Value Investing

Prescience Short Cheetah Mobile Inc (CMCM)

Prescience Point Research Opinions:

  •  CMCM shares are worth no more than $1.69 per share.
  • ~55% of CMCM’s reported consolidated revenue does not exist.
  • CMCM should be de-listed from the NYSE.
  • CMCM will restate its historical results because of the issues exposed in this report.
  • CMCM is the subject of an ongoing, undisclosed SEC investigation, which will result in severe enforcement actions against CMCM and its management team. The SEC is in possession of our findings.

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Research Highlights:

  • ~87% of estimated Live.me revenue and ~57% of reported utility revenue is fabricated, based on PP calculations that are supported by App Annie Intelligence data.
  • CMCM is its own largest Live.me customer, based on our research – of what revenue Live.me does generate, we estimate 75% came from CMCM’s balance sheet and was spent in the app via company-controlled accounts.
  • CMCM reported that its mobile MAUs increased 17.7% from Q2’15 to Q2’17, which is not possible given the 49.9% decline in its core utility app MAUs, according to our calculations based on App Annie Intelligence data.
  • CMCM’s cash balance is suspect.(1) From FY’14 to 1H’17, CMCM’s average cash balance ballooned 77.3% from $177.9m to $315.5m, yet at the same time its annualized interest income plummeted 67.7% from $4.5m to $1.5m -- during that time period. In spite of its sizeable cash balance, CMCM’s debt balance has grown to >$70m.
  • From Q2’16 to Q2’17, CMCM’s share-based compensation declined 72.9% from $13.3m to $3.6m. This 72.9% YoY decline 1) appears baseless as it implies an estimated, and unrealistic 5.4x increase in forfeiture rates, and 2) accounted for an estimated 93% of Q2’17 earnings.
  • Former employees we interviewed doubt the credibility of CMCM’s financials. Here is what one told us: “Sometimes the numbers on my side were going down…and at the same time we were reporting growing numbers in the financial statements.”
  • CMCM recently invested $40m into OrionStar, a robotics company owned by CMCM’s CEO. The transaction price implies a $135m post-money valuation for a company that has only existed for ~8 months, and that was originally intended to be a CMCM subsidiary, based on our research.
  • Form 144 filings CMCM does not file electronically indicate insiders have sold $17.3m worth of CMCM stock over the past 5 months.
  • Facebook, CMCM’s largest customer, allegedly discovered the Company’s fake traffic and in response has been phasing out CMCM from its ad network. Given the industry’s increased focus on eliminating ad fraud, we believe other top utility clients like Google will follow suit.
  • Former CMCM CFO Mr. Ka Wei Andy Yeung, a seasoned US-trained executive, was viewed by some as a seal of approval for the legitimacy of the Company. He suddenly departed CMCM in March, and now that seal of approval is gone.
  • CMCM’s auditor E&Y Hua Ming was the auditor for Sino-Forest. Aside from Sino-Forest, it blessed the books of a plethora of now-proven and defunct Chinese frauds, SinoTech Energy and China Agritech.
  • The SEC Enforcement division is already investigating CMCM based on the responses to our FOIA requests. CMCM has not disclosed the investigation.

Introduction

Cheetah Mobile (“CMCM” or “the Company”) bears a striking resemblance to a number of US-listed Chinese frauds Prescience Point has previously exposed. In this report, we present a body of evidence which in our opinion indicates that CMCM too is materially misrepresenting its reported financial performance and that its management is so untrustworthy that CMCM is simply uninvestable.

CMCM initially caught our attention when we learned of its plans to invest in a related party entity owned by its CEO Sheng Fu. On May 26, 2017, CMCM announced its intent to invest $40m of shareholder capital in OrionStar, an AI and robotic business, in exchange for a 29.55% equity stake, effectively valuing OrionStar at $95.4m on a pre-money basis. Upon further analysis, we were troubled by the circumstances surrounding the deal:

  • Only one year prior to the announcement of the deal, in April 2016, Mr. Fu announced that CMCM intended to set up a subsidiary called Cheetah Robotics to pursue AI/robotics. Our research indicates the legal formation of this entity did take place in May 2016.
  • Mr. Fu then appears to have hi-jacked the opportunity away from CMCM shareholders, forming his own AI and robotics company OrionStar in September 2016, only several months after Cheetah Robotics’ formation. Cheetah Robotics now appears to be a disregarded entity, as CMCM does not talk about it, it is not mentioned in CMCM SEC filings, and it is not accounted for in CMCM’s corporate structure as mapped out in the 2016 20-F (refer to the Appendix).
  • At the time the CMCM deal was announced, OrionStar had existed for only 8 months, casting serious doubt on the legitimacy of its lofty ~$100m pre-money valuation.

OrionStar appeared to be a vehicle for the misappropriation of shareholder capital, in our view.
Our interest in the CMCM story was piqued upon learning of the astounding, yet improbable success of CMCM’s Live.me business. CMCM launched Live.me, a mobile live streaming app, in early 2016. From Q3’16 to Q2’17, Live.me revenue grew by an estimated 429.9% % from $5.9m to $31.3m, based on our estimates; thus, in the span of just nine months, annualized Live.me revenue had increased from an estimated $23.6m to $125.2m! This large and rapid increase in Live.me’s revenue appeared too good to be true, especially when considering that comparable, more well-established live streaming apps with longer operating histories were generating just a fraction of the revenue it claimed.

The more we dug, the more we found. Our 5-month long investigation included a thorough scrub of CMCM’s public disclosures and filings, interviews of several former CMCM employees (including many former managers), the engagement of several private investigators, and exhaustive examination of App Annie Intelligence estimates and other app analytics data.

We found CMCM to be worse than we initially thought:

  • Our research indicates ~55% of CMCM’s Q2’17 consolidated revenue was fabricated, including ~87% of its estimated Live.me revenue and ~57% of its reported utility revenue.
  • CMCM is its own largest Live.me customer, based on our research – of what revenue Live.me does generate, we estimate 75% came from CMCM’s balance sheet and was spent in the app via company-controlled accounts.
  • Many other aspects of CMCM’s financial reports are suspect. Among them – CMCM’s cash balance appears to be significantly overstated. From FY’14 to 1H’17, CMCM’s average cash balance ballooned 77.3% from $177.9m to $315.5m, yet at the same time its annualized interest income plummeted 67.7% from $4.5m to $1.5m. In spite of its sizeable cash balance, CMCM’s debt balance has grown to >$70m.1
  • CMCM’s auditor E&Y Hua Ming was the auditor for Sino-Forest. It has also blessed the books of a plethora of now-proven and defunct Chinese frauds, including SinoTech Energy and China Agritech.
  • CMCM has extensively used bots and click farms to generate fake accounts and fake ad impressions on its utility apps, according to former employees. Thus, it appears that a large portion of whatever real revenue CMCM is receiving has been generated through questionable if not illegitimate means.
  • CMCM appears to be on the verge of imploding: Its real revenue appears to be rapidly diminishing due to a growing focus by its top clients, like Facebook, on cracking down on fake ad traffic; our FOIA requests have confirmed that it is the subject of an active, undisclosed SEC investigation; some of its key executives – including its US-trained CFO – have recently departed; and insiders have been rampantly liquidating their shares ($17.3m worth of CMCM stock over the past 5 months).

We are not alone in our suspicions related to CMCM; consider the following comments from our interviews with several former CMCM managers:

Former Employee #1: One of the reasons I left the company is there is definitely some fuzzy accounting going on… saI’ve worked with a lot Chinese companies, and I know they do business differently, but Cheetah is a different scale in terms of how worried I would be.

Former Employee #2: I was never able to understand the numbers that were published in the financial statements of the Company…Sometimes the numbers on my side were going down… and at the same time we were reporting growing numbers in the financial statements.

Former Employee #3: … they make up (the numbers) for sure… People they watch the news and (the news) says “Cheetah Mobile has increased their revenue”. (But) every weekly meeting we had, we definitely see the downloads is going down when I was working there...I mean they must do something to the numbers…There’s definitely something wrong with the company, so that’s why I left

Over the years, we have successfully exposed several fraudulent US-listed Chinese companies (read more about them here, here and here). Following the publication of our findings, these companies collapsed, were investigated by the SEC, had their shares delisted, and/or ceased to exist. We believe CMCM will soon meet a similar fate due to the issues covered in this report.

We hope that current and future investors and creditors familiarize themselves with the risks we have addressed and take immediate action to preserve the value of their holdings. We also hope that the NYSE, regulatory and law enforcement agencies, and CMCM’s auditor take necessary precautions in protecting investors.

Company Overview

CMCM is a China-based developer of mobile (iOS and Android) and PC applications. In Q2’17, mobile accounted for 86.5% of CMCM’s total revenue, while PC accounted for the remaining 13.5%. The Company generates the majority of its revenue from international markets outside of China such as the US, UK, etc.

Cheetah Mobile Inc (CMCM)

CMCM discloses its revenue by business line as follows:

  • Utility products & related services (“utility revenue”) – Consists primarily of revenue generated from in-app advertising in CMCM’s mobile utility apps. The Company’s core mobile utility apps include Clean Master, CM Security, Battery Doctor, CM Launcher, CM Browser, Photo Grid and CM Locker.2
  • Content driven products (“content revenue”) – Consists of revenue generated from Live.me and News Republic.3 Live.me is a live video streaming mobile app for iOS and Android devices. News Republic is a personalized news aggregator app for iOS and Android devices. We estimate Live.me accounted for >97% of content driven revenue in Q2’17.
  • Mobile games – Consists primarily of revenue generated from advertising and virtual currency purchases in CMCM’s web-based and mobile games. Some of its most popular games include Tap Tap Fish, Piano Tiles 2 and Rolling Sky.
  • Other – Miscellaneous revenue representing just a small portion of CMCM’s business.

CMCM went public on the NYSE in May 2014 as a spin-off from Kingsoft Corporation, a large IT service provider and software developer traded on the Hong Kong Stock Exchange. From FY’13 to FY’16, the Company grew its reported revenue by 430% from $123.9m to $657.4m. CMCM’s revenue has continued to grow in FY’17 – In Q2’17, CMCM’s reported revenue grew 14.8% YoY to $177.2m, or $708.8m on an annualized basis.

Below is the Company’s historical consolidated revenue according to SEC filings and earnings releases:

Cheetah Mobile Inc (CMCM)

We will provide a body of evidence that we believe indicates the data in the chart above is fiction.

Article by Prescience Point

See the full PDF below.