21Vianet Shareholders Hit With a One-Two Punch

Price Target Lowered to $9.00
  

Link To News Story
  
May 10, 2016
 
On November 25th of last year, we reported our findings of fraud in the financial statements of 21Vianet Group, Inc. (NASDAQ:VNET) to the U.S. Securities and Exchange Commission and issued a $13 price target on the security.  Yesterday, VNET hit a 52-week low of $13.86 on fears that its reported “going private” transaction may not come to fruition.  This is on top of news two weeks ago that the main operating entity of VNET plans to issue RMB 1.75 billion in convertible bonds to repay existing bonds and fund operations.
 
To say that the Chinese stock market has experienced some volatility for the past year would be an understatement.  From a high of nearly 5,200 last June, the Shanghai Composite is now trading in the 2,800 range.  Chinese investors lost over $5 trillion in value last summer alone.  Last night, Bloomberg reported that “the world’s most extreme speculative mania” is unraveling in China.  According to Bloomberg’s report:  “Now, as Chinese authorities introduce trading curbs to prevent surging commodities from fueling inflation and undermining plans to shut down inefficient producers, speculators are retreating as fast as they poured in. It’s the latest in a series of boom-bust market cycles that critics say are becoming more extreme as China’s policy makers flood the financial system with cash to stave off an economic hard landing.” 
 
Clearly the Chinese market is in for more volatility.  Altaira Capital Partners analyst Ralph Acampora now expects the Shanghai exchange to “retest its January/February 2016 low at 2,638.”  Furthermore, according to Investor’s Business Daily:  “The People’s Daily, the [Chinese] government’s official newspaper, on Monday warned that China’s economic recovery might stall. The economic trend may be “L-shaped,” meaning flat growth, rather than a stronger “U-shaped” recovery, said the People’s Daily.  Even so, the article said the government will not use excessive investment or rapid credit expansion to stimulate growth.”  Naturally, investor sentiment toward Chinese stocks has turned significantly more bearish.
 
In addition to the volatility in the Chinese market, several U.S.-traded Chinese companies that had expressed plans to move their listings back to mainland China crashed yesterday amidst concerns that Chinese regulators will “move to prevent the deals from going through.”  VNET shaved over 24% off its stock price yesterday, probably the year’s single largest one-day decline and hitting a fresh new 52-week low on nearly six times average daily volume.  MOMO, Inc. (NASDAQ:MOMO), a Chinese dating app, “fell 16% to $12.27, the most since its initial public offering in 2014,” according to Bloomberg.  On Friday, the China Securities Regulatory Commission (CSRC) announced that it is conducting an “in-depth” analysis of how companies delisting abroad and relisting on Chinese exchanges via IPOs would impact the Chinese stock market.  Traditionally, because of the almost guaranteed one-day gain of over 40% on new IPOs in China, Chinese investors will drain the Chinese equity market one day in hopes of cashing in on the IPO the following day, creating huge swings in the market.  These huge swings are of particular concern to the CSRC which has expressed a desire to make Chinese IPOs more like those in the US.
 
Last June, 21Vianet announced that its Board of Directors had received a “non-binding going-private” proposal at $23 per ADS from co-founder Josh Sheng Chen, Kingsoft Corporation, and Tsinghua Unigroup.  We never felt this transaction would occur because once Kingsoft and Tsinghua uncovered VNET’s real set of numbers, no amount of personal ties that Chen had to Tsinghua would make them budge.
 
Additionally, Ming Zhao’s 86Research, a boutique research firm registered in Hong Kong and headquartered in Shanghai, says it expects “continued downward pressure” on U.S.-listed Chinese companies that had previously announced “going-private” transactions because the difficulty for Chinese ADRs to relist has increased “substantially.”
 
Just as telling (and the other part of the one-two punch) is why were Kingsoft and Unigroup not among the named investors in the bond sale of RMB 1.75 billion (over USD $268 million) just a couple weeks ago?  The company announced that it plans to use these proceeds to pay off its existing bonds and to fund operations.  The bonds are convertible 13 to 48 months from now, which means that at current exchange rates, a 22% dilution of current shares is possible 13 months from now.  As shareholders, Kingsoft and Tsinghua will also suffer the dilutive effects of any share conversions, but neither company is willing to go in any further by buying into these new bonds.  The company had no choice but to issue new debt because the last time it showed a profit was 12 quarters ago.
 
The final piece of our discussion involves fraud, which, in addition to the dilution, prompted us to further lower our price target to $9 from $13.  In November of last year when we first reported our findings of fraud in VNET’s financial statements, we reported that the company exhibited “a pattern of overinflating top line revenues and/or understating bottom line losses over multiple quarters for several years.”  Our prior analysis covered the company’s quarterly reports through Q4-2014.  The pattern was so egregious that we reported the company to the SEC.  We will not rehash that discussion in this article except to say that the pattern of fraud carries on throughout the 2015 year.  Just to give an example, consider the following:
 
Top line Total net revenues on the Consolidated Statements of Operations (reported in thousands of US dollars) are $138,749 for Q1-2015, $139,804 for Q2-2015, $145,399 for Q3-2015, and $151,808 for Q4-2015, for a total of $575,760 for all four quarters; yet the annual YTD Total net revenues reported on the Q4-2015 financial statements are only $561,050.  What happened to that other nearly $15 million of revenue reported on the quarterly financials?  Are we to rely on the quarterly data or on the annual data? 

Clearly, there is something still amiss in the company’s numbers!
 
Disclosure:  We remain short VNET.  We do not have a financial relationship with the company.