A new report out from top short-seller Gotham Research on a Hong Kong company – entitled AAC Technologies LTD (Ticker = 2018): Why are reported profit margins higher AND smoother than Apple’s?
Gotham states:
GOTHAM CITY RESEARCH HAS REASON TO BELIEVE THAT:
- AAC has used 20+ undisclosed related parties & dubious accounting to overstate & smoothen profits since 2014.
- At least 20 undisclosed related party suppliers are owned or managed by AAC CEO’s family members or employees.
- These undisclosed related party suppliers are not listed in Apple’s supplier list, despite some claiming otherwise.
- Some of the undisclosed related entities supply the same products as AAC does, are based in the same locations as AAC is, & hire employees under AAC’s name.
- AAC has used these hidden entities to evade Apple’s labor standards specified in the Apple Supplier Code of Conduct.
- Apple (and other parties) will conduct independent investigations, & validate our findings. As a result, AAC’s profit margins will decline, converging to its peers’ levels.
- AAC is in violation of Hong Kong listing rules, Apple’s supplier code of conduct, and its own representations.
- AAC’s share price will initially decline to 40 HKD – 50 HKD per share, as the undisclosed related party supplier revelations are digested.
- We see far greater downside potential to the share price if the company were to concurrently experience the same problems that other Apple suppliers have in the past, e.g. increased competition, pricing pressure from its customers, wage inflation, etc.
………………
What is AAC Technologies’ “secret sauce”? How does AAC, an Apple supplier, achieve higher and smoother profit margins than Apple, Google, & Microsoft? Some have attributed AAC’s superior & smooth margins to a myriad of factors, such as workforce automation. While some of these explanations may sound plausible, we see it differently.
In our opinion, the evidence supports a more nefarious explanation: AAC uses undisclosed related party suppliers to inflate and smoothen its margins. Such an explanation may seem far-fetched, except that there are a number of case studies of companies that relied on nearly identical schemes to overstate profits (and whose share prices subsequently declined). Take for example, Longtop Financial Technologies Ltd (“LFT”), a formerly US-listed Chinese company that used undisclosed related parties to overstate its profits. In this regard, AAC reminds us of LFT (coincidentally, AAC uses the same auditor as LFT did). Unlike certain schemes that can last indefinitely, Gotham City Research believes that AAC’s apparent schemes will come to an end shortly. We believe Apple (and other parties) will conduct their own investigations, and independently come to similar conclusions as we have.
We believe shares will initially decline to 40 HKD – 50 HKD per share, as the undisclosed related party supplier revelations are digested. We see far greater downside potential if the company were to concurrently experience the same problems that other Apple suppliers have in the past, e.g. increased competition, pricing pressure from its customers, wage inflation, etc. In our coming report(s), which we intend to release in the near future, we will explain our case for these opinions.
Full report below.
