Cloopen: A Clean Cloud, or Still Under Stormy Skies?

Cloud services provider’s investigation confirms revenue inflation last year, while separate, but similar, investigation by retailer Miniso finds no evidence of misleading claims involving its franchise model

Key Takeaways:

  • An internal investigation by cloud services provider Cloopen found the company inflated its revenue by about 5% in last year’s second and third quarters
  • The new China-U.S. information-sharing agreement could help restore investor confidence in such U.S.-listed Chinese companies

By Doug Young

A couple of new announcements involving internal investigations results for two U.S.-listed Chinese companies are showing why we need the agreement reached last month giving the U.S. securities regulator authority to directly investigate such firms. The group has basically been allowed to self-police itself in the more than two decades since Chinese companies began listing in the U.S., which is hardly reassuring coming from a country where inflating data is almost an ingrained part of the business culture.

The practice of inflating data certainly isn’t new, and seems to originate in China’s planned economic era where people were always trying to please their bosses by not only meeting, but often exceeding, their targets. Supervisors often claim ignorance in such situations and pin the blame on rogue underlings. But the reality is that people throughout such organizations are usually responsible, since bosses often pressure their underlings to achieve impossible targets and then pretend not to notice when they know the results they receive are probably exaggerated.  

Results of the latest internal investigations are coming from cloud services company Cloopen Group Holding Ltd. (RAAS.US) and retailer Miniso Group Holding Ltd. (MNSO.US; 9896.HK). Cloopen launched its investigation in May after its former auditor, the China affiliate of KPMG, uncovered evidence of revenue inflation and resigned. Miniso launched its investigation after a short seller accused the company in July of exaggerating its franchise model.

These two internal investigations follow two similar ones, including one that we wrote about earlier this week involving online grocer Missfresh (MF.US), also alleging revenue inflation; and another more famous one in 2020 involving coffee chain Luckin (LKNCY.US), also involving revenue inflation on a massive scale. In all four cases, suspicions of wrongdoing came from short seller reports or from the companies’ auditors. In each case, the U.S. Securities and Exchange Commission (SEC) was presumably relegated to the sidelines due to previous Chinese prohibitions banning it from conducting its own investigations.

We’ll end the suspense now by saying Cloopen’s investigation found that revenue inflation did indeed occur, though it was less than initially suspected. Meanwhile, Miniso said its investigation found no evidence of wrongdoing.

Investors didn’t seem too convinced by either report.

Cloopen shares dropped 7% after its announcement last week. But at their latest close of $1.01, we should also note the stock is up nearly 30% from where it traded just before initial announcement of the investigation in May. That seems to indicate that perhaps investors are betting that Cloopen has cleaned up its act and they may be willing to have more faith in the company going forward.

Miniso shares were down slightly in Thursday trade after it released its announcement clearing itself. But at its latest close of $5.50, the stock is now at roughly the level it tumbled to after short seller Blue Orca Capital issued its report accusing the company of misrepresenting its franchise model because many of its franchisees were, in fact, invested by the company’s owner. The stock last closed at $7.21 before the short seller report’s release, meaning the lukewarm response to results of the investigation may show investors remain skeptical about the company.

Less-than-expected revenue inflation

With all that big-picture background, we’ll take a closer look at the findings of both reports, starting with Cloopen. The company raised $320 million in its New York IPO in February last year, making it one of the last major Chinese listings in New York before most such listings ground to halt starting around July last year. Somewhat ironically, the amount of money Cloopen raised is now roughly double the company’s latest market value of $166 million, showing just how far the stock has fallen from its IPO price of $16.

Cloopen said its investigation found its revenue was inflated by 11.6 million yuan ($1.7 million) in last year’s second quarter, representing 4% of the total. The figure was inflated by 17.8 million yuan in the third quarter, or 6% of the total. While any inflation is never good, those figures were lower than the company’s original estimate saying that 5% to 10% of second quarter revenue and 15% to 20% of third quarter revenue might be bogus.

Cloopen added the investigation also found that its costs and expenses were inflated by 9.2 million yuan and 1.8 million yuan in last year’s second and third quarters, respectively.

The company hasn’t reported any financial results since last year’s third quarter due to the investigation. But it said in its latest announcement that its fourth-quarter results from last year “would also fall significantly below its previously announced revenue guidance” of 328 million yuan to 333 million yuan given last November with its third-quarter results.

Cloopen said it has taken corrective measures, including closing some business departments involved in the fraud and getting rid of or disciplining employees involved. It added the investigation “did not uncover any evidence indicating that the company’s CEO or CFO had participated in the employee misconduct and transaction irregularities.” But as we noted earlier, top executives in China often put big pressure on their underlings to reach difficult targets and then simply pretend not to notice when they get the numbers they want.

There’s not too much more to say about Miniso, since the company’s investigation turned up no evidence of wrongdoing. But again, the committee that conducted the investigation, while nominally independent, almost certainly came under big pressure from Miniso’s founder and CEO Ye Guofu to reach its “not guilty” conclusion.

So, the final question becomes: are these companies now more credible after conducting such internal investigations? Investors seem to think that maybe the answer is “yes” for Cloopen, probably because it admitted to the fraud and has taken corrective action. They don’t seem quite as convinced about Miniso. But at the end of the day, the new China-U.S. agreement could help address this credibility issue in a much broader way by making the U.S. securities regulator – and not the actual companies – the final judge in cases where companies are suspected of wrongdoing.

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