US hedge fund Muddy Waters Capital — which has a long and successful history of exposing fraud by Chinese companies listed in US markets — has thrown a huge wrench into plans by Nasdaq-listed Chinese search giant Baidu to buy live streaming YY Live from Chinese Video Giant Joyy for $US3.6 billion.

The Chinese live-streaming market is worth $US66 billion, and is accelerating so quickly it could double in size this year, according to Fortune.

However, Muddy Waters says up to 90 per cent of YY Live’s revenues from this vast market are fraudulent.

According to Muddy Waters’s report, “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.”

Muddy Waters has a pedigree in exposing fraud by North American listed Chinese businesses. In 2011 its report into Toronto listed Sino-Forest — which it described as a multi-billion-dollar Ponzi scheme — led to that company’s bankruptcy and the finding by the Ontario Securities Commission that the founder, along with other senior managers, committed fraud.

More recently, in the middle of this year Nasdaq delisted Luckin after a Muddy Waters report in January exposed its practices. 

YY Live is a social media platform which Wikipedia says has over 300 million users. It also has a dating site called Bigo, which Muddy Waters also says is mostly generating fraudulent revenues.

The hedge fund says it studied YY’s businesses for more than one year, utilising both macro data collection and analysis through automated means of 115.6 million transactions. It then reviewed the company’s filings and accounts, undercover fieldwork, and human sourcing. 

In its report posted last week, called “YY: You Can’t Make This Stuff Up. Well … Actually You Can,” the authors write, “While trawling the sewers of the world’s capital markets over the past ten 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 per cent fraudulent.”

Three types of fraud are identified in the report:

  • The company is running Paying User (“PU”) bots on its 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.”
  • The creation of alter ego PU accounts to recycle gifts through the system — “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 (~$US350,000).”
  • The channel owners, which manage performers, are part of the scheme — “The large channel owners are primarily 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 per cent of what YY claims.”

The report describes YY Live as an ecosystem of mirages, and the authors argue that its “supposedly high-earning performers, in reality, take home only a fraction of their reported totals.”

The report makes the case that YY Live’s “independent channel owners” are largely controlled by YY in order to facilitate continuous sham transactions. 

“The legions of benefactor fans are almost entirely bots operating from YY’s internal network (~50 per cent of YY Live gift volume), bots operating from external bot farms, and performers roundtripping gifts to themselves.”

Following an analysis of the company and its ecosystem, Muddy Waters concludes that “YY Live is ~90 per cent fraudulent. YY’s international livestreaming business, Bigo, seems barely more real.”

JOYY Responds

In a statement released on 19 November, the company denied the accusations.

“Yesterday, Muddy Waters issued a short-seller report on JOYY, causing anxiety and market disturbance, leading to abnormal share price movements. The Company believes that the report contains numerous errors, unsubstantiated statements, and misleading conclusions and interpretations regarding information relating to the Company.”

It accused Muddy Waters of lacking a basic understanding of the live streaming industry in China, although its defence — that the operating metrics disclosed by JOYY are commonly used and publicised by its industry peers — doesn’t necessarily inspire confidence. 

Still, it argues that “live streaming has become a key revenue engine for companies in the internet sector, including a number of public companies listed in the US and Hong Kong.”

According to the company, “JOYY has solid cash balance and has consistently generated strong cash flow. To conclusively refute the report’s false allegation regarding the authenticity of JOYY’s profit figures, the Company is open to cash verification and diligence to be conducted by competent third-party advisers. The Company’s dividend policy of $US300 million announced in August 2020, with $US25 million already paid out in the third quarter of 2020, is also testament to the Company’s confidence in its operating cash flow.”

It also defended its acquisition of Bigo, saying it strictly followed the necessary corporate governance procedures and obtained all requisite approvals. “In the 20 months since the acquisition, Bigo witnessed rapid revenue growth, with its top-line increasing from $US181 million in the second quarter of 2019 to $US490 million in the third quarter of 2020. Bigo Live ranked as the sixth highest-grossing non-game mobile app in the world in September 2020, according to App Annie.”

However, as the Muddy Waters report makes clear, concerns about Bigo — whose revenues it estimates to be 60 to 80 per cent fraudulent — are not new. 

“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 YY was complete. These fact patterns support our conclusion that Bigo is also substantially fraudulent.”

Heat on Baidu

Muddy Waters says Baidu’s acquisition of YY raises questions about the Chinese internet giant and the wider Chinese digital ecosystem.

“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 $US3.6 billion cash, or seven per cent of its market cap?!”

The hedge fund says it has been arguing for the past ten years that the rot in “China Inc.” is far greater than most investors either understand or want to 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 US law permeate the highest echelons of China’s public companies.”

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

In its report, Muddy Waters issues the following challenge to Baidu: “You’ve announced that you’re going to pay seven per cent 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.”

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