post citron, post conf call
May 06, 2011 11:14 AM ETLFT-OLD8 Comments
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Seeking Alpha Analyst Since 2011
Small time portfolio manager trying to make sense of a crazy world.
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.
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