Advertisement

Muddy Waters' Carson Block on his latest short, GSX Techedu

Muddy Waters Capital Founder & CIO Carson Block joined Yahoo Finance's Jen Rogers, Myles Udland, and Dan Roberts to discuss his latest short call on GSX Techedu.

Video Transcript

MYLES UDLAND: All right, let's switch gears a little bit and talk about a single name under a little bit of pressure today. That's a name many of our viewers may not have heard of-- GSX Techedu, an online Chinese, I guess, education company. We're joined now by Carson Block, he is the founder and CIO at Muddy Waters published.

Their latest short thesis on the company. Just this morning, Carson [INAUDIBLE] join us today. I guess kind of walk us through the headline of your thesis here and what you've seen in this name.

ADVERTISEMENT

CARSON BLOCK: Sure, well, calling GSX a company is arguably a bit generous. So they claim to provide online, mainly K through 12. But the reality is that the vast majority of its users-- and we think easily north of 80%-- are not real. What we did was we registered for over 200 paid classes.

And then using Google developer tools embedded in Chrome, we're able to see that the company hopefully provides zip files for each class that show each unique by each unique user login pattern, IP. And from that, we were able to deduce three patterns that we're highly confident mean that users are bots. So these are what we call precise joiners who join.

These classes are held weekly, so the same day every week. These are joiners who join at the exact same second multiple times, which we think is just highly improbable if you're human. Another are GSX-linked IPs. So we can see the teacher and tutor IPs. But when purported students login from those same IPs, that seems to be a problem. So we deem those bots.

And then the final high confidence category is what we call burst joiners. So these are people who are use-- sorry, users-- that will be logged in within the same second in groups of 10 or more. And so we excluded a window right around when class starts to be conservative. But, you know, the way that often worked was there'd be no login activity. And then boom, here are 20 or 30 users.

So that's how we came up with this high confidence measure of bots, which took us to about 72%, 73% of the 54,000 users in our data sample. But then we also said, well, there's this weird pattern of early joiners who joined more than 30 minutes before classes start. And, again, this is an online class. It's not hanging out in the lecture hall before the next class. And so if we add those in, that takes us a little bit north of 80%.

If we use some assumptions that we're less conservative, I think we could be at 90% safe users. My assumption is that, you know, revenue-- at least, 80% of revenue is fake. I think it probably would be fair to say at least 90% of revenue is fake. The company reports profits. There is no way this company is remotely close to break even. So it's just basically an $8 billion market cap nearly empty box at the end of the day.

MYLES UDLAND: And Carson, I want to ask a little bit about the process here, because you guys highlight at the top of this presentation that the company publicly stated basically that we think if Muddy Waters looks into our business, they'll find that everything is above board. They basically dared you to publish the report that you published today.

I can only imagine that that set off the alarm bells that you already had even louder, because, as you know well, when a company starts discussing the short sellers, usually their business tends to be on the wrong side of that trade.

CARSON BLOCK: Yeah, and there's also an element that I found kind of distinctly Chinese about that in a way where it's not uncommon if you're a business person, and your business is failing. It's not uncommon in China for such a business person to actually spend more lavishly than usual to create the opposite perception.

So, you know, I kind of looked at this. And I thought, all right, well, I think this is-- you know, this is trying to appear strong when you are, in fact, quite weak and maybe also just hoping that that would dissuade us. I mean, we've been working on this for several months. So it's not that that was the signal for us to take a look. But, yeah, it's kind of a new twist in this one.

JENNIFER ROGERS: Hey, Carson, what's it like operating right now during the pandemic? I mean, there is that famous Warren buffet quote-- You find out who's swimming naked when the tide goes out. And we've had the Luckin Coffee issue surface recently. You've got this research here.

Are we finding more of these right now because of what's happening with the economy? Or you said you've been working on this for months. Were they just there before and not even exposed more right now?

CARSON BLOCK: Well, if you're talking about China frauds, I mean, that's really independent of kind of the, you know, the rest of the market, the rest of the economy. I mean, that's a problem that has not gone away. We began-- we were among the first to expose these problems starting literally 10 years ago. In fact, you know, next month will be the 10th anniversary of our first report which was on a China fraud.

I think enforcement kind of threw in the towel on these for a while. A number of them went dark and delisted. But then when they started IPOing, they were better frauds. Most of them are not-- you know, I guess the percentage fraudulent behaviors did not approach where GSX is.

But, yeah, the SEC and DOJ just been always really frustrated trying to investigate these companies because it's so resource-intensive. I mean, just if you think about the translation work alone that's needed and get stonewalled on the China side if you're a US regulator. So, which by the way, this is a really important thing that any of your viewers who are interested in China stocks should know.

China, a revised company law went into effect this year that actually states that if a company based in China is publicly traded overseas that the China securities regulatory commission has exclusive jurisdiction to investigate wrongdoing and that these companies may not cooperate with foreign regulators, read the SEC, unless the CSRC expressly allows it.

So what had been an unwritten rule that basically a company in China, you know, and its service providers, like auditors, have to give the finger to US investors is now codified as an actual law in China. So it did strike me as ridiculous that, you know, we continue to allow these listings.

DAN ROBERTS: Carson, Dan Roberts here. You're addressing a little bit how many of these Chinese tech companies may have fraudulent user accounts. But also with GSX, it's EdTech. How many other companies in these kind of industries might be boosting and juicing their user accounts? I mean, even Zoom about two months ago had to revise its user count. And it had sort of accidentally inflated its total number of users.

A lot of businesses like this come out pretty early with really big user numbers that might be questionable. Is that something you guys think about, not just Chinese companies, but these companies that, yeah, maybe we haven't heard of them as much. And suddenly they say, we're coming to use what we have. They're using our software.

CARSON BLOCK: Sure. Yeah, I think that measuring users and user engagement is more challenging for legitimate tech companies than a lot of them want to admit. And my impression is that the main reason for that is that when these companies are founded, you know, four people in a garage, nobody-- none of the founders wants to work on the measurement side, because that's just not as fun and interesting as the product side. But it's a necessary evil. So it gets a half effort.

And then they start measuring. And maybe they're not measuring correctly. And they just haven't built this well. They go and start pitching BCs. And our understanding is that whenever they give BCs their user metrics, BCs do not expect those to be audited. Or they don't expect any checking of that. So it kind of perpetuates. And the companies raise money. They build the dashboard on top of what's often a very flawed backend.

And, you know, later as they go public or get ready to go public, then, you know, people start saying, ooh, this isn't really a good system. But what are we going to do here? So I think there is a problem in legitimate companies. But to be clear, GSX has been using bots since 2015. That's according to a former GSX manager who confirmed much of our analysis or, well, confirmed everything and added a little bit of, I guess, color to it.

And this went public with the idea of being a hard core stock fraud. The chairman here is on paper worth a few billion US dollars. And, you know, I'm sure if he's able to, he's going to try to grab every single penny of that before this thing implodes.

JENNIFER ROGERS: Hey, Carson, it's Jen again. There's a story up on Marketwatch. You did interview with them. And they said that coronavirus has you thinking about a new career-- weighing a career change and thinking of stopping what you're doing now being a short seller and going and doing something else. And what would it be?

CARSON BLOCK: [LAUGHS] Well, yeah. I mean, it was kind of a fun interview this morning when it went into that. But what I've said is that, you know, watching our completely inept political response to coronavirus, I mean, it's just added to my myriad frustrations with how poorly governed we are. And it has made me think that maybe in the medium to long term, maybe I should look to go into public service in some way.

I've long felt that, you know, I-- that if you're complaining about the way something is done, you should try to do it yourself. And, yeah, I mean, no plans in the near future. I have a pretty powerful platform. And, you know, right now, I'd like to think that it does some good when I use it to expose fraudulent companies or other abusers. But, yeah, the time may come when I decide to try to do something that's more public-oriented or public service-oriented. So I wouldn't preclude that.

MYLES UDLAND: All right, Carson Block, thanks so much for joining the program today. Again, the founder at Muddy Waters research. The short this time around is on GSX Techedu, ticker, GSX. Carson, thanks so much. We'll talk to you soon.

CARSON BLOCK: Thank you.