Uxin (UXIN -1.08%) shares plunged Tuesday after J Capital Research, a short-seller of Chinese stocks, issued a broadside against the Chinese online used-car dealer, essentially accusing the company of fraud in a variety of ways. 

Uxin shares, which were already trading around all-time lows coming into the day, fell as much as 54% on the report and closed down 36% after a modest recovery. The stock has since recovered those losses as management bluntly rejected the report, but investors shouldn't totally dismiss the attack as J Capital's claims were detailed and thorough.

A businessman knocks down wooden dominoes.

Image source: Getty Images.

What J Capital had to say

In a 34-page report, J Capital, which has also urged investors to short stocks like FanhuaChina Customer Relations Centers, and Sorrento Therapeutics, outlined a number of issues at Uxin, and concluded by saying, "Everything about Uxin suggests a company whose chief raison d'etre is to hoodwink investors as much as possible in order for a few people in management to make a bundle of money from selling highly priced stock. There is no reason for public investors to play along."

J Capital's claims were as follows:

  • Uxin inflates sales by as much as 40%. J Capital's research found that Uxin used a number of tactics to inflate its sales and transactions. First, the company gives dealers a specially designed POS (point-of-sale) system that allows Uxin to record transactions that should only belong to the dealer, J Capital said. According to eight interviews conducted by J Capital, Uxin has participating dealers use its POS system to record all their transactions even though only 5% to 10% may belong to Uxin, and Uxin incentivizes the dealers by subsidizing the banking charges. Uxin would reportedly automatically reimburse the dealers to reassure them that it wouldn't keep that money.
  • Transaction volume and inventory are grossly overstated. J Capital said Uxin's listings were also greatly exaggerated. The research firm said Uxin claims to have cars for sale in 900 cities, but J Capital found with its own specially designed software that there were only 399 cities in China with Uxin inventory. J Capital also found just 103,600 listings compared with the 200,000 that management claims, and said the company was "double posting" the same car in different cities. J Capital went on to say Uxin was inflating its listings by adding cars that were also available on other sites, and keeping cars on the site after they've sold. The short-seller also said Uxin employees photographed used cars in lots to put on the website without dealer authorization.
  • Unreported debt. J Capital said that Kaifeng Financing Lease, a wholly owned subsidiary of Uxin, has $3.6 billion in debt on its books, which is not disclosed in its U.S. financial statements.
  • CEO Kun Dai took $280 million out of the company without reporting it. The short-seller said that Kun first took a $100 million loan that was repaid in company stock and then received $180 million through a "forced" margin sale, technically allowing the company to say that he hadn't sold any shares.

What's an investor to do now?

A short-seller report almost always presents a dilemma for investors. Short-sellers have their own motivations -- to make money by knocking the stock lower -- so their charges are often trumped up or even outright bogus. Therefore, investors should take J Capital's claims with a grain of salt. 

Uxin responded to the allegations Tuesday night, saying the report:

Contains errors of facts, misleading speculations and malicious interpretations of events. Uxin believes that the allegations in the report are completely without merit, and strongly condemns the publishing of false and misleading information. The Company firmly denies the baseless allegations that it has falsified any sales data. Kun Dai, the Founder, Chairman and Chief Executive Officer of Uxin, also confirmed that he had never voluntarily sold any shares in Uxin as alleged in the report. 

Uxin also said, "The company is carefully reviewing the report and will provide additional information on the allegations as appropriate."

For investors, it's also worth remembering that Uxin is no fly by-night company: It has backing from some of the biggest companies in China, including Baidu, in addition to its partnership with Alibaba's Taobao. Hedge funds like Tiger Global and KKR also have significant stakes in the company. 

Some of J Capital's charges also seem a little dated or irrelevant at this point. For instance, Uxin is moving away from its "2B" dealer-focused business, and instead growing its "2C" business, which revolves around connecting buyers and sellers, so J Capital's allegations about dealer shenanigans may not mean much going forward, even though investors deserve the truth on the matter. If Uxin is doing things like inflating sales through the POS system, that may explain why sales and marketing expenses have been so high, and even higher than revenue in some quarters.

Though the stock has recovered from the sell-off, investors still deserve a detailed rebuttal from management. These are serious allegations and warrant a thorough response.