Nio (NIO -5.00%) stock is down this week after a short-seller attack.
It's typical for a stock to fall when a short-seller accuses a company of any wrongdoing. In Nio's case, Grizzly Research alleges the electric vehicle (EV) manufacturer used an "audacious scheme" to inflate its revenue and profitability, even likening it to the Valeant Pharmaceuticals scandal in which the company was found guilty of using related-party transactions to boost sales.
The third party that Grizzly Research is referring to is linked to Nio's popular battery program, which is a major competitive advantage. Needless to say, investors are worried. On Wednesday, Nio stock fell about 11% on both the Hong Kong and Singapore stock exchanges (before ticking up today), and it opened the U.S. market deep in the red before recovering to a dip of about 2%.
Here's what you, as a Nio investor, should make of this short-seller attack.
The short-seller allegations
In a detailed report released on June 28, Grizzly Research accused Nio of using affiliate Wuhan Weineng to inflate its numbers and consistently beat Wall Street estimates.
Nio's battery-as-a-service (BaaS) program is one of its most enticing offerings, allowing customers to purchase Nio vehicles without battery packs at a lower price and instead subscribe to rent and swap batteries as needed. The catch here is that Weineng, and not Nio, leases the batteries. So, every time Nio sells a car under BaaS, it also sells battery packs to Weineng and generates revenue from those sales. Weineng earns the subscription fees from BaaS customers.
Image source: Nio.
Grizzly Research claims its investigators in China have found Nio to have oversupplied battery packs to Weineng to inflate revenue.
Based on Weineng's inventory as of Sept. 30, 2021, for instance, the researcher estimates Nio to have oversupplied more than 21,000 batteries worth more than 1.1 billion Chinese yuan. Grizzly Research says this potentially inflated Nio's revenue by 10% and understated its net loss by about half (that is, it should have been 95% higher) for those nine months. For perspective, Nio reported a 122% growth in revenue to 36 billion Chinese Yuan (or roughly $5.7 billion) and a 24% drop in its net loss for the full year 2021.
Grizzly Research also questions why Nio immediately recognizes revenue from the sale of a battery pack to Weineng instead of spreading it out over the BaaS subscription period of around seven years. It says Nio is using links between its and Weineng's executives to pull off these accounting games, and warns some of the company's arrangements with the Chinese government could dilute shareholder wealth "materially" in the future.
Nio's response leaves room for more
Nio has, as expected, rebutted the short-seller's findings and said the report contains "numerous errors, unsupported speculations, and misleading conclusions and interpretations regarding information" relating to the company.
What I also expected from Nio, though, was a more in-depth response detailing its relationship and agreement with Weineng that has a direct bearing on the EV maker's bottom line, in particular. Nio, though, has said it is reviewing the allegations and will make relevant additional disclosures as required by the regulatory authorities in the U.S., Hong Kong, and Singapore.
Does this mean you should sell Nio stock now?
Investing in stocks of foreign companies comes with its fair share of risks. That said, Nio is listed on three global stock exchanges, so it must be more vigilant, as it has to comply with more regulatory laws than most companies. Nio sells vehicles and offers BaaS in Europe as well.
Also, Nio owns only a 19.8% stake in Weineng, so any dealing with Weineng that directly affects the battery company's inventory and bottom line will also affect other stakeholders, which include some of the largest battery manufacturers in China.
Moreover, of the roughly $5.7 billion in revenue that Nio generated last year, $5.2 billion came from vehicle sales. Not all of the remaining revenue came from the sale of battery packs. In fact, almost 55% came from the sale of chargers, energy and service packages, battery upgrade services, and the sale of automotive regulatory credits.
Further, Grizzly Research's calculation of Nio inflating net income by 95% appears to be based entirely on its views that Nio itself -- and not Weineng -- should lease batteries, and therefore recognize revenue and depreciation from battery sales over the BaaS subscription period and not up front. It also assumes Weineng should have the exact number of batteries in inventory as the number of BaaS customers based largely on two things: its investigators' conversation with one Nio salesman and low footfall at some of Nio's battery swapping stations.
The point is, you should take a short-seller report with a grain of salt. While you'd want to watch out for what "additional disclosures" Nio makes henceforth, Nio's growth plans look promising and there's no reason to sell the stock now.
