Early this month, a short-seller report was released causing NIO (NYSE : NIO) to retest its $20 support.
This report came from Grizzly Research which had also released other notable short-seller reports on trending companies such as MP Materials (NYSE : MP) and TuSimple (NASDAQ:TSP).
While it is not my role to pass judgment on the credibility of their claims, I do think that readers may benefit from further analysis on some key points mentioned in the report. As always, my focus will be on keeping this analysis objective, concise and “jargon-free”.
NIO short seller report summary – a TLDR
Prefer to learn via a video? Here’s Alvin’s breakdown:
The report is almost 30 pages long (pdf version here) with allegations ranging from issues arising from inflated revenue & profitability to the ‘shady’ affiliations of Nio’s CEO, Bin Li.
In my opinion, the foundation of this report mostly revolves around a single claim of NIO being able to ..
“…recognize revenue from the batteries they sell immediately … instead of recognizing revenue over the life of the subscription.”
Grizzly Research – paraphrased.
For those unfamiliar with NIO’s business model, one key Unique Selling Point that NIO has over its competition is the concept of Battery as a Service (BaaS). With this, the central idea was to give buyers the option of purchasing a NIO vehicle WITHOUT the battery.
The objective was to decrease the upfront cost of a NIO car and in doing so, stimulate Electric Vehicle (EV) adoption (Lower price = lower barrier to entry for new buyers)
As favorable as this sounds for buyers, BaaS does have some significant drawbacks for NIO with one being how they are unable to recognize the revenue from the batteries that they sell given that they are instead collecting a monthly subscription fee from their buyers
This now brings us back to the claims, as outlined by Grizzly Research above, which revolve around the ‘creative accounting’ that NIO has been engaging in to recognize the entire lifetime revenue of their battery subscriptions at the point of sale.
Long story short, the following is how Grizzly Research claims that NIO is doing this.
- 3rd Party known as Wuhan Weineng Battery Asset Co. Ltd (aka. Weining) pays NIO upfront for the batteries allowing NIO to immediately recognize the revenue from the sale of such batteries. (Buyers then pay Subscription Fees a to Weineng.)
- This relationship that NIO has with Weineng has been the “convenient difference-maker helping NIO exceed lofty growth and profitability estimates on The Street”
While the story does get deeper than what I’ve summarised in the two points above, overall, Grizzly research believes that “sales to Weineng have inflated NIO’s revenue and net income by ~10% and 95%, respectively. Specifically, we find that at least 60% of its FY2021 earnings beat seems attributable to Weineng.”
So, what’s “wrong” with this arrangement between NIO & Weineng?
According to Grizzly Research, this arrangement develops an almost questionable symbiotic relationship between both companies as,
If Weineng did not exist, NIO would have to recognize subscription revenue from customers over the lifetime of their subscription. Luckily for NIO, they don’t have to wait… Consider a 70K RMB sale. Normally it would take NIO approximately 7 years (inflation-adjusted) to generate the full subscription revenue, but with Weineng, they can recognize the revenue immediately.
Never Stop Pulling: How NIO is Pulling Forward Future Revenues Using Wuhan Weineng
Inadvertently, Grizzly Research claims that this relationship allows NIO to have a “willing counterparty to sell more batteries than their required network needs”.
With this, 2 questions would naturally come to mind,
- How much influence does NIO have over Weineng?
- Has NIO been ‘oversupplying’ Weineng with more batteries than needed?
Grizzly Research has provided answers to both questions above which add further validation to their claims.
1) How much influence does NIO have over Weineng?
NIO Maintains Effective Control: Top Weineng Managers Are Current NIO Executives.
2) Has NIO been ‘oversupplying’ Weineng with more batteries than needed?
According to Grizzly Research, “as of September 30, 2021, Weineng had 19,000 subscribers under the agreement but held 40,053 batteries in inventory”
Hence. “from both an operational and structural standpoint, Weineng has no need for any excess batteries. Therefore this evidence leads us to believe that NIO has oversupplied Weineng by up to 21,053 batteries as of Q3 2021 to boost its financials.“
What does the market think?
In line with market volatility, I infer that shareholders do not seem to be rattled by this short-seller report given that the price of NIO has fallen by a mere 16%+ (From $25 to $20) since the report was released. This seems to be consistent with other similar companies such as XPENG which has also seen its price fall from $35 to around $30 in this same time period.
It is almost apparent investors have already made up their minds on this report given that we did not experience any extreme volatility relating specifically to the price action of NIO.
What am I doing as a NIO shareholder?
At the time of writing, I hold shares of NIO (even at $40, lol) hence this short-seller report has indeed caught my attention. In my opinion, I do think that this report does have some merit however, I see this as an opportunity for management to step up and for them to come clear with these accusations.
As questionable as it is, I believe that it is not uncommon for companies to “sell” an asset to a leasing company only for them to recognize the sale at present and for the leasing company to “deal with it”.
The real question that we should ask ourselves here is how transparent NIO’s management is in doing so and if they are doing this to cover up any shortfall in revenue.
Latest Update (7 July 22)
On 7th Jul 22, NIO has provided an update on their next move following this short-seller report and that is to “form an independent committee…to oversee an independent investigation regarding the allegations made in the Short Seller Report”.
In my opinion, it is good to see NIO’s management stepping up to address this.
tl;dr: Grizzly Research released a short-seller report targeting NIO. In it, they highlight NIO’s apparent ‘creative accounting’ which allowed them to recognize the entire lifetime revenue of their battery subscriptions immediately. If to be believed, this means NIO has been ‘inflating’ their battery revenue figures. Despite the report, the market hasn’t respond negatively.
I will be observing the situation closely and will be sure not to make any rash decisions before more information comes to light.
Hi
I am not au-fait with accounting, but from layman’s point of view, why do NIO needs to form an independent committee to investigate the said matter? NIO has all the numbers, and thus I will have expect them to just explain how they do the accounting and whether it is acceptable to accounting rules and whether it is an industry norm as what they were doing. Also, I read that the committee will be formed by their independent directors. So where were these independent directors before the short seller report came out?
Hi Ms Kim,
No update from NIO thus far hence it is difficult for me to provide any conclusive answers.
The concept of an independent director is also debatable at best as while these directors do not part-take directly with the day-to-day actions NIO, they are likely renumerated one way or another by NIO hence it would be in the best interest for their goals to be aligned.
For now, best to see what their findings will report although it does seem to lack urgency.