Muddy Waters Capital LLC (“Muddy Waters”) is an investment advisor to private funds. Muddy Waters has analyzed the U.K.-listed company IQE plc (“IQE”) and is hereby publishing the outcome and the conclusions of our analysis, which is based on publicly available information. Funds Muddy Waters manages are short shares of IQE and for this reason there might be a conflict of interest.
Muddy Waters is Short IQE plc (AIM: IQE LN)
Muddy Waters Capital LLC is short IQE. IQE is, in our opinion, an egregious accounting manipulator. We adjust downward the company’s reported net income for 2015 and 2016, respectively, by 58.5% and 25.4%. We believe it is reasonable to adjust 1H 2017 net income down by approximately £5 million or 69% to account for likely aggressive capitalization of expenses.
The 2015 and 2016 adjustments reflect our belief that IQE’s transactions with CSC are not substantive, and the accounting is possibly designed to deceive investors. We estimate that when IQE booked gains on transferring PP&E to CSC, it transferred the PP&E at a valuation 4.6x carrying value. This markup strains credulity. We call upon IQE to release the purportedly independent valuation report in full, and we will publicly opine on it (even if it convincingly supports the valuation). IQE was CSC’s only customer through 2016, and CSC generated an abysmal negative -105.9% gross margin! (It is almost amazing anyone would claim that it “holds itself to the highest standards of corporate governance, transparency, and integrity” with a straight face under these circumstances.)
We identify five previously unknown issues with the accounting for transactions between IQE and CSC. Time and again, IQE seems to be employing “having one’s cake and eating it too” accounting. We feel that IQE dominates CSC, and CSC is therefore likely an alter ego for IQE.
We believe IQE began aggressively capitalizing expenses in 1H 2017. CSC’s funds were largely exhausted by the end of 2016, and we suspect IQE was desperate for some more earnings magic. We note that insiders, who presciently purchased a substantial number of shares just before the JVs’ accounting benefits began flowing to IQE, sold millions of pounds of stock around the end of 1H 2017. These sales could be a sign that IQE’s ability to generate profits has hit the wall as the result of the exhaustion of its financial engineering options.
On February 2nd, a firm called ShadowFall circulated a report criticizing IQE’s accounting for two joint ventures. IQE responded on February 5th, calling the contents of the report “without merit” and “misleading”. Our research has been independent of ShadowFall, ShadowFall’s report does not address the vast majority of the issues with IQE’s accounts we have identified.
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