Short-selling institutions pointed to the "five deadly sins" of ZTO Express, saying that the stock price has at least 50% room to fall

Focus

• 1 The report pointed out that there is a discrepancy between the financial data submitted by ZTO Express to the US Securities and Exchange Commission (SEC) and the report figures it submitted to the SAIC in China.
• 2 In addition to inconsistencies in revenue and profit figures, short-sellers also found significant discrepancies in their balance sheets.
• 3 The report believes that ZTO Express regulates profit figures through unverifiable capital expenditure figures, and uses high profit margins to attract investors in the capital market and obtain financing.
• 4 In addition, short sellers believe that under the "new crown" measures, ZTO still has huge capital expansion, which is inconsistent with the general trend of the general environment.

Tencent News "Periscope" Ji Zhenyu was published from Silicon Valley on March 2

Grizzly Research, a U.S. short-selling agency that issued short reports on NIO, now has a new goal.

On March 2, local time in the United States, the institution released a short report, saying that ZTO Express's ultra-high profitability caused the institution's suspicions, after careful due diligence, the institution believes that ZTO Express has several doubts such as inconsistent data submitted to the US Securities and Exchange Commission (SEC) financial report and the China Administration for Industry and Commerce, not including outsourcing personnel costs, and profiting insiders through related party transactions, and pointed out that the financial data submitted by ZTO Express to the SEC is unreliable and the stock price is significantly overvalued. At present, the company's market price, compared to its real value, has room to fall by 50-70% in the medium to long term.

After the release of the short report, ZTO Express once fell more than 3% in the US stock market on the day, but then the stock price rebounded to a certain extent, maintaining a slight shock, and as of the close, ZTO Express fell slightly by 0.25%.

As of press time, ZTO has not responded to the questions pointed out in the short report.

One "doubt": the level of profitability far exceeds that of peers

Grizzly's short report first compares the profitability of ZTO Express with major domestic large express companies, as well as large express companies UPS and FedEX in the United States, and finds that ZTO Express's gross margin, operating profit margin and net profit margin, which are key indicators reflecting corporate profitability, are far beyond the average level of the domestic express industry, and are also much higher than UPS and FedEX in the United States.

For example, in 2021, the average gross profit margin of China's express delivery industry, including SF, Yuantong, Yunda and Shentong, was 8.0%, the operating profit margin was 2.1%, and the net profit margin was 1.7%, while the corresponding three indicators of ZTO Express were as high as 21.7%, 18.1% and 15.6% respectively.

The profitability of ZTO Express is significantly higher than that of competitors in the same industry

In recent years, the express delivery industry has declined, and ZTO's profitability continues to lead

In the past few years, although ZTO Express has experienced a decline in performance like the whole industry, even so, various profit indicators still dominate the industry.

ZTO's profitability was once comparable to that of big blue-chip company Apple, the report said.

According to the report, in order to make the comparison fairer, it needs to be considered that the financial reports of YTO, Shentong and Yunda Express include the corresponding performance of "last mile" delivery services, while ZTO's financial reports do not include this part, but even after removing this factor, ZTO Express's profit performance is still much higher than other competitors in the same industry.

Horizontal comparison of industries excluding "last mile" business

Based on this, the report believes that ZTO's business must be "special" and can achieve such excellent profitability performance, either because the company has a very good management team, or its financial data is too good good to be true.

"While we would like to believe that ZTO's management team is extraordinary, our due diligence has led us in the direction that investors have been deceived." The report said.

Financial reports submitted to the SEC and the SAIC are inconsistent

After raising the question that profitability is unusually high, the report makes the case. First of all, it is pointed out that there is a discrepancy between the financial report data submitted by ZTO Express to the US Securities and Exchange Commission (SEC) and the report figures it submitted to the SAIC in China.

Specifically, the report first refers to the corporate structure disclosed by ZTO Express in its annual report, and ZTO has a total of five affiliated entities in China.

The company's domestic structure as disclosed by ZTO

The short-selling agency obtained the reports submitted by these five entities to the SAIC from 2019 to 2021, and compared the data with ZTO Express's financial reports to the SEC.

The aggregated data submitted to SAIC is inconsistent with the SEC filings

After comparison, it is found that there are significant differences in the data submitted by ZTO Express on both sides, for example, in 2021, the total revenue in the report submitted to the SAIC was 61.75 billion yuan, while the total revenue in the financial report submitted to the SEC was 30.4 billion yuan, less than half. The figures of net profit in the two reports were 3.867 billion yuan and 4.701 billion yuan respectively, a difference of 21.6%.

This difference resulted in ZTO's net profit margin to 6.3 percent in SAIC, compared with 15.5 percent in SEC filings, 9.2 percent higher.

Inconsistencies in revenue and profit figures also occurred in the 2019 and 2020 reports.

In addition to inconsistencies in revenue and profit figures, the shortseller also found significant discrepancies in the balance sheet.

Outsourced personnel costs are not included

According to the inconsistency of the financial report data revealed in the above report, the short seller has led to a new argument, believing that the reason for the inconsistency of the financial report data is that ZTO Express is particularly profitable in the financial report submitted to the SEC is that ZTO Express has carried out "selective screening" (cherry pick), that is, it intends to include the financial report data of its profitable entities into the overall financial results, specifically through its "network of partners" partners) model, as well as disclosed and undisclosed related party transactions.

The "collaborator network" model mentioned in the report was also explained in detail in ZTO's 2016 listing prospectus, referring to ZTO's focus on establishing core sorting centers and long-distance transportation networks, and relying on "collaborator networks" to implement last-mile delivery services.

Based on this business model, ZTO is focusing on its core business while outsourcing its "last mile" delivery services.

But the report notes that such a model gives ZTO room to manipulate financial data.

According to ZTO's financial report, from 2016 to 2021, its direct network partners increased from 3,500 to 5,700, and its non-direct network partners increased from 4,200 to 5,200 from 2016 to 2018, and from 2019, ZTO no longer discloses the number of non-direct network partners.

Although ZTO disclosed in its SEC filing that it had signed an agreement with an outsourcing company, it did not have a direct contractual relationship with the outsourced staff and did not assume any obligations to the outsourced personnel, the short-selling agency found that an interview with ZTO Chairman Lai Meisong in August 2021 concluded that ZTO's own employees and outsourced employees have paid 100% of their social insurance.

Therefore, the short-selling agency believes that ZTO failed to include the cost of this part of the employees, resulting in inflated profits.

Profit margins are extremely high, but they've been short of money, and they're going to be transfused through capital markets.

Although ZTO Express's profit margin is extremely high, the operating cash flow has been tight, and it needs to be transfused through continuous external financing, which is another obvious contradiction raised by short-selling institutions.

Working capital has lost blood for years and relies on the capital market for "blood transfusion"

From 2016 to 2021, ZTO Express's free cash flow was -4.177 billion yuan, raising a total of 34.839 billion yuan through listing, issuing shares and bonds during the same period, and using 12.598 billion yuan to pay dividends and repurchase shares, with a net financing of 22.241 billion yuan during this period.

It can be seen from the above that ZTO's business from 2016 to 2021 was actually "transfused" for the business through external financing.

The report further found that from 2019 to 2021, ZTO Express's capital expenditure was 5.2 billion yuan, 9.2 billion yuan and 9.3 billion yuan, respectively, and short sellers believe that under the "new crown" measures, ZTO still has such a huge capital expansion, which is inconsistent with the general trend of the general environment.

Capital expenditure growth was significantly higher than revenue growth

As can be seen from the above chart, from 2018 to 2021, ZTO Express's revenue growth rate was significantly lower than the capital expenditure-related growth rate in each year.

According to the short report, by reviewing the prospectus documents submitted by ZTO Express for listing on the Hong Kong Stock Exchange, the company failed to obtain some land qualification certificates for parcel sorting and office purposes, and without detailed information on these lands and office buildings, investors could not assess the true value of capital expenditures such as land and office land purchased by ZTO Express.

Therefore, the short report believes that ZTO Express has used high profit margins to attract investors and obtain financing through unverifiable capital expenditure figures, and this strategy has worked very well so far, and since its listing in 2016, ZTO has raised 34.8 billion yuan from the capital market.

Profit insiders through M&A transactions and related party transactions

The short report notes that from 2014 to 2015, ZTO paid 122 million in cash and 3.66 billion worth of shares to acquire 24 network partners. However, the total value of fixed assets of these network partners is only 122 million yuan, which is exactly equal to the total amount of cash paid by ZTO for all acquisitions.

The short-selling agency believes that according to the public data submitted by ZTO, ZTO paid excessive acquisition fees for these acquisition targets. According to the purchase price and the operating and financial calculations of these acquired objects, the ratio of enterprise value and EBIT acquired in 2015 was as high as 54.2 times, the price-earnings ratio was as high as 80.6 times, and the ratio of enterprise value to fixed assets was as high as 31 times.

High-priced acquisition of related party transactions

Another indicator to calculate the overvaluation of the acquisition price is the current franchise cost, according to ZTO's purchase price, the average franchise fee of these 24 acquired entities is as high as 160 million yuan, and according to the current ZTO announcement, even in provincial capital cities, the franchise investment fee is only 322,000 yuan.

More bizarrely, the report notes that 3 of the 8 acquisitions made in 2014 did not change ownership, and 6 of the 16 acquisitions made in 2015 did not, according to the Qicha data. These acquired companies, eight years later, did not reflect ZTO as their shareholders.

In terms of suspicious related party transactions, the short report pointed out that Tonglu Tongze Logistics Company and Shanghai Mingyu Barcode Technology Company had major suspicions.

Short-selling institutions believe that the relationship between Tonglu Tongze Logistics Company and ZTO Express has exceeded related parties, and should be counted as a subsidiary, according to public information, Wang Fang, the actual controller of 40% of the company's shareholders, is also the director of ZTO Group's service quality center.

From 2014 to 2021, ZTO paid transportation service fees to Tonglu Tongze Logistics Company every year, but the number of social insurance employees paid by the company decreased from 1,380 to 17 in 2020, but the payment service fees paid by ZTO did not decrease significantly.

For another company, Shanghai Mingyu, the short-selling agency said that the actual controller of the company, Lai Mingsong, was the brother of Zhongtong Chairman Lai Meisong. From 2017 to 2021, ZTO's payment to Shanghai Mingyu increased year after year, reaching 235 million yuan in 2021, but the company's employees only increased from 41 to 53 during the same period.

The short-selling agency also found that the financial director of Shanghai Mingyu also served as the accountant of ZTO Express, which also facilitated financial manipulation.

More "suspicious" related party transactions

The short report said that as of December 31, 2021, Zhongkuai Tonglu and Zhejiang Tongyu owed ZTO Express a total of 611 million yuan.

The short agency found that Hu Hongqun, the chief operating officer of ZTO Express, is also the main shareholder of Zhejiang Tongyu, and Lai Jianchang, the legal representative of Zhejiang Tongyu, is also a related party of ZTO Express.

According to the report, ZTO Express provides loans to real estate projects controlled by insiders, exposing investors to risks in the real estate industry, which has declined significantly in recent years.

In addition to providing loans to the above two entities, the short-selling agency also found that ZTO Express also provided loans totaling 300 million yuan to employees through different channels.

According to the report, ZTO Express was abused by company insiders and became their personal "piggy bank".

In addition, through on-site research, the report also disclosed a series of related party transactions that ZTO Express did not publicly disclose, and the actual controllers of these related parties were ZTO Chairman Lai Meisong and his brother Lai Mingsong.

The report also noted that at least four undisclosed related parties were used to move ZTO Express' costs off-balance sheet.

Summary: Stock prices are overvalued by 55% to 77%

Short sellers believe that there are many large express delivery companies in China, and it is more fair to consider that the ratio of enterprise value to sales ratio (EV/S) is more fair based on the horizontal valuation comparison of the same industry.

As can be seen from the above table, the average EV/S of the four major express companies in China excluding ZTO Express is 0.83 times, the median is 0.87 times, and the current EV/S of ZTO Express is as high as 3.91 times.

If valued at the industry-wide median EV/S, ZTO's share price should be $5.51 per share, which is 77.3% lower than ZTO Express's closing price of $24.30 per share on March 1, 2023, and $10.89 per share if valued at 2x EV/S, 55.2% lower than $24.30 per share.

The report concluded: "While we believe ZTO Express has some fundamental value and respect the company's achievements in the express delivery industry, there are very significant concerns about their report to the SEC. ”

The report points out that the numerous disclosed and undisclosed related party transactions should cause investors to be vigilant, especially if these related party transactions are not directly related to ZTO Express' core business. Further, we believe that we have demonstrated numerous cases of insider-friendly conflicts of interest at the expense of shareholders.

"We believe that ZTO Express' SEC financial report is not credible and that the stock price has at least 50% room to decline in the short and medium term."

Overview of ZTO Express:

According to the information on the official website of ZTO Express, founded on May 8, 2002, it is a comprehensive logistics service enterprise with express delivery as its core business, integrating cross-border, express, commercial, cloud warehouse, aviation, cold chain, finance, intelligence, Tuxi community life services, Zhongkuai digital marketing and other ecological sectors.

In 2021, ZTO Express has 30,400+ service outlets, 99 transshipment centers, 5,700+ direct network partners, 10,900 self-owned trunk transport vehicles (of which more than 9,000 are high-capacity dump trailers), about 3,700 trunk line transportation lines, and more than 99% of districts and counties, and more than 93% of township coverage. In 2021, ZTO Express's annual business volume reached 22.3 billion pieces, a year-on-year increase of 31.1%.

ZTO Express was listed on the New York Stock Exchange in 2016 and raised $14, making it the largest IPO in the U.S. stock market that year. On September 29, 2020, it achieved a secondary listing in Hong Kong, becoming the first express delivery company to be listed in the United States and Hong Kong at the same time.

According to the research report of the Prospective Industry Research Institute, in 2021, among the listed enterprises in China's express delivery industry, ZTO Express has the highest market share in business volume, exceeding 20%, followed by Yunda and YTO Express, both with a market share of more than 15%; The combined market share of the above three leading companies exceeds 50%.

As of March 2, 2023, ZTO Express has a market capitalization of approximately $20 billion.

About the short agency Grizzly Bear Research:

Grizzly Research is a research institute focused on providing research ideas through due diligence of listed companies, founded by Siegfried G. Eggert, the organization's team in the United States consists of accountants, economists, engineers, etc., Grizzly Research has an investigation team in China engaged in field research.

Through research and on-the-ground due diligence, the firm advises on M&A transactions and structured investment transactions, with major clients including family offices, hedge funds, investment banks and corporations.