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Muddy Waters becomes third short-seller this year to accuse China's GSX Techedu of systemic “fraud”

Muddy Waters has published a damning report on GSX Techedu calling it a “near-total fraud” – the third short-seller this year to accuse the New York-listed Chinese moonshot of systemic fraud.

GSX Techedu was four weeks ago called “the most blatant Chinese stock fraud since 2011” by Citron Research, after another short-seller, Grizzly Research, said in February that “GSX’s success is actually based on a fraudulent scheme”. VIPKid, one of GSX Techedu’s rivals, in April launched legal proceedings against the organisation related to alleged intellectual property theft.

Muddy Waters, similar to Citron and Grizzly before it, said “we think it’s quite likely that at least 80%” of GSX Techedu’s users are “fake”, adding that it based its findings on “user and attendance data files” downloaded “from more than 200 paid K12 classes covering 54,065 users”.

The short-seller claimed that “a former GSX manager corroborated our analysis, and explained various details of GSX’s extensive bot operation”, which, according to Muddy Waters, has been used to inflate student numbers and give weight to robust financial growth.

“We conclude that GSX is a massive loss-making business”, said Muddy Waters in its report, which included detailed break-downs of methodology and extensive evidence supporting allegations. “Without users, there is no revenue.

“We also conclude that GSX greatly understates expenses.

“Regardless of how one cuts it, though, GSX is an almost completely empty box.”

On publication of the new report, compiled by one of the world’s most prominent short-sellers, GSX Techedu’s share price fell from $35.43 to $29.71, before recovering to, and closing at, $32.84 on 18 May. In February, the business was trading at $45.

In a statement dated 19 May, GSX Techedu “refuted the false allegations” in Muddy Waters’ report: “The company respects Muddy Waters' efforts. However, after analysing the report, the company believes that Muddy Waters lacks a basic understanding of GSX's operations.

“The company's management regrets to see confusion in the market and will continue to use its best efforts to ensure that investors fully understand all aspects of the business.”

US law firm Wolf Haldenstein Adler Freeman & Herz announced on 15 April that it was investigating “serious and disturbing class action claims” about GSX Techedu on behalf of shareholders in the company.

Listed on the New York Stock Exchange but based in China, GSX Techedu is an online after-school tutoring company that claims to achieve extremely high margins by employing high-quality teachers to instruct classes comprising thousands of students in middle-tier mainland cities.

In the fourth quarter of last year, GSX Techedu reported a standalone gross profit margin of 79%, and said full-year revenue for 2019 was ¥1.58 billion (£181 million), up 520% from ¥254.6 million the year prior.

The report by Muddy Waters, which said it is “highly confident” that at least 73.2% of the nearly 55,000 GSX Techedu users it analysed “are bots”, will likely carry more weight than previous allegations by less well-known short-sellers. The firm is perhaps best known for its short position on Sino-Forest Corp, a Canada-listed Chinese organisation, at which it uncovered fraud that later led to criminal charges being tabled against the now-defunct company and its executives.

In its report, Muddy Waters said that GSX Techedu’s chairman, Larry Chen, “strangely tried to dissuade us from looking at GSX last month” in an interview with Chinese media on 8 April, during which he reportedly said: “I think if Muddy Waters analyses our data seriously, there is a high probability that think Muddy Waters will not be so stupid. The level and IQ of the people in Muddy Waters is quite high.”

GSX Techedu, which earlier this year became the first listed ed tech company to reach a market capitalisation of $10 billion, is currently valued at around $8.5 billion.

Muddy Waters explained that more than half (52.8%) of the unique GSX Techedu users it identified as bots were “precise joiners” – users which joined a class at the “same time, to the second, on the same day of at least two different weeks”. It compared the likelihood of this occurrence to “a weekly flight from city A to city B touching down two or more times at exactly the same second”.

The firm – which, ironically, is named after the Chinese proverb “muddy waters make it easy to catch fish” – added in its report that fraud at GSX Techedu was further evidenced by “IP joiners” – purportedly unique “student users that use the same IP address as a teacher or student, or are linked to such users”.

The report continued: “Because GSX no longer operates physical schools or learning centres, it should not be possible for students to share the IP of a teacher or tutor.

“Yet, 15,239 purported student users (28.2%) shared a teacher or tutor IP on at least one occasion.

“The former GSX manager confirmed that some teachers and tutors operate bot networks for GSX.

“Almost two-thirds of GSX IP joiners are also precise joiners, which reinforces our conclusions.”

GSX Techedu has consistently denied the allegations against it. 

Posted on: 19/05/2020

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