Vipshop: When All Else Fails, Try A Bit of Fraud

Price Target $8.00

November 8, 2016 10:45 AM EST

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(SI Newswire) November 8, 2016

This article is intended to be a summary of our findings of fraud in the financial statements of Vipshop Holdings, Ltd. (NYSE: VIPS). Our research has uncovered “accounting irregularities” in Vipshop’s numbers to the tune of nearly $150 million. One thing we know for sure, when financial statement fraud is first uncovered, the actual fraud is typically two to ten times worse than the initial findings.

Last November, we reported our first of multiple findings of fraud in the financial statements of another Chinese company, 21Vianet Group, Inc. (NASDAQ: VNET). At that time, 21Vianet was trading in the low $20s…currently the company is trading in the low $7s, having bounced off a 52-week low of $6.77 last month. For multiple quarters over multiple years, the company exaggerated its financial health by overinflating top line revenues and bottom line profits. Even the buyer group proposing to privatize 21Vianet finally had to back out earlier in June.

Guangzhou-based Vipshop is an online discount retailer for brands in China, primarily apparel and cosmetics. The company offers products to its customers mainly through “flash sales” via its website. Flash sales are significantly discounted prices offered by an online e-commerce site for a brief period of time on a limited quantity of goods. The time limit and limited availability entices customers to buy on the spot. The company was a Wall Street darling from its 2012 IPO up until about April of last year when its stock price peaked in the low $30s. However, since that time, the company’s share price has been on a southbound roller coaster ride due to a softening in the Chinese economy, cutthroat competition, a maturing flash sale market, and a marked decline in the company’s key metrics. All of this can be seen as reasons for turning to fraud to “enhance” the company’s numbers.

Softening of the Chinese Economy:

Over the last two years, according to China Business News market participants have been “feeling the heat of an uncertain economic environment and growing concerns regarding the future of the Chinese economy.” And, according to Bloomberg, “Last year’s leverage-fueled equities rally and the subsequent implosion brought worldwide attention to the shortcomings of China’s markets…Critics contend that the government’s efforts to restore market calm last year only served to hurt investor confidence further.” The price of many key market items such as oil and copper are in constant decline due to oversupply and diminished demand.

China’s slowing economy has hurt Vipshop more than some of its larger rivals because of its product mix. While Alibaba (NYSE: BABA) and (NASDAQ: JD) sell a diverse mix of products, Vipshop sells primarily discretionary products such as perfume and handbags. The Shanghai Composite has been tanking since June of last year, and it has taken many Chinese ADRs down with it since then. The timing of Vipshop’s fraudulent statements seems to coincide with the market rout in China last summer.

Cutthroat Competition:

A marked rise in competition from other e-commerce giants such as Alibaba Group, JD.Com, Amazon China (NASDAQ: AMZN), Jumei International (NYSE: JMEI), and a slew of others has also served to significantly slow Vipshop’s pace of growth over the last 6 quarters. Alibaba and have both become more aggressive in online flash sales and offer the convenience of an all-in-one shopping experience. Since the company’s first quarter 2015 numbers disappointed in May of last year, the stock price has been on a fairly steady decline. First quarter of this year missed analysts’ expectations for revenues, profits, and its second quarter outlook. And while second quarter’s numbers failed to disappoint as much, they were based on lowered expectations.

Vipshop is now attempting to expand beyond the demography of its core niche market, middle class urbanites who are early adopters of technology, due to market saturation. The company is now trying to stimulate growth by appealing to millennials. While this effort has increased the number of active customers, it has reduced the average revenue per user (ARPU) by 7%. According to Barron’s, this is “likely due to Vipshop’s customer mix shifting towards a younger generation with less spending power and a less profitable product mix.” The change in product mix in tandem with more generous discounts is crimping the company’s margins.

Softening Metrics:

Notwithstanding the fraud issue, which we will discuss a bit later, the company has seen marked declines in many of its key metrics over the last several years:

The rate of growth in total net revenues has been consistently sliding:

In FY 2012, total net revenues grew by 204.7% year over year

In FY 2013, total net revenues grew by 145.1% YOY

In FY 2014, total net revenues grew by 108.9% YOY

In FY 2015, total net revenues grew by 74% YOY

For FY 2016, total net revenues are expected to grow by 37% to 43%

The quarter over quarter total net revenues for the first 2 quarters of this fiscal year grew somewhere in the mid 30% range

The rate of growth in active customers has been consistently sliding:

In FY 2012, the number of total active customers grew by 175.7% year over year

In FY 2013, the number of total active customers grew by 129.8% YOY

In FY 2014, the number of total active customers grew by 114.2% YOY

In FY 2015, the number of total active customers grew by 51% YOY

The company’s current ratio has deteriorated from a more solid rate of 1.3 at the end of FY 2014 to 1.0 at the end of the most current quarter.

When All Else Fails, Just Fudge the Numbers: ​ Because of forces outside of the company’s control (and some within its control), revenues, margins, and active customers have all been decelerating. What’s a company to do in this situation? Why not artificially “enhance” the numbers?

The company’s first quarter 2015 Condensed Consolidated Statements of Income and Comprehensive Income shows Q1 Total Net Revenues of USD $1,389,369,000, see page 7 of link below:​

The company’s second quarter 2015 Condensed Consolidated Statements of Income and Comprehensive Income shows Q2 Total Net Revenues of USD $1,454,535,000, see page 7 of link below:

The company’s third quarter 2015 Condensed Consolidated Statements of Income and Comprehensive Income shows reduced Q3 Total Net Revenues of USD $1,364,347,000, see page 7 of link below:

The company’s fourth quarter 2015 Condensed Consolidated Statements of Income and Comprehensive Income shows Q4 Total Net Revenues of USD $2,145,967,000 and 2015 Total Net Revenues of USD $6,206,307,000, see page 8 of link below:

When we total the amounts given for the four individual quarters of FY 2015, we arrive at 2015 annual sales of USD $6,354,218,000, a number that is almost $148 million different from the 2015 sales figures reported to the SEC in April. Clearly, either the quarterly figures are incorrect, or the annual figures are incorrect, or both sets are incorrect. Unfortunately, we don’t know which set(s) of figures are incorrect, but what we have extrapolated from this data is that the quarterly figures have been “enhanced” to make the numbers not as bad as they in fact are. Similarly, the profit reported to the SEC at the end of the year is less than the profit reported for each of the four quarters of 2015. When the total 2016 figures are reported to the SEC next February, we’ll be able to make a similar analysis for 2016.

It is interesting to note that during our review, the same discrepancies did not occur in 2011, 2012, 2013, nor 2014; nor were they a product of foreign currency fluctuations. Additionally, the discrepancies were not seen in the amounts reported in the Chinese currency. What this tells us is that these irregularities are not due to incompetent accounting, but rather a deliberate attempt to manipulate the US market in a feeble attempt to keep the share prices from tanking.

At yesterday’s closing price of $13.18, the stock is trading at a trailing PE of 30. Given the challenges facing the company, we believe a more appropriate PE is 25, implying a stock price of $11. Considering that the company is now resorting to fraud to try to meet analysts’ quarterly expectations and that its annual financial statements are NOT audited, we reduce our price target to $8. ​ About us: Street Watchdog Research comprises a small group of investors, analysts, & short sellers based in Scottsdale, AZ. Our principals include Maxwell Athanis, Timothy Diggs, Cynthia Wayne, Angelene Dunlap, and Marissa Cabrera.

Disclosure: We are short VIPS. We do not have a financial relationship with the company.


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