Muddy Waters’ Carson Block pitched a new short candidate at the Value Investing Congress that is being held in New York. While Block did not spend much time on this company, they did say that they noticed some red flags with 500.com Ltd (NYSE:WBAI).

Leader in sports lottery

500.com Ltd (NYSE:WBAI) is a Chinese company that provides online sports lottery services. At the end of last year, it was launched as the sole licensee holder in sports lottery in China. 500.com has a market cap of 1.2 billion and trades at 37x P/E. Since its IPO in November 2013, WBAI’s stock has gained over 80%. Some of the hedge funds who have positions in 500.com are Steve Kuhn’s Pine River Capital and Millennium Management. Short interest peaked around mid-May and is just around 3% as of August 15.

500.com’s success in FIFA

Early in the year, 500.com was marred by reports that its license had legal issues. However, Sports Lottery Administration made a statement in May that cleared the lottery company of any legal troubles. In a report from Deutsche Bank, analysts Alan Hellawell and Vivian Hao said that 500.com had used the FIFA World Cup as its staging ground to put forward new activities and games which gained popularity among customers. 500.com Ltd (NYSE:WBAI) is also set to obtain mobile welfare lottery licenses later in the year which will be another stepping stone for the company. While the company reported 2Q profits in line with analyst estimates, Deutsche Bank said in a report from August 11,

“Issues remain around lottery licensing and other matters. The national sports lottery initiative could drive up prize payout ratios and thus lead industry commission rates to decline. WBAI could suffer from the potential rate cut; the time line is not clear.”

The company is the only player that is an officially licensed commercial operator of online sports lottery. When new licenses will be issued to other entrants in this field, it could be a risk to 500.com’s business, said Deutsche Bank’s analysts. DB rates the company at Hold because it had eclipsed its price target back in May.

500.com’s business practices fall in the grey area

Carson Block said that company’s business practices fall in the grey area as its licensing framework is unclear. Once the licensing issues get resolved, 500.com will likely have to face tougher competition and compressed margins. According to regulations, the company is not allowed to sell lottery tickets abroad. As per Piper Jaffray’s estimates, online sales of lottery tickets are 6% nationwide. The company has a complex tax system, apparently 70% of last year’s income was attributable to a tax benefit. Another red flag is the way money changes hands at 500.com. Employee bank accounts are used to collect winnings meaning that it is the employee who can claim the winnings. From there, the funds are transferred to the company account and then finally to the winner.

500.com has said that their mobile app has been downloaded 20 million times. Block found this statistic odd since the respective app stores don’t even list 2 million downloads.

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