Big call

Short-seller attacks key iPhone supplier


Batman almost never makes a mistake as the caped crusader who fights crime in Gotham City. Back in the real world, Daniel Yu, the Asian-American behind Gotham City Research, has a pretty consistent hit rate himself against the companies he accuses of wrongdoing in his financial reports.

Since February 2013, Gotham City has published reports on nine listed firms in the UK, the US, Germany and now Hong Kong. The stock prices of all but one (the first) are trading below levels when the reports were first published. Some, like Quindell in the UK, have been the subject of fraud investigations (still ongoing), while Spanish WiFi provider Let’s Gowex has been wound up.

Research companies like Muddy Waters, Glaucus and Gotham City consider themselves the dark knights of the corporate world, determined to uncover fraud and stock price manipulation. But their detractors portray them more as its villains for publishing inflammatory allegations and taking profit from short positions when share prices fall.

Last week Gotham published its first report on an Asian company: AAC Technologies. The Hong Kong-listed group is one of Apple’s key iPhone suppliers, with a focus on audio components (although it has been diversifying into optics and casings). Gotham alleges the company utilised more than 20 related parties to massage its profits, boost its margins above Apple’s and bypass the tech giant’s labour standards. It also claims that one of the companies, Lian Tai, is owned by a relative of AAC’s boss Pan Zhengmin. It alleges this is in breach of Hong Kong’s listing rules.

AAC’s stock price fell sharply when the initial report was released (on May 11) and yesterday it fell another 9% as a follow-up Gotham report came out. The stock – which is down a cumulative 25.5% – was suspended by the company. AAC has made several announcements to the stock exchange denying the allegations and it reiterated the same message to analysts during its first quarter earnings call, insisting that the board “considers the information contained” in the report to be “inaccurate and misleading”.

Equity analysts have largely accepted the company’s explanation for why it has been able to maintain such consistently good earnings growth, which helped year-on-year profit surge 66%. Chinese brokerages have been particularly forthright in their defence of the tech firm. One analyst at Shenwan Hongyuan says he “couldn’t stop laughing” when he read Gotham’s review, which questions how AAC’s margins can be higher and more consistent than those of its key client, Apple. “It’s not uncommon for suppliers to have a higher margin,” he insisted, citing Apple’s lens supplier Largan Precision, which has been reporting gross margins in the 60% to 70% range over the past few quarters.

The analyst goes on to say that the presence of the wife of the AAC boss on the audit and risk committee smacks of poor governance, but that it is not “equivalent to fraud”.

Others defended AAC as well, saying that it has pricing power because it is one of only three acoustic component suppliers to Apple. Its main rival, Shenzhen-listed GoerTek, has similar market share and reports 35%-plus gross margins.

Haitong, another broker, said that the investors that it has canvassed are concerned about the impact of the report, however. While they do not believe AAC is guilty of the charges, most investors are adopting a wait-and-see approach.

HSBC’s research team also cautioned investors to “stay on the sidelines” because the share price “already fully reflects AAC’s long-term drivers at current levels, despite the continued positive outlook”.

Before the stock price plunged it had been trading at around 19 times forward earnings, the upper end of its historical range. Another reason for the sudden decline may be investor sensitivity to higher valuations at a time when Apple’s sales outlook looks less certain. The skittishness could be exacerbated if the Taiwan Weighted Index (Taiex) pierces the all-time high (10,202) it reached during the dotcom boom. The index passed the 10,000 mark again in early May and has a heavy weighting of companies which derive a majority of their revenues from Apple.

Analysts estimate that if you combine the sales of its 874-constitutent stocks, an incredible 42% of revenues are derived from Apple’s component suppliers.

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