Consumer Discretionary Author: Qasim Khan Editor: Luke Sheehan Jun 28, 2020 08:24 PM (GMT+8)

The online education firm has been a hot topic during the past few months, with as many as 10 reports being published trying to prove a fraud is taking place.

Stocks. Image credit: Jason Briscoe/unsplash

GSX Techedu, a firm with a current market cap of USD 13.4 billion, saw its stocks reach USD 57.81 – an all-time high since getting listed almost a year ago, in June 2019. The firm has been performing rather well on the stock market regardless of being shorted 10 times within 3 months. 

One of China’s largest online education firms is becoming a battle-ground stock. Short interest – people betting against it – is surging due to prominent fraud allegations. The reason behind the stock surging may well be the firm’s management openly disputing the accusations since which the stock has rallied nearly 60%, suggesting at least some investors find the explanations reasonable.

On February 26, Grizzly Research, a research firm that produces differentiated research insights on publicly traded companies, released a 50-page report, ‘Why We Believe GSX Techedu is the Worst Publicly Traded Education Company.’ The firm really took a hit on April 14, after short-seller Citron said it's ‘the most blatant Chinese stock fraud since 2011.’

Following Citron's first report, as many as 16 US law firms initiated class actions to investigate the Chinese education company that was recently valued at USD 10 billion, for exaggerating profitability. The survey focused on whether the company overstated indicators such as profitability, income, student enrollment, and teacher qualifications, or did not disclose information related to investors.

What’s worse, on May 7, Citron Research issued the third part of the report in a series of GSX Investigations. Citron presented to US regulators definitive evidence of GSX Techedu committing securities fraud using multiple undisclosed related party transactions to hide expenses/liabilities. The report also pointed out that it is highly unlikely that GSX claimed to acquire a customer at half the cost vs. peers. And over 80 highly suspicious WeChat official accounts engaging in customer acquisition solely for GSX that were not registered to any disclosed GSX entity.

Muddy Waters, the same firm which unveiled the Luckin Coffee fraud, joined the party in late May, claiming at least 70% of the firm’s users are robots and calling it a massive loss-making business. The ADRs tumbled 34% from their Feb. 24 peak the following day. 

Larry Chen, the founder of GSX, replied via his social media account by saying, “Muddy Waters did some homework for the report. It’s just a pity that they didn’t understand the business model of our online live large class.”

As of June 24, according to Bloomberg, Carson Block, the founder of Muddy Waters Capital LLC, has renewed his short-selling attack on the Chinese after-school tutoring platform.

Block called the USD 14 billion stock’s recent price surge “a massive middle finger pointed at Washington.” He also alleged failure by China’s securities watchdog to regulate the US-listed company.

It's fair to note GSX’s management has been providing investors with explanations for these fraud accusations. So, the investors have to either believe the company they have invested in – or put faith in these short sellers. Both Muddy Waters and Grizzly Research provided instructions for investors wanting to replicate their findings. The accusations are quite serious. Such stories can bring a company’s stock to record lows or even get delisted if proven. The investors themselves should do some extra due diligence with the stock – i.e. verify the research findings and compare to GSX Techedu management's explanations. The ones not willing to put forth this extra effort shouldn't consider buying shares, at least until these allegations are resolved. 

It is evident that the epidemic has created a window of opportunity for huge tech giants to enter the education industry but at the same time firms which are already are in the business have stepped up to prove the strength and advantages of online education. By providing free online classes, companies such as Yuanfudao, GSX Tecchedu and Zuoyebang gained millions of users.

According to a recently released iiMedia's (艾媒) research report on the development of China's online education industry, the online education market in China reached CNY 404.1 billion in 2019 and it is expected to reach CNY 453.8 billion in 2020. The report further stated that the total number of online education users in China is expected to reach 309 million by 2020, around 40 million more than the estimates of iResearch.