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NQ, Time To Get Delisted

|Includes: Link Motion Inc. (LKM)

All too often you hear the warnings of taking your company public before it is ready. It's the start of having to deal with the public filings and the scrutiny of your shareholders. Carson Block has coined a new caveat: If you take your company public, it might not really exist.

With the majority of allegations brought by Muddy Waters (MW) proven to be false, the few minor issues that remain seem to be characteristic of a fledging tech enterprise. Having been founded by 3 brilliant individuals (2 have PhDs), NQ Mobile (NQ)was taken public 6 short years lader under these three academics . Shortly after, they recruited Omar Khan, an executive with accolades from Samsung and Citigroup.

This bears much resemblance to another company founded by 2 PhD candidates, who later brought on a seasoned executive to help them grow their business. This company needs no introduction, but if you need help, you can Google it.

The only difference was Omar Khan needed to hit the ground running, sorting out issues that all new companies have, in a disparate cultural environment, under the unforgiving eye of public scrutiny. Meanwhile, Eric Schmidt had 3 years as a private company to whip it into shape. There are some changes that the company implement to make it a stronger operator, but it is difficult to undergo a transitional phase as a public company.

With its strong growth prospects and need for operational efficiency, NQ would be a strong candidate for a private equity buyout.

So what are the issues and which ones need to be addressed?

Financials

Cash Balances and 90% of Revenue is non-existent - FALSE

NQ has been more than forthcoming with this their cash balances and begun transferring funds into the reputable Standard Chartered Bank. These transfers will continue with the maturation of term deposits.

There's been some confusion about the Level II classification. For those without a Finance/Accounting background, all that means is that it's slightly harder to get to than the money in your pocket. The Federal Reserve classifies all our money the same way. They use the M2 designation, which includes money in your savings account and certificates of deposits (CD = Term deposit). For some more information, you can refer here.

With cash position established, it's difficult to allege than the revenue does not exist. Or who knows, maybe the people allegedly stealing money have decided to return more than they've taken? Unlikely.

High Days Sales Outstanding (DSO) Ratio is a problem - It could be, but it can be resolved.

DSO is an accounting ratio that measures how long it takes a company to get paid. In NQ's case, it's 145 days for its latest quarter. They can certainly bring this number down with a more proactive collections team.

Drew Bernstein, an expert of Chinese accounting methods, says that its not unusual for Chinese companies to have long collection periods as long as 2 years (730 days). In fact, he points out that AsiaInfo-Linkage, a company being acquired by a PE firm, took 30% longer to collect on their bills than NQ.

This is a case of money sooner rather than later. While I'd rather have it today, the most important thing is that it gets to me. With this issue having been brought to attention, I can see NQ bringing recruiting a more proactive collections team to bring this number down.

Product

It's not real - Oh, but it is

MW alleges that NQ's market share is likely to be under 1.5%, if anything at all. This statement is contradicted in a number of ways. It's already been established that they have money and that the money had to have been earned somehow. Google Play shows reviews for NQ Products and are public available. Piper Jaffray, a reputable investment bank, has public stated that their research shows NQ's market share is several times larger than what MW claimed. And these figures don't include the unbranded NQ products.

How many people have heard of ARM Holdings? Probably not that many, yet millions of people use its products everyday. Apple licenses ARM's chip technology and uses it in its iPhones, yet they are still branded as Apple products. This goes for an innumerable number of products that are licensed and then rebranded.

Poor quality - Says Who?

I am not a software expert, but I can certainly judge the facts.

NQ's products have been repeatedly vetted by reputable firms. And the result? Certifications and awards.

On the flip side, Muddy Water's claims of inferior product are backed by unknown parties. The cache of a reputable company can go a long way, so why wouldn't it be disclosed? Maybe it was tested by a farmer, or maybe it was tested by a competitor who may have some bias? We don't know, but for a company demanding more disclosure, MW isn't setting a very good example.

Other Matters

Yidatong's Office - We found it

In an age of famed corporate excess, it is surprising that corporate frugality can be equally vilified. Reporters were able to track down Yidatong, an associate of NQ, at their office in Beijing. Rather than be report on the false allegations of the non-existent offices, they sensationalize the fact the workers there were sharing an economical space.

While we lambaste the executives that lavish themselves with sprawling offices in Manhattan office towers and glorify the startups that pride themselves by squeezing in to the smallest of spaces, it's a shame to see the double standard that can be applied when the media wants to.

When was Xu Rong there? - Who cares?

There is some controversy surrounding the employment of Xu Rong, a former employee that now heads one of NQ's partners. The main issue was Matt Mathison's, the VP of Investor Relations, response did not match up to previously stated facts.

I must point out that Matt was hired less than 4 months before MW came out with their report, which Xu was employed more than 5 years before that. If you were asked about an incident that happened 5 years before you started working, what would your response be?

She worked there and now she doesn't. End of story.

The Buyback - The Case for an increase

There has been some negative mention of a buyback being announced right after MW's report. For clarification, the buyback was announced long before the report. It was subsequently increased, again, long before the report was issued.

While a case can certainly be made for making better use of capital, keep in mind, they essentially just raised money at a $25.61 valuation with their convertible notes, why would they not take advantage of the massive drop in price by buying these shares back?

Partnerships and Client List - A Ridiculous Notion

I'll keep this one short. When was the last time that China Mobile announced a new partnership? See for yourself.

Look up Man Group, one of the largest hedge funds in the world, and try to get their client list. The same goes for Microsoft. Client lists are the bread and butter for these types of companies. It's the equivalent of asking Coca Cola for their secret recipe or Google for their proprietary code. Enough said.

The Short Seller - Muddying up the Waters

For a company that was founded in 2005, NQ Mobile has done extraordinarily well. As a result, it makes the company a target for short sellers. And to date, the short sellers have been pretty successful, with NQ's stock still down almost 48% from before Muddy Water's report. Below is a quick overview of MW's short targets.

Company

Before

After

Orient Paper

$ 8.49

$ 2.40

Rino International

$ 15.52

Delisted

China Media Express

$ 12.27

Delisted

Duoyuan Global Water

$ 5.49

Delisted

Sino-Forest

$ 20.00

Delisted

Spreadtrum Communications (Taken private)

$ 13.55

$ 31.00

Focus Media Holdings (Taken private)

$ 25.50

$ 27.50

Fushi Copperweld (Taken private)

$ 6.65

$ 9.50

New Oriental Education

$ 22.45

$ 28.08

Olam International

$ 1.66

$ 1.56

American Tower

$ 74.71

$ 80.82

I updated their Wikipedia page. Feel free to add anything I missed. It is interesting that a research company with a 45% success rate (you'd have better chances guessing the outcome of a coin flip), has so much clout. Reason? Simple. When you lose, you lose big. Among MW's successes, 4 companies were delisted. So if you held on, you loss 100% of your investment. However, on his many errors, those who held on and took advantage of the turmoil were handsomely rewarded.

NQ Mobile is a classic example of a promising company that went public too early. While I would like to see the issue of better reporting and controls being addressed, this company is clearly not the "massive fraud" that it was made out to be. Muddy Waters did shareholders a favor by pointing out the minor issues that would make NQ a stronger company. It also shined a light on a promising prospect for private equity firms. Either way it makes for a solid investment.

Disclosure: I am long NQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.