Below is the original retention press release. DT was hired as forensic accountants.
DALLAS and BEIJING, Nov. 1, 2013 /PRNewswire/ -- NQ Mobile (NYSE: NQ), a leading global provider of mobile Internet services, announced today that the Independent Special Committee of its Board of Directors has retained the global law firm of Shearman & Sterling LLP to advise it in connection with its independent review of the allegations raised in a report issued by a short-seller research company dated October 24, 2013. Shearman & Sterling has engaged Deloitte & Touche Financial Advisory Services Limited as forensic accountants to assist it in the matter.
This is a summary of a forensic audit plan. It is actually much longer than what I posted, but for sake of the prevention of an exceeding long and boring posts these are the high points. The press release cites many areas they investigated that are consistent with a forensic audit plan. These include cash, principal financial documents, ledgers, bank slips, revenue forecasts, invoice, org charts, contracts, databases for accounting, tax and customer transactions, 50 interviews with management and staff, review of major business partners including aging of A/R, review of major contracts and acquisitions and e-mails from top management, etc.
The full press release is more extensive than this summary and is on NQ's website. It is consistent with DT conducting a full forensic audit. I would not expect the press release to include all DT's work papers and audit testing. That would be a very long press release.
In order to complete their forensic review, DT reviewed for fictitious revenues, timing differences in revenues and expenses, concealed liabilities, improper capitalization of expenses, related party transactions, changes in accounting principles, improper asset valuation with emphasis on cash and A/R, booking of fictitious assets or misclassifying assets, review of financial ratios for red flags and detailed interviews with the CEO, CFO and other senior management as necessary and such other testing they deemed appropriate based on the review of the items above. The idea that DT just reviewed cash is a misunderstanding or distortion of DT's work. In fact DT's work was more extensive than PWC's annual audit work which is why it took 8 months to complete and why PWC needs to expand its scope. PWC will need to review DT's work product, do its own testing and ultimately put its stamp of approval on NQ, but I'd be surprised if PWC uncovers fraud or other irregularities after DT's thorough review.
PWC has ever right to expand the scope, and if NQ refuses they should issue an opinion commensurate with that refusal. My point is that PWC cannot live in a vacuum when their client is teetering on the brink because they are waiting for PWC work product without other client's noticing NQ's predicament.
Your first scenario would be my best estimate, perhaps even sooner than September. Assuming cooperation by NQ (i.e. I suspect they have moved past that nonsense about "considering PWC's request), even with extensive I.C. testing this should not take until November. PWC's other field work should have been proceeding on its normal course during DT's work, therefore, their work should be limited to deficiencies identified by DT and other deficiencies PWC discovered during their own testing. This should not require a redo of all field work. As I mentioned in a prior post, hanging NQ out to dry for several months is not exactly a good calling card for retaining existing China business or attracting new clients.
NQ should work on completing the 20-F and, assuming an unqualified opinion, let the dust settle for a while and share price rise before contemplating any MBO or M&A. YONG faced accounting issues, actually had trading suspended for a view months, and then once the accounting issues were rectified took the company private for just North of $7. The company was probably worth double that amount. Essentially management was rewarded for their own incompetence in allowing accounting issues to lead to the stocks suspension and lower valuation. NQ needs to complete the 20-F restore the stock price to some semblance of true value before contemplating any buyouts, especially a MBO that would enrich management at the expense of shareholders.
Once PWC's field work is completed and PWC is working on the audit report, NQ might have a better handle on a time frame, but I doubt PWC will give them anything definitive on timing. Then NQ has a decision. Do we make an educated guess on the time needed to finish the audit report to keep the market informed, but risk being wrong again? In view of prior issues in this regard, a very tough call for NQ management. I would rather they wait and get it right, but in the past few days NQ appears to be on a PR blitz so they might go forward with an educated guess if presented that option.
As regards scope of additional audit procedure, I would expect that discussion only if PWC was comfortable discussing their work product. I doubt PWC would be comfortable with this approach. Auditors typically like the opinion to speak for itself and typically do not publically discuss work product, especially uncompleted work product. PWC might may an exception due to NQ's difficult circumstances but that would be unusually. To the extent PWC comments outside the boundaries of their formal audit report they increase their own risk that ancillary comments can later be used against PWC.
Unfortunately, NQ's hands are likely tied on this matter. Despite their frustration with the pace of the audit, NQ likely does not want to do anything that appears to compromise PWC's independence in this matter. That would include trying to box PWC in on a time frame via public announcement. I also don't expect PWC to say anything until their work product is completed, the opinion is final and ready for publication. That said, PWC cannot stretch this out forever. Other Chinese companies are watching this unfold, including current clients and potential future clients. These clients and prospective clients are not in NQ's position, have a lot more leverage with PWC and may have a few questions for PWC when audit renewal comes around about how PWC might respond if they face a similar short attack or some other crises. PWC has to be careful not to overplay their hand.
I don't think you will see any change in auditor by NQ in the near term. As you point out, it would devastate the share price, and make last week's announcement look tame in comparison. It appears NQ is trying to front run this issue by making board changes and "improving corporate governance and transparency for the benefit of all our shareholders." That is about all they can do at this point. I'm not implying PWC will go out of their way to qualify the opinion. Just that they will take some time to reach a result.
Sorry for the delay in responding, my two replies yesterday vanished after being posted. Anyway, a lot depends on PWC's attitude toward this engagement. My sense is that PWC was not happy about having their work reviewed by DT their number one competitor worldwide and in China. To add insult to injury, DT writes a report stating your audit is not bad but you missed some things most notably internal control issues. O.K., you want to bring in a third party competitor and call us out on our work product, fine, we will do an exhaustive review of internal control to make sure we get it right. If that is their view of this matter, the review could take longer than usual.
bronsonouest |gdx, you recall if Spreadtrum, Focus Media and Fushi went private before completing 20-F? anyone?
Sorry for the delay in responding. My posts seem to be disappearing from the MB after I respond so I will try responding to my own post. In answer to your question, all three had 20f's filed with unqualified audit opinions.
If NQ is a fraud, the board of directors, senior management, PWC and DT will all be sued. All these entities have assets, there is likely a Directors and Officers insurance policy in place, and the two accounting firms both self insure and have large excess professional liability policies. The CEO and CFO who attest to the veracity of financial information face both criminal and civil penalties under SOX. Of course, there is the issue of extradition should this come to pass. But even with that issue, suffice to say, all these parties have substantial "skin in the game" if NQ is a fraud. Most Chinese frauds I've researched go dark as the noose tightens if they are actually committing fraud and you get very little information short of a delisting or suspension notice by an exchange. For what its worth, clearly, NQ has not gone dark on the information front.
The press release did not cover much new ground, but it does appear NQ has abandoned the strategy that if we ignore the shorts and all the negative articles they will just go away. This is a step in the right direction. The audit will eventually take care of itself, but I suspect NQ finally released this constant beating in the press was not only taking a toll on share price, but has or will start impacting new and existing clients. It is hard enough to get and keep clients without bad press. It is doubly hard when your competitors are likely telling folks there are all type of reports (whether true or not) NQ might not be long for this world.
The transition to DT would be easy in view of the forensic work product already in place. A lot depends on where NQ wants to go with the company in the next twelve months after the 20-F is filed. If they are thinking MBO or M&A within that time frame, I doubt they would want to complicate that process with a new firm. The proxy takes a lot of work, and they would want PWC on board to help with that process (assuming, of course, PWC's opinion is ultimately favorable). However, if they have a long time horizon as an independent company, then PWC might be replaced. If they are leaning in that direction, NQ needs to play that card extremely close to the vest, because if PWC thinks this is their last engagement, the field work and time frame likely expands even further.
I don't believe NQ has anything to say about timing of audit completion, and I doubt they will have much to say on this topic until the audit is complete. PWC might give a tenative timetable to NQ, but it will always have the caveat that it all depends on what we find during additional field work. Even if Yao is a better negotiator with PWC and PWC gives him a fairly definitive timetable this week, NQ has already been burned once by a moving target date, so I doubt you will see any public announcement until the audit report is final. NQ cannot post another date for audit completion unless 100% sure of that date, or risk last week's fall will being replicated again if the date proves wrong.
Yes, NQ could then file the 20F and it would be up to the market to make its determination on the internal control issues impact on the veracity of the financial statements. The only two opinions that would create serious listing issues would be an adverse or going concern opinion, and those do not appear in the cards. My comment on square one was just anticipating the short seller argument that, despite all the work done by DT/PWC, the financial statements cannot be trusted because poor internal controls allow the statements to be compromised by management.
As regards going private or a third party purchase, qualified financials would make both difficult. Since the HP/Autonomy mess, I can't see a third-party stepping up and wading into a I.T/software company that at least has the appearance of an accounting scandal. Same goes for lenders or other investors that would be needed for a MBO. As indicated below, despite the near term pain, I think NQ has to ride out the storm with PWC. PWC is well respected in China, probably more so than DT, who, early in the China listing boom, ran into a few Chinese accounting scandals on their watch. After the audit issues are resolved, I think founders Lin and Shi need to evaluate what Khan is bringing to the table. I believe they brought him aboard to bring the business savvy they may have lacked, but I'm not seeing that savvy at this point.
I don't think NQ lied, but it is clear NQ made assumptions about PWC's field work and timing of the audit report that were wrong. It is hard to determine, based on disclosures to date or lack thereof, if they had a reasonable basis for these assumptions based on comments from PWC or Ms. Han through communications with PWC, or they just assumed thirty days post DT's report was a reasonable time frame for PWC to wrap up the audit. The problem NQ is facing is that the more you give auditors the more they want. A month ago PWC may have asked for x and y, and then after reviewing x and y they now need Z. It appears the last comment in the press release regarding consideration of PWC's request is some push back by NQ on the scope and timing of the audit. Realistically, they should know they don't have much choice in scope or timing of the audit. If they say no more information will be forthcoming to PWC, then PWC issues a qualified opinion with a scope limitation likely on the adequacy of internal controls, and NQ is back to square one. If they fire PWC, then NQ appears to be opinion shopping and that is certainly not a good impression for the market. Yao may be able to get a tighter commitment on scope and timing than Han, but if I were NQ, I would not make any more announcements until PWC's final opinion is in my hand. One of NQ's problems throughout this process is the lack of control of their message (i.e. significant statements in the IR blog, random answers to investors, etc.). Shorts are clearly on message, and either Lin or Khan or both should indicate in no uncertain terms that all updates will come through their office via formal press release.
On the plus side for NQ, not too long ago, a major short argument was the DT/PWC process was a whitewash orchestrated by NQ. Based on 8 months of work by DT and the seemingly never ending PWC audit, that argument lacks credibility. What once appeared a sprint is now a marathon.
I don't see a delisting in the future unless PWC issued an adverse or going concern opinion which appears unlikely. It appears NQ has kept the NYSE in the loop on progress with PWC, and with the NYSE battling Nasdaq for Chinese listings (Alibaba for example), it is not good PR for the NYSE to suspend or begin delisting procedings on a company that is a profitable going concern, short of the event I mentioned above.
As regards the sale of minority stakes in FL mobile and Nationsky, it was a clever way to do a quasi convertible debt offering. NQ got an interest free loan, and borrows/investors got an investment option in the future similar to convertible debt. In view of the structure of the deal, I don't think you can take too much from the valuations extrapolated from the offering, but it was a clever deal by management. If NQ can finally clear the decks with the PWC opinion, I suspect you will see interest in NQ, especially if the price stays relatively suppressed. This may be either internal or external or both. With a clean audit report, NQ is basically on sale for a limited time only.
The three companies I mentioned in my post SPRD, FSIN and FMCN all more than doubled off their short attack lows. However, none of these companies had the prospects of NQ. If NQ receives a clean audit opinion and maintains its clients during the pendancy of PWC's field work, at some point this should be a $20 stock. Unfortunately, management may step in on the MBO side before the stock reaches that valuation. Ironically, management often profits from these situations by being able to take out the company at less than fair value. Shareholders are so weary from the roller coaster ride they are ready to get out at whatever price is proposed.
NQ bought a knife to a gun fight from the beginning. Perception is often the reality in the market. I've worked with a lot of I.T. folks, attorneys and accountants. I.T. folks are logical thinkers, often brilliant, but also often lacking street smarts. Attorneys, for the most part are not brilliant, but will do and say anything to advocate their position. From the beginning, Block set the tone and controlled the message for the entire conversation. He goaded NQ into hiring DT knowing this would extend this drama for months while shorts profited handsomely. Of course he knew DT would find something (internal control issue). You give me 8 months and a decent budget and I'll find issues at IBM, MSFT, etc. This leads to the current PWC issue which PWC must resolve before issuing their opinion. In hindsight, NQ should have told Block to pound sand and not hired DT. Once that decision was made, all the other consequences flowed from that decision.
However, if you look at many other Block targets, SPRD, FMCN, FSIN to name a few, eventually reality replaces perception and shares are valued in line with non-targeted peers. You must give Block credit for planing and executing his attack, and NQ clearly underestimated who they were dealing with in this case. However, even Block can't stop a MBO or other M&A activity. Nothing will happen until PWC issues their opinion, but if NQ follows the pattern of other Block targets, reality will eventually catch up to perception.