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VNET "Rebuttal" Deconstructed

|Includes: AMBO, LFT, LKM, SNFRY, 21Vianet Group (VNET)


I became bearish on 21vianet after reading Trinity Research's (NYSE:TR) report but what made me really jump on the short bandwagon was the "rebuttal" by the VNET itself. Now before I begin analyzing all the obvious red flags and inconsistencies that I have spotted straight away I have to note that I am not challenging everything written by Vianet in defense of itself. Basically my stance is that the company has very likely materially misstated the revenue and falsely presented itself as a growth stock with high prospects. Whether all of its acquisitions are fake companies or not is really not that important in my opinion - there are numerous examples of fraudster businesses trying to legitimize themselves by buying normal firms with investors' money and in the end they still blow up once the fraud is uncovered.

Here is a short summary of the points that I address in my analysis:

  • VNET's explanation of A/R balance and DSO growth is very weak and likely a blatant lie. I show this by demonstrating that the issue has begun earlier than 2013 like the company implies and that (according to JP Morgan's inquiry) its comparable competitors have not faced tax-related invoice collection issues.
  • VNET additionally challenges Trinity's statement that the revenue per S&M employee explosion is fishy by providing the "correct" S&M employee numbers that paint exactly the same picture as implied by TR
  • VNET goes into lengthy discussion of their Implied balance sheet strength ignoring the fact that Trinity clearly stated that the company is insolvent/troubled conditional on the revenue, EBITDA and A/R balance numbers being less than reported (which is very likely the case given that the company has not provided credible explanation for the DSO issue as I show above)
  • While other acquired companies maybe legitimate deals (or not which just makes the bear case for VNET even stronger) recent Aipu acquisition certainly feels like capital destruction. VNET shrugs off the accusations of mispricing by saying that one cannot compare price it has paid for the company and the multiple at which one of the founders has sold part of his stake saying it was some internal capital reshuffling at non-market prices. However, per Trinity's report private equity JD Capital has bought a part of Aipu in 2011 for much more humble valuation. Since the end 2011 Aipu business has stagnated so VNET's valuation of the company two years later indeed looks absurd as stated by TR.

1 Accounts Receivable

The central part of the fraud story told in TR's research report is the misrepresentation of revenue numbers by VNET which while not very large by itself translates into huge discrepancy between reported EBITDA and one guessed by TR due to large fixed costs of the company's business. (plus the issues with the whole MNS stuff). A common pattern among fraudulent companies falsifying revenue numbers (especially Chinese ones) is that their Account Receivables tend to rocket upwards together revenues. This also causes surges in DSOs. This is not particularly surprising as it's relatively easy to fake transactions and thus revenues but forging cash is truly cumbersome so the best way is to report

Vianet responds to Trinity's accusations by implying that the rise in DSOs is merely due to the new VAT tax policy that was implemented non-simultaneously across Chinese tech firms and thus some of their counterparts decided to wait a little before sending their invoices. Sound convincing, right?

Well, there are two glaring problems with this explanation. First of all, take a look at Trinity's report. Does it state that the problem began in 2013? Nope. According to TR VNET's DSO figures and accounts receivable started exploding in 2012 precisely when the IDC utilization rate has plummeted. So one simply cannot refute TR's claims by addressing only the year 2013. In its response Vianet very conveniently "forgets" to explain the reasons behind the ramp in receivables in 2012.

DSO and utilization rate dynamics as per Trinity

One can say something like "Hey, these guys were probably targeting 70-90 DSO figure from the start. Nothing to see here, folks". Well, here's another problem. The dreadful taxation issues that have plagued VNET were for some bizarre reason unknown to its competitors in the same industry. Don't take my word for it - here is what JPM (that tiny unknown investment bank that's probably very biased unlike objective Morgan Stanley that has never been involved in underwriting the debt for shady Chinese companies) has to say about DSO issue in their follow-up report on VNET's defense:

"Improvement in account receivable balance and DSO does not seem remarkable so far. We have noticed Dr. Peng's AR balance has declined YTD and China Net Center, which also has AR balance growth issue, told us their AR increase has nothing to do with VAT."

2 Revenue Per Employee

Revenue per Employee provided by Trinity (note the inconsistency with utilization rates)

Why is revenue per worker dynamics debate important anyway, you may ask? Well, for starters because VNET thinks so as they have devoted a separate page to the specific response to this part of Trinity's thesis. You see, as I've mentioned earlier it's relatively easy to pull the rabbit of hat on case of revenue figures but faking cash is way more challenging. So is misstating your workforce size. Now when your revenue per worker shoots up you either have made tremendous breakthrough in operational efficiency (be it by actually improving it or just laying of nonproductive excessive labor force) or your revenue growth exists only on paper. Trinity points out that one simply cannot have S&M worker (the way this term is defined by VNET basically means all sales and customer support guys) productivity larger with utilization rate getting lower. How does VNET respond? Flawlessly, as usual.

Revenue per S&M employee data provided by Vianet. Notice the same explosive growth in 2013

Revenue per Employee dynamics from VNET - notice the same 2013 explosion as in Trinity

Turns out we were looking at wrong numbers all along one has to look at MNS workers occupied with hosting services only. And voila! You get exactly the same dynamics of revenue per employee. You really can't make this up!

Thank for clearing this up, guys!

Borat Approves

3.Pristine Balance Sheet

A big share of VNET's rebuttal is devoted to Finance 101 style overview of the company's balance and financial statement. Well, it's nice to know they care about educating the investors on some basic accounting matters but the purpose of all this is rather puzzling. Where did TR imply that there is a problem with Vianet's report figures? Sure, conditional on revenue, net income and other figures being correct VNET's pre-report market cap makes sense. Except that Trinity for some strange reason thinks this is not the case. Using similar logic one can say that Nixon was the best US president conditional on all that Watergate thing not being true.

VNET is absolutely legit, I guarantee you!

The problem here is that when you are responding to the fraud allegations it makes sense to concentrate on important issues and not waste too much space on something that is rather self-evident unless of course you desperately want to divert investor's' attention from some shaky part of your defense.

4.Aipu Purchase

Now it is time to address the issue with Aipu purchase. VNET's line of defense is based on two premises: 1.Company is valued fairly if one applies P/E multipliers similar to those for Dr Peng's deal made in 2011(purchase of Great Wall)

2.Sale of Aipu stake by insider in 2012 with P/E multiplier of 1,4 is just accounting bogus for moving the capital within the company

Let's first address the second claim. You see, Trinity in its research shows that in fact there were other deals involving Aipu share capital that I have summarized in a table together with Vianet purchase. What immediately comes to mind of anyone looking at the figures is how they (NASDAQ:VNET) arrived 1400 price tag?




Valuation (Mln RMB)


Aipu Investment




JD Capital




Chengdu Guotao Investment







I guess all those Chinese PE guys were blind not to see the true gem that is Aipu. Vianet's shareholders should be proud of their company - these guys have managed to buy a business that is shrinking in revenues and earnings at only 23 trailing P/E. Amateur western investors who are not ready to buy negative growth stocks at more than 8-10 P/E ratios max could learn a thing or two from these guys.

Aipu Financials

So what about Great Wall acquisition made by Dr. Peng that Vianet cites as an example of a similar transaction at P/E multiple of 15? Well, at that time the industry was booming and investors were ready to pay large multiples for growth firms. With the market getting saturated and commoditized paying 1,5 more for a company that is stagnating at best simply makes no sense.

Goofy does not Approve


Having shown how VNET is dishonest even in the basic parts of the response to Trinity's report I plan to additionally cover the two following issues in separate pieces on VNET:

· "Trustworthy" management and "unbiased" sell-side analysts that have a solid track record of pumping ChiScams.

· Very handy 100 mln USD buyback authorization that magically coincides with the company's stock being artificially supported at 20 USD level. VNET investors should really like the fact that the management in burning cash in millions by helping short-sellers to accumulate their positions.

Disclosure: The author is short VNET.