Muddy Waters Is Short JOYY Inc (YY)

Muddy Waters Research is short JOYY Inc (NASDAQ:YY).

Get Our Activist Investing Case Study!

Get The Full Activist Investing Study In PDF

Q3 2020 hedge fund letters, conferences and more

Muddy Waters' Short Case For JOYY Inc

While trawling the sewers of the world’s capital markets over the past 10 years, irony has never been in short supply. And yet, nothing could prepare us for the surreality of Baidu announcing its intention to buy YY Live from JOYY, which happened just as we were preparing to reveal that our year-long investigation shows YY Live is about 90% fraudulent.

It was clear to us from early on that YY Live was almost entirely fake. YY Live is an ecosystem of mirages. Its supposedly high-earning performers in reality take home only a fraction of their reported totals. The purportedly independent channel owners are largely controlled by JOYY Inc in order to facilitate continuous sham transactions. The legions of benefactor fans are almost entirely bots operating from YY’s internal network (~50% of YY Live gift volume), bots operating from external bot farms, and performers roundtripping gifts to themselves. We conclude that YY Live is ~90% fraudulent. YY’s international livestreaming business, Bigo, seems barely more real.

So, the question is: What will Baidu do? It’s no secret that Baidu is struggling to grow. But will Baidu really try to buy “growth” in the form of an almost completely fake business? And for $3.6 billion cash, or seven percent of its market cap?! We have been arguing for the past 10 years that the rot in “China Inc.” is far greater than most investors either understand or admit. Many have called us overly cynical. Baidu / YY Live will be THE test of whether China Inc. is really just a few bad apples; or, whether the incessant cheating, lying, and indifference to U.S. law permeate the highest echelons of China’s public companies.

In April, Baidu’s ethics committee released a statement in response to the arrest of its group vice president of finance and former CFO, which read in part:1

“Baidu resolutely cracks down on all violations of the law and discipline, and has zero tolerance for any behavior that touches the red line of professional ethics. It will never relax for anyone, at any time!”2

To Baidu we say, “You’ve announced that you’re going to pay seven percent of your market cap in cash for a business that’s almost entirely fraudulent. The enormous scale of this fraud will be inescapable in due diligence. You say there are real ethics and respect for the law at Baidu? Show us.”

Summary

We are short JOYY Inc. (YY) because we conclude that YY is a multibillion-dollar fraud. We conclude that YY’s component businesses are a fraction of the size it reports, and that the company’s reported user metrics, revenues, and cash balances are predominantly fraudulent. Our conclusions apply not only to the legacy YY Live business, but also to Bigo, YY’s online dating business, and really everything these people have touched.

• Approximately 84% of JOYY Inc’s reported consolidated revenue appears to be fraudulent. Changing our base case assumptions to more company-favorable / conservative assumptions yields consolidated fraudulent revenue of approximately 73%.
• We have observed three primary methods through which JOYY Inc commits fraud:
  • Paying User (“PU”) bots from YY’s own servers – in our data sample, gifts associated with YY’s own servers, disguised as PUs, constituted roughly half of the total value of all gifts
    sent.
  • Performers whose gifts are recycled into the system through alter ego PU accounts. We understand that the top performers, who purportedly earn tens of millions of RMB per year, are in fact often on fixed salaries paying them no more than 2.5 million RMB per year (~$350,000).
  • Channel owners, which manage performers, are part of the scheme. The large channel owners are primarily owned by former YY employees who are clearly “in on” the scam. PRC credit bureau report financial statements for the five largest channel owners show combined 2018 revenue of only ~15% of what YY claims.

YY Live’s Livestreaming Revenue Is Fraudulent

• We conclude that YY Live, Bigo, and JOYY Inc’s online dating business are substantially fraudulent:
  • We conclude that ~90% of YY Live’s livestreaming revenue is fraudulent. Livestreaming accounts for ~95.8% of purported Q3 2020 YY Live revenue.
  • We conclude that ~80% of YY Live’s online dating revenue is fraudulent. Online dating accounts for ~20% of purported YY Live revenue.
  • We estimate that ~80% of Bigo revenue is fraudulent. Using more company-favorable assumptions yields a fraudulent revenue contribution of ~60%.
  • Bigo’s Singapore parent changed auditors three times in its first four years. Bigo also received three consecutive going concern opinions from its auditor in 2016-2018. Bigo made a major restatement of its 2017 financials in August of 2019, months after the acquisition by JOYY Inc was complete. These fact patterns support our conclusion that Bigo is also substantially fraudulent.
  • Bigo’s rot stems from its inception. JOYY Inc claims that it purchased Bigo from Chairman David Li. This is a lie that enabled Chairman Li to take at least $156.1 million of real money from YY shareholders and for YY to fraudulently report remeasurement gains in its profits. In reality, JOYY Inc founded Bigo – not Chairman Li.
  • Bigo consolidates a significant amount of revenue from Mainland China. Bigo tacked on a mainland China business Hello that we believe to be almost entirely fake, per our primary diligence and discussions with former Bigo employees. As of Q3 2020, we estimate this overwhelmingly fraudulent PRC unit was still 13.4% of Bigo’s reported revenues.

Two-Prong Approach

• We researched JOYY Inc’s businesses for more than one year, taking a two-prong approach. The first prong was macro data collection and analysis through automated means of 115.6 million transactions. The second prong was traditional Muddy Waters techniques of reviewing filings and accounts, undercover fieldwork, and human sourcing.
• Studying various purportedly top earning performers closely shows the enormity of the fraud on a micro level:
  • Purported pop music success Modern Brothers gives free concerts in a popular shopping area, and yet attendee “fans” are paid to show up. Modern Brothers rarely performs on YY Live these days, but they receive gifts continuously through the platform when off air. Many of these gifts were coming from YY’s servers. Analyzing data from 96 randomly selected purported donors shows that ~97.9% of sampled gift revenues were likely fake.
  • A random sample of YY PUs in Wuhan during its COVID-19 lockdown indicated that ~87.5% of their gift revenues were likely fraudulent. The majority of the fraudulent PUs had mobile device IDs (IMEIs) linking back to YY servers, while a significant minority of Wuhan PUs displayed IP addresses that inexplicably jumped from city to city amid the lockdown.
  • “Big Li” is a big lie. Big Li won YY’s 2019 annual competition for the most gifts received. However, our data shows that during this December event, Big Li’s mobile device was shared with his largest contributor, who sent RMB seven million in gifts, or approximately 40% of the total. Beyond that, devices associated with his sent more in gifts than Big Li received, laying bare a network of related accounts that recycle gifts and inflate YY’s revenue totals.
  • Top Bigo earner RCT_Khan purportedly receives ~$50,000 in gifts per month for literally sitting at his desk doing paperwork. His stream gets even less enthralling, with the camera often pointed at the wall or ceiling. Until very recently, his purported #2 contributor was clearly himself. (His other top contributors are almost certainly part of a gift recycling network.)
  • We lay out findings from four additional top-earning performers, four more Top PUs, and numerous interviews with senior members of the JOYY Inc ecosystem supporting our finding that YY Live and Bigo are a sham and their gift revenue is substantially fake.

Read the full article here by Muddy Waters