We may never fully understand Vipshop

Chinese ADRs are hard to get a grip on these days.

On the surface, Vipshop has a great story: secular tailwinds as a higher proportion of retail sales moves online, growth rates of almost 100% per year, a CEO that Jack Ma counts as one of his favorite businessmen and a shareholder register that includes investors such as Tiger Global and Passport Capital.

The story looks great… as long as we believe in the audited accounts. Should we?

In the past, short-sellers compared financials statements provided to China’s State Administration of Industry and Commerce (SAIC) with SEC filings to see whether a company may have misrepresented its true condition. When Beijing-based J Capital did this earlier this year, they claim to have found a discrepancy of 10x between their own consolidated version of Vipshop’s SAIC financials and SEC accounts. But in mid-May, Vipshop altered their SAIC filings such that such a large discrepancy no longer exists. In addition, regulatory changes from 1 March 2015 eliminated the requirements for Chinese companies to submit audited financial statements to SAIC. So this way of identifying frauds may soon no longer be available.


Altered SAIC financials for one of the subsidiaries

How about third party checks on Vipshop? According to iResearch, Vipshop had a market share of total China B2C e-commerce GMV of 2.9%. This works out to a GMV of about US$5.7 billion on an annualized basis. Given that most though not all of Vipshop sales is on a consignment basis (and therefore reported net), the SEC filing revenue figure of US$3.7 billion for 2014 could be true. The question is whether iResearch can really be trusted upon. First, the research is paid for by its clients so conflicts of interest are undeniable. iResearch also makes venture investments into Chinese Internet companies itself – hardly qualifies as an “independent provider” of research! NQ Mobile, Sinoforest, etc all used similar types of research institutes in their SEC filings, and they all turned out to be wrong. So here is another source: research institute CECRC (中国电商研究中心) claims that Vipshop has a market share of 2.8%, almost the same number as iResearch’s. It is not clear whether they relied upon management-supplied data for this ranking. Alexa, as flawed as it the website may be, shows a website ranking for vip.com of 1443 vs 985 for Dangdang, which sounds low considering that Dangdang has a market cap of US$845m vs US$13 billion for Vipshop. Counting website traffic from sites such as Baidu indicates falling traffic for Vipshop over the past year… but then again, it is undeniable that most of the growth in traffic comes from mobile these. So it is hard to draw any conclusions from either of these sources.

In April this year, further allegations about fake products were raised by competitor Jumei. Jumei claims that Vipshop copied parts of its website for brands that Jumei has an exclusive right to sell in China. If those allegations are true, Vipshop either 1) sells fake goods to its customers or 2) does not sell some of the goods it has on its website. You might think that customers should be furious when they hear this. But no, customers actually do not seem to care. There are countless stories of customers complaining about quality and wondering whether Vipshop products are fake. An equal amount of customers are bewildered of how cheap products on the website are. And also how much customers love buying goods that are heavily discounted from their MSRPs (loss aversion/anchoring or what behavioral economists call “positive transaction utility”). So maybe it is reasonable to expect high profitability when you are just selling poor-quality versions of reputed brand-name products?

Other questions raised by short-seller Mithra Forensic Research and J Capital:

  • Inventory is high, given that the vast majority of sales comes from goods on consignment. Has capitalization of assets (inventory) been used to keep COGS low and thus increase gross profit?
  • Why is days payable 125 days, compared with management’s goal of 45 days?
  • Failure to disclose 9 physical Vipshop retail stores
  • How can the company only have 4 logistics centers throughout the nation, compared to JD.com’s 97 warehouses for example?
  • The large discrepancies between the AIC and SEC filings that J Capital documented in its first report before the filings were allegedly altered

What is the truth?

It is hard to prove anything. But as investors we have to rely on probabilities:

  • What is the probability that a company in a commoditized industry goes from terrible performance pre-IPO to an ROE of 40%+? What has changed? Highly successful Chinese retailer JD.com still does not make any profit. Dangdang makes 14% and Jumei 18%.
  • What is the probability that a company that has had a cumulative cash build up of negative US$36 million (CFO-CFI) over the last three years is also a huge money making machine?
  • What is the probability that a company that lies about having physical stores and the authenticity of its products, is also truthful about its finances?
  • In general – what is the probability that a Chinese company listed in the US does not use the lack of rule of law to its advantage and rape foreign investors (convertible notes, anyone)?

The burden of proof should not be on short sellers. Long investors must also use their heads when they jump on to the next hot Chinese Internet story. And instead of questioning the legality of J Capital’s research methods and underlying motives, why did Vipshop not just release their SAIC filings directly to clear all doubts? Everything that comes out of the People’s Republic must be questioned. Yet we probably have to accept that we may never fully understand Chinese companies such as Vipshop.

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