFT, if it was a fraud, would IPO as an ADR instead of going the reverse merger route. Why choose to make your life more difficult?
     
     
    So who knows, the 23rd will be interesting.


    Disclosure: I am long LFT.
    Stocks: LFT
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Comments (8)
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  • Compare revenue per employee of LFT with us companies does not seem to be a correct way. You can't compare an Italian shoe maker with chinese shoe maker, right? Anyway, good to see some article comes out to discuss the lft
    6 May 2011, 10:36 PM Reply Like
  • About xiamen employment agency, citron's point is whether it is a related Party of lft. Now that the company are cutting out the 3rd party, but they never explains why it went through the 3rd party.and this 3rd party should be mentioned in ipo files, but it's not. Longtop is the only customer of the agency, and longtop denies it's a related party. Doesn't it sound suspicous?
    6 May 2011, 10:49 PM Reply Like
  • Author’s reply » Related party is a legal definition that implies that there is cross ownership or a family bond between the two parties in a contract. It doesn't speak to the degree of interaction between the businesses or the dependency of one for the other.

     

    Directly from 2009 20-F (equivalent to 10K) which I think is the first mention of their use of employment agencies:

     

    Employees
    The following table sets forth the number of our employees and contractors categorized by function as of the dates indicated:

     

    March 31, March 31, March 31, December 31,
    2009 2008 2007 2006

     

    Software development 1,310 913 402 267

     

    Revenue other services 559 253 125 117

     

    Research and Development 208 164 63 62

     

    Sales and Marketing 287 129 76 64

     

    General and Administration 238 200 124 113

     

    Total 2,602 ** 1,659 * 790 623

     

    * This number includes 1,496 contracted employees provided by Xiamen Longtop Human Resource Services Co., Ltd, an unrelated party, pursuant to a human resource service agreement with us. Under this agreement, we have agreed to pay a monthly service fee to Xiamen Longtop Human Resource Services Co., Ltd to cover the cost of those contracted employees as well as operational expenses. We consider these 1,496 persons to be employees.

     

    ** This number includes 2,039, 35 and 57 contracted employees, respectively, provided by Xiamen Longtop Human Resource Services Co., Ltd, Beijing Foreign Enterprise Human Resources Service Co., Ltd., or Beijing FESCO, Randstad Shanghai Temporary Staffing, each an unrelated party pursuant to a human resource service agreement with us. Under each applicable agreement, we have agreed to pay a monthly service fee to Xiamen Longtop Human Resource Services Co., Ltd., Beijing FESCO, and Randstad Shanghai Temporary Staffing to cover the cost of those contracted employees as well as operational expenses. We consider these 2,131 persons to be employees.
    8 May 2011, 10:16 AM Reply Like
  • Author’s reply » As for the cost/employee comment, I'm not comparing rev/employee between PRC and US, I'm looking at the ratio of revenue/expense and not the absolute numbers.

     

    Looks like PRC made changes to their employment contract law in 2008, which is precisely when Longtop started making use of employment agencies.
    8 May 2011, 10:23 AM Reply Like
  • Thanks for sharing.
    For those month, the lft stock price dropped from 30+ to current 20. I lost so much.
    Crying..
    9 May 2011, 07:04 AM Reply Like
  • Thanks for sharing. I brought quite a lot call option which will expired in May. 20. Do you think will lft be able to go up to 24 before that?
    For the past month, I lost quite a lot when the price went from 30+ to 20. (Crying...)
    9 May 2011, 07:04 AM Reply Like
  • Author’s reply » some other info from rummaging around the IPO filings:

     

    Tiger Global (which is a respected tiger-cub hedge fund) was one of the initial investors in LFT and held 25% of the equity pre-IPO. They didn't sell any in the IPO and still own just shy of 5%. So if LFT is a "fraud from day one" they managed to hide it from their largest initial independent equity investor. Someone that was free to do as much unconstrained due diligence as they wanted.

     

    This may not mean much to some people but Goldman and DB ran the initial offering back in 2007. In IPO circles that's about as close as you're going to get to a good housekeeping stamp of approval. Someone posted a list of defunkt Chinese stocks on this board a couple of days ago, guys like CCME and CAGC, and if you look at who ran the offerings you won't find the big bulge bracket banks. Instead you'll find smaller 3rd tier ibanks like Rodman and Pali. Obviously isn't definitive, but there is a reason people pay attention to strong institutional sponsorship. Now anything is possible but LFT just doesn't 'look' like the other Chinese fraud cases.
    10 May 2011, 09:42 AM Reply Like
  • where do you guys come from? The stock get shown to be a fraud by Citron and all of the sudden, out of nowhere, you make this post defending the company. Is there any doubt that you work for this fraud?
    10 May 2011, 01:12 PM Reply Like
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