What happened
Shares of GSX Techedu (GOTU -6.95%) continued their downward march on Wednesday after fraud allegations from a famed short seller sparked investor fear earlier this week. Today, the stock is down 11% as of 3:30 p.m. EDT. But it's down over 15% since this started.
It didn't take long for GSX Techedu management to respond. Yesterday, it released a statement attempting to clarify things for investors. But based on the stock's movement, it seems not everyone is buying it.
So what
On May 18, research firm Muddy Waters told the world it was short GSX Techedu stock. It went through the company's user data and said it's "highly confident" over 70% of users are fake and another 8% are "highly likely" fake. Only around 19% of users are "somewhat real." This led the firm to the only logical conclusion: "it is a near-total fraud." The stock immediately fell as a result. Investors don't like fraud.
Now, GSX Techedu says Muddy Waters doesn't know what it's talking about. For example, two claims by Muddy Waters concern "precise joiners" (students who join a class at the exact same time) and "IP joiners" (students who share an IP address with a teacher or student). By looking at patterns from the data, Muddy Waters concluded the precise joiners were too precise to be people and must therefore be bots. And the shared IP addresses are suspect since GSX Techedu doesn't operate a physical classroom.
GSX Techedu, however, has an explanation for the precise joiners. Students arrive to class early and do warm-ups with tutors. But when class starts, students transition to the instructor's classroom at the same time. This creates the suspicious precise-joiner issue Muddy Waters noticed.
Concerning IP joiners, GSX Techedu says Muddy Waters is just plain wrong. While Muddy Waters found 28.2% overlap in IP addresses, GSX Techedu says it's actually only 0.78% overlap.
Image source: Getty Images.
Now what
Muddy Water's 25-page report is detailed and explains how it came to its conclusions every step of the way. Moreover, it claims corroboration from a former GSX Techedu insider. Having uncovered fraudulent Chinese companies before, these allegations should be taken seriously.
However, to be fair, there's room for Muddy Waters to be incorrect. GSX Techedu had a response to several things alleged in the report, and each sounds reasonable. Did Muddy Waters draw solid conclusions from faulty assumptions? It's possible.
If I were a shareholder of GSX Techedu, or thinking of buying or shorting shares, I wouldn't do anything without digging deeper into this issue and coming to my own conclusions. Muddy Waters includes instructions on how to access the data it analyzed in its report. One could examine whether GSX Techedu's explanation looks reasonable given the data presented by Muddy Waters. It's extra work but worth it given this technology stock faces fraud accusations of this magnitude.
