If you're anything like me, your first stop in the morning isn't towards the shower or the kitchen, but checking your electronic device to see whether or not NQ Mobile's (NQ) annual report (20-F) has been released.
I'm sure most of us are all guilty of this and even more so now that the Special Independent Committee report has been released. The independent committee worked with Shearman & Sterling LLP, an international law firm as well as Deloitte & Touche, one of the "Big Four" auditing firms who acted as the forensic accountants.
The only thing left for investors to digest is whether or not PricewaterhouseCoopers ("PwC"), NQ Mobile's auditor, gives the final seal of approval.
Over the last couple of days, I've been asked many times by investors about what my thoughts were on NQ Mobile and whether or not I believed the Company would receive an unqualified audit, or a qualified audit. Today I would like to go through some of these steps and give investors a better idea of what is about to come forth and how to play all of the volatility.
What Is A Qualified Audit?
First, investors need to understand the difference between a qualified audit versus an unqualified audit. Contrary to its suggestion, a qualified opinion is not a good thing for a company and its shareholders. Auditors that issue qualified opinions most likely report a lack of compliance with GAAP principles, inadequate disclosures, limitation of scope, or statements of cash flows being excluded.
A scope limitation occurs when auditors are unable to audit some of a company's financial statements. One of the most common reasons is the inability of the auditor to correctly audit the inventory balance. If auditors are unable to do so for whatever reason, a qualified opinion is issued. A qualified opinion suggests that the information provided was limited on the scope of the audit, meaning the auditor was unable to obtain sufficient evidence to correctly verify transactions and reports being audited.
If an auditor determines the financial statements of a company are in accordance with GAAP, except for a couple of minor mistakes, a qualified opinion is still issued. It's been said that this type of opinion isn't very common, but still occurs from time to time. In most cases, depending on the circumstances, a company could correct the errors in order to receive an unqualified opinion.
An adverse opinion will be issued if it is deemed that the financial statements are misrepresented, misstated or are not in compliance with GAAP. Adverse opinions are very negative for companies because they imply wrongdoing. Thankfully for shareholders, these instances are few and far between.
Disclaimer of Opinion
If scope limitations are so unwelcome that auditors are not able to give an opinion on the financial statements overall, a disclaimer of opinion is issued. This is because auditors have not completed a thorough examination of accounts, or the examination is not broad enough in scope to enable them to form an opinion. In these types of cases, companies are required to fix certain issues and must begin the audit process all over again.
The Final Verdict - Based on what was written in the Special Committee's Independent Investigation report, I believe the chances that NQ Mobile receives a qualified opinion is legitimately slim. Below is a summary of the report;
Scope of investigation
(i) The Investigation Team conducted a thorough review of cash reported on the Company's financial statements and the Company's cash transactions, which included the following procedures: obtained bank confirmations for the Company's accounts through in-person visits and mail; ... verified all cash transactions exceeding $1 million, all cash transactions related to the proceeds of the Company's convertible bond offering, and all cash transactions that the Investigation Team otherwise determined merited review, ... confirmed the authenticity of major savings accounts in Beijing by tracing cash deposits made by the forensic accountants without notifying Company management or its staff.
(ii) Reviewed and examined selected financial information and records (such as principal financial documents, ledgers and vouchers, bank slips and advices, revenue forecast and other financial forms, invoices, organization charts, and contracts) for any indications of fraudulent activity or improper financial reporting.
(iii) Reviewed and examined selected databases of the Company (including those relating to the tracking of accounting data, tax data, and customer transactions) for any indications of fraudulent activity or improper financial reporting."
The Investigation Team determined that the Company's cash balances were verifiable and consistent with public disclosures. ... (ii) The Investigation Team did not find evidence that the Company's revenues were inconsistent with public disclosures."
What Is An Unqualified Audit?
Contrary to its name, an unqualified opinion is great news for a company and its shareholders. An unqualified report, or "clean bill of health," is the ultimate goal for companies as you can imagine. This means that after a thorough investigation, the auditor did not detect any red flags (fraud), during the examination. So how likely is it that NQ Mobile will receive an unqualified audit? I think the chances of that happening are highly likely as I've already outlined above.
Investors should remember that PwC, which has been NQ's auditor for a number of years now, has not found any red flags to date in its previous annual reports that it has signed off on. Now that the independent report has been made public, and with no fraud found, is PwC going to suddenly raise some red flags and say that it missed a bunch of stuff that it should have caught years ago? Not likely in my opinion, and if they did for some reason, it would be a major blow to their reputation and business.
Based on what I have seen and read, I believe NQ Mobile will receive a favorable outcome (unqualified audit). This will finally give investors the chance to value the company based on its fundamentals and growth and not on all of the shenanigans that have come into play over the last half of the year.
I'm not the only one who thinks this, as many large institutions and hedge funds have been buying shares ever since the Muddy Waters ("MW") report came out. Just last Friday, ChinaRock disclosed in an amended filing that it had more than doubled its stake in NQ Mobile. Below is a table of ChinaRock's amended filings.
|ChinaRock Capital Management||Shares||% of Shares|
* These shares represent American Depositary Shares ("ADS") which represents five Class A Common Shares
** Float has increased over the last eight months which is why there is a discrepancy in the percentage of shares
Short Interest On The Decline - It's not hard to find the bears that have been telling investors that shares are going to zero and that MW was right all along.
My question to them is simple; why has the short interest declined over the last month if NQ Mobile was such a "fraud"? Seems like some shorts are pulling the Ol' Switcheroo by saying one thing and doing the exact opposite. Just take a look at the short interest figures in the table below.
|Settlement Date||Short Interest||Days To Cover|
As you can see, short interest has been on the decline over the last month or so. In that month, short interest has gone down almost 15%.
One of the biggest claims that MW made was that NQ Mobile had no cash. After the Company provided accounts, bank statements etc., as well as forensic accountants from the independent committee to verify the cash, it looks like one of MW's biggest arguments has gone right out the window (just like its other accusations). Of course, all eyes are on PwC for the final seal of approval, but it sure looks like the odds are in favor of the longs at this point.
The last remaining question is when is the 20-F going to come out? While nobody knows the answer to this question, there has been a lot of speculation going around of when the report will come out.
Here is my take on the whole situation again. Last week, I said that it will most likely be a week or so before the report comes out. So far I am right on track. This means that the report could come out over the next couple of days or in the early part of next week. Of course it could definitely take longer than that, but that's my expectation.
With so much information going around, investors should remember one very important thing. There is no exact timetable or requirement for PwC to finish the report. The results could come out tomorrow morning for all we know, or they could come out a month or two later. So either trade the volatility on the intraday pops and drops, hedge your positions with options, or if you are really confident, sit back, relax, and wait for the fireworks to begin.
As always, I'm providing you with my track record and other particular stocks that I recommend. The link provided will show you all of my picks, how they have fared, and where I think they will be going in the near future. I think you will find my track record to be very impressive and useful.
Disclaimer: Investors are always reminded that before making any investment, you should do your own proper due diligence on any stock mentioned in this article. On that note, have a great day and as always, I look forward to hearing your thoughts or questions that you might have.
Disclosure: The author is long NQ. 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.