Battle lines drawn: A closer look at WiseTech vs J Capital

WiseTech Global Ltd (ASX: WTC) shares have been pummelled again as the war between the technology stock and short seller heats up. Here's a detailed look at the timeline of events.

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WiseTech Global Ltd (ASX: WTC) shares took a tumble last week when short seller J Capital released a report declaring the technology stock had overstated profits by as much as $116 million over 3 years. Shares in WiseTech fell from $33.40 on Wednesday to $30 on Thursday following the release of part 1 of J Capital's report before being placed in a trading halt.

WiseTech released a statement to the market on Friday denying the veracity of J Capital's report. Shares resumed trading yesterday morning only to be hit with Part 2 of the report, which prompted another slide in the share price and another trading halt.

In part 1 of the report, J Capital accused the WAAAX company of overstating organic growth, estimating organic growth was closer to 10% than the 25% claimed by WiseTech. Accusing WiseTech of performing 'IPO magic' J Capital found claimed profit growth, which soared from 6% pre-IPO to 1,100% post IPO, suspect.

Revenue from European subsidiaries is estimated by J Capital to have been overstated by as much as $48 million in FY18. International revenue had been channelled through Australian subsidiaries, which J Capital posits are shielded from audit scrutiny through the use of a deed of cross guarantee. The recent resignation of the chair of WiseTech's Audit and Risk Management Committee was also labelled a red flag by J Capital.

Since its IPO, WiseTech has spent some $409 million on 34 acquisitions, which J Capital claims are poorly integrated and underperforming. According to J Capital's report, most acquisitions remain stand-alone due to WiseTech's failure to allocate resources to integration. J Capital states, "WiseTech's acquisition spree looks like a frantic effort to maintain the narrative that this is a fast-growing technology business."

Part 1 of J Capital's report concluded that WiseTech was "manipulating its accounts to make growth and profits appear higher than they really are." The purpose of this manipulation was to enrich management and directors, who J Capital point out have sold $259 million worth of shares since WiseTech's IPO.

WiseTech's response

WiseTech issued a statement to the market on Friday denying the allegations contained in the J Capital report. The technology company stated it "rejects entirely the allegations of financial impropriety and irregularity." CEO Richard White expressed concern that "the allegations in the document may mislead and manipulate the market to the detriment of WiseTech's business and its shareholders, large and small."

WiseTech's rebuttal stated that organic growth in FY19 was 33% and claimed that J Capital's assessment of profits was erroneous due to a misapplication of accounting standards. Further, WiseTech stated, there were "numerous and significant errors" in checks of profit figures conducted by J Capital.

WiseTech stated that J Capital had understated European revenue by excluding numerous acquisitions completed to the end of FY18. WiseTech also took issue with J Capital's use of FY16 statutory results as a point of comparison as these results included the significant one-off costs of the initial public offering.

While agreeing that the deed of cross guarantee meant subsidiaries were not required to lodge separate audited financial statements, WiseTech dismissed the suggestion that it shielded subsidiaries from scrutiny. Subsidiaries, the company noted, were required to maintain detailed accounting transaction records to support group audit procedures.

The resignation of the Audit Partner was not considered unusual by WiseTech, which noted a number of other historical changes that had occurred to audit providers. Finally, the company denied reporting was designed to facilitate a "cash-in" by insiders, White concluded the rebuttal by saying "we are deeply concerned about the extensive value destruction that can be wrought from short-seller reports."

J Capital bites back

J Capital yesterday issued part 2 of its report on WiseTech, sending the company's shares into a further dive. After falling to $30 before the trading halt on Thursday, shares plunged to $26.30 yesterday as the market digested the contents of the second report before a second trading halt was called.

J capital dismissed WiseTech's defense as following "a well-worn playbook by cherry picking immaterial points to refute, remaining silent on major points, and taking a high moral tone about 'short-sellers'". The short-seller pointed to WiseTech's confirmation that subsidiaries are not individually audited and failure to directly address the resignation of the head of the Audit Committee as clear 'tells'.

To WiseTech's claim that J Capital left out a number of subsidiaries from calculations of European revenue, J Capital retorted that the inclusion of said subsidiaries would only marginally change their estimate of revenue overstatement, and would not alter their estimate of $33 million in overstated profit in the same period.

Claiming WiseTech's response was "long on indignation, short on facts," J Capital claimed WiseTech's "bogus metrics" provided no comparable statistics on organic growth between FY18 and FY19. While agreeing that capitalising software expenses was legitimate, the short-seller took issue with WiseTech expensing and capitalising the same costs.

Part 2 of the report goes on to research 7 of WiseTech's acquisitions across China, the US, Australia, Singapore, and South Africa to demonstrate why the acquisition strategy is not working. Key findings include:

  • acquisitions have failed in their objective to acquire clients and convert them to the company's core CargoWise One platform
  • acquisitions have been ad hoc and poorly managed
  • WiseTech seems to ignore its acquisitions once the deals are sealed – it wants higher prices but does not even provide a local language interface
  • client churn on acquired platforms is up to 50%, with acquired clients choosing to leave for competing platforms and solutions
  • WiseTech overpays for underperforming assets.

According to J Capital's research, WiseTech under-invests in the companies it acquires and increases prices on legacy platforms to force customers to move to WiseTech's CargoWise platform. When the acquired companies don't produce the results the business is seeking, it accelerates acquisitions in order to fuel the growth narrative.

J Capital states: "when WiseTech slows or stops acquisitions, shareholders will realize they own a motley global collection of small, poorly integrated companies with dispirited staff." If this is true it will hardly warm the souls of investors who (at current prices) have paid 170x earnings and 27x sales.

To fund their acquisition spree, WiseTech has raised $565 million over 2017–19. Over the same period, CEO Richard White has sold shares worth at least $73 million, which WiseTech claims has been in order to provide 'liquidity'. As J Capital points out, it is news that management is responsible for market liquidity. 

Foolish takeaway

J Capital's report concludes that WiseTech is significantly more leveraged to a global trade downturn that its competitors in the logistics technology market. Clients, J Capital conclude, will be more likely to drop CargoWise than competing systems as CargoWise is more expensive and provides inferior service.

WiseTech are yet to respond to J Capital's latest volley, however after reading part 2 of the short seller's report, we look forward to hearing what the company has to say in response.

Kate O'Brien has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of WiseTech Global. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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