FAB Universal: Glaring Contradictions in its 2013 10-K

On July 16th, 2014, FAB Universal (FU) will make an oral appeal to the NYSE’s April 28th, 2014 delisting decision. Presumably FAB will try to explain how its secret $16.3 million Chinese bond offering was not a sufficiently bad corporate governance-lapse to merit a delisting. FAB will also have to explain how its decision to downgrade its auditor somehow made sense given its admitted lack of internal control over its Chinese subsidiaries. On top of all this, FAB will have to convince the NYSE that its contradictory disclosures in its belatedly filed 2013 10-K finally paint a true picture of FAB’s Chinese business. In today’s report, I analyze and expose contradictions in FAB’s new description of its media kiosk business and question why FAB’s former auditor was unable to perform cash balance confirmations.

Is FAB a Provider and Operator of Media Kiosks or a Seller of Technology Licenses?

In Note 1 to FAB’s 2012 audited financials in its 2012 10-K FAB described its core Chinese business as follows:

“[FAB]’s products and services are primarily distributed through its flagship stores, wholesale services, proprietary ‘FAB’ kiosks, and online virtual stores. FAB kiosks, located in high-traffic areas of office buildings, shopping malls, retail stores and airports, are self-service terminals that provide a range of entertainment and consumer applications.”

“FAB Media was incorporated as a private enterprise in the PRC in April 2008 with a registered capital of RMB 1 million. FAB Media is primarily engaged in operating and providing proprietary multimedia kiosks for music downloads, information exchange and advertising.” (Page 49)

FAB claimed to be responsible for the placement and location of the media kiosks, which FAB refers to as “our Kiosks” in the following risk factor related to FAB’s business disclosed in the 2012 10-K:

“Our failure to maintain existing relationships or obtain new relationships that allow us to place our Kiosks in desirable locations would harm our business and prospects.”

“Our ability to generate revenues from Kiosks depends largely upon our ability to provide licensees networks of Kiosks in desirable locations throughout major urban areas in China. This, in turn, requires that we develop and maintain business relationships with real estate developers, landlords, property managers, hypermarkets, retailers, and other businesses and locations in which we are provided space for our facilities. If we fail to maintain our relationships with landlords and property managers, or if a significant number of our existing Kiosks placement agreements are terminated or not renewed or if we fail to maintain our relationship with our location provider, licensees may find our networks unattractive and may not renew agreement after the termination of five years agreement, which would cause our revenues to decline and our business and prospects to deteriorate.” (Page 13)

Recall that in my December 9th, 2013 report, I announced that I was only able to locate 20 of the 3,954 media kiosks FAB claimed to have installed in Beijing alone. All FAB had to do was publish a detailed list of its Beijing media kiosk locations. FAB did not do this and I believe FAB could not do this because the kiosks simply do not exist.

So rather than simply publishing the locations of the media kiosks, FAB revised its entire business model in its delinquently filed 2013 10-K (filed June 27th, 2014). FAB removed all the previous references to the number of media kiosks installed or deployed in China. Instead, FAB now states that the kiosk business merely involves the sale of “FAB brand licenses:”

“FAB has grown its business through its licensing and regional agent programs and has sold 17,944 brand licenses, which allows the licensees to use FAB’s brand on the kiosks.”

“FAB generates revenues from the sale of FAB Brand licenses, as well as advertising, and FAB membership card sales.” (Page 32)

This seems to be a bold act of recanting the previously disclosed business model (in every single public announcement related to Wizzard’s acquisition of FAB up until now) and recasting it in a new, albeit equally dubious direction. The first hint of this change in business description appeared in FAB’s December 20th, 2013 announcement that its Board of Directors had taken the time to review thousands of “licenses to operate kiosks.” In this same press release, FAB also reiterated that 3,954 media kiosks had been deployed in Beijing. With the absence of any mention of deployments in the new 10-K, FAB has taken an unconvincing but decisive step toward being able to disavow any knowledge of the location of the kiosks. The bottom line is that “FAB brand licenses” for kiosks that FAB cannot prove exist are simply meaningless. Where are the kiosks?

Turning back to FAB’s historical filings, let’s not forget that FAB in fact described its media kiosk licensing program in great detail in the June 1st, 2012 Proxy, which again showed that FAB was in complete control of the location and operation of all the media kiosks:

FAB licensing program is a merchant program that binds the FAB and each small investor or vendor. Under this program and associated contract, both licensor and licensee take their joint-business obligations as follows:

1. The licensee pays for FAB Kiosk and other equipment and fixtures while the licensor (FAB Media) is responsible for the complete set-up of each FAB outlet from the location selection to construction or conversion, remodeling and equipment installation.
2. All FAB outlets will be owned by the licensee, but supervised by a designated management company – Beijing Huzhong Culture Co., Ltd (“Huzhong Culture”) in accordance with FAB’s distinctive business formats.
3. FAB kiosks are linked to the server station through the internet to remain updated. Such maintenances are operated by Huzhong Culture.” (Page 35)

The 2012 10-K also confirmed that the media kiosks are networked:

“The content is contained on internal hard drives within each terminal thereby eliminating bandwidth download problems associated with the internet and providing content owners with a secure closed system for digital file protection and accurate transparent accounting. The terminals are updated and monitored via web-linked electronic communications.” (Page 29)

Based on these and other 2012 disclosures in its SEC filings, FAB explicitly portrayed as fact that it owns and/or operates a vast network of thousands of media kiosks. FAB’s licensees invested in thousands of the media kiosks, which were located in places FAB selected, built out, and maintained.  FAB (via a related party known as Huzhong) supervised the media kiosks in operation, and the media kiosks were networked to a central server.

However, in its delinquently filed 2013 10-K, FAB makes no mention of the kiosks being “networked” to a central server and even removes all mention of FAB’s provision of “desirable locations” for kiosk placements “throughout major urban areas of China,” as it repeatedly stated in the past filings and public announcements.

Further, FAB makes a deceitful attempt to “backdate” the 2013 10-K business description changes to 2010:

“Prior to 2010, the Company’s business model consisted of brand licensing and agreements that allowed for the purchase and operation of kiosks under the FAB brand.  After 2010, the Company only sold license agreements which were outside of Beijing.” (Page 3)

FAB’s purported 2010 change to its business model is contradicted by my research that found that as recently as late 2013, FAB’s Beijing kiosk franchising sales office was still offering media kiosks to Chinese investors on a turnkey basis – whereby FAB was responsible for placing and operating the kiosks and guaranteed franchisees a positive return on their investments.

FAB also suspiciously discloses in the 2013 10-K that only “some kiosks” have media download capabilities:

“The Kiosks provide a variety of functions, and some provide multiple functions.  The great majority of the kiosks generate revenue from the sale of advertising.  Some kiosks are ATM style terminals where consumers can download content directly to their cell phones, memory sticks or other mobile storage devices.  Others provide directions or other services or offer coupons or other goods for sale.” (Page 3)

Contrast the 2013 10-K statement with FAB’s June 1st, 2012 proxy that described the standard kiosk as having media download capabilities:

“The standard FAB kiosks have the following features:

· The user can review and select a variety of licensed music, movies, mobile phone ringtones and games from a touch screen.

· The user can stream the selected content or titles to different kinds of portable devices, such as, MP3, MP4, memory cards, hard disks, flash disks, mobile phones.” (Page 35)

FAB’s new claim that only “some kiosks” are media kiosks indicates to me that the true number of media kiosks in Beijing is not much more than the 20 I found in my investigation. This further explains FAB’s reluctance to disclose the media kiosk locations.

The Auditor Downgrade – Why Did Management Not Let Friedman Verify $100 Million Purported Cash Balance?

Through April 30th, 2014, the date of FAB’s dismissal of its auditor (Friedman):

“(a) due to the time requirements placed on management because of an internal investigation (the “Internal Investigation”) being conducted by an outside independent consulting firm at the same time as the audit, Company personnel were not readily available to assist Friedman in completion of certain audit procedures, (b) certain requests for additional documentation and procedures were not complied with, and (c) Friedman was unwilling to express an opinion on the Company’s financial statements prior to the completion of the Internal Investigation and prior to the confirmation of bank balances at certain depository institutions in China,…”

From this disclosure, it is apparent that as of April 30th, 2014, Friedman had not verified FAB’s December 31st, 2013 bank balances of $99,077,811. The excuse that FAB’s management personnel were unavailable to assist Friedman to verify bank balances is simply absurd and insulting to U.S. investors and regulators.


FAB has been given a full 8 months to disclose the locations of the media kiosks. Instead, FAB tossed aside the facts in its previous disclosures and overhauled its entire business description to focus on “FAB Brand licenses” that make the existence of the actual kiosks completely unverifiable. FAB further called its financials into question by downgrading its auditor, during a period of intense scrutiny of FAB’s failed internal controls, and would not assist its former auditor to verify nearly $100 million of purported bank balances.

Disclosure: Short FU.

Review of “How Constraining Are Limits to Arbitrage? Evidence from a Recent Financial Innovation”

by Alexander Ljungqvist[1] and Wenlan Qian[2], Working Paper 19834 of the National Bureau of Economic Research

In this NBER Working Paper, Alexander Ljungqvist and Wenlan Qian (“L&Q”) independently analyzed 332 reports published by 17 small activist short-sellers (who L&Q refer to as “shallow-pocketed arbitrageurs”) spanning from 2006 until 2011.  L&Q made the following observations:

  • Short sellers spend considerable money conducting their research while facing high lending fees, difficulty borrowing shares, and expensive put option premiums.
  • Despite these challenges, short sellers are quite successful in correcting the overpriced stocks: “On average, the prices of target companies in our sample fall by 21.9% over 3 months and by 56.8% over 12 months, net of market movements.”
  • Short sellers overcome their high costs by publishing very detailed reports revealing new negative information that, only if credible, results in investors selling their holdings causing large share price declines.
  • With considerable accuracy, the short sellers’ reports are usually proven to be true:  “For example, 35% of targets are subsequently delisted, 38% replace their auditors or see their auditors resign, and 23% restate earnings. In fact, in only 19% of cases do subsequent investigations by the SEC, the Department of Justice, or a stock exchange disprove the alleged facts contained in the reports.”
  • Only short sellers “…with a history of making claims that are subsequently confirmed are able to induce the longs to sell and thereby put pressure on a target’s share price.  And it is only credible reports that generate profits for the [shorts], net of shorting fees: without credibility, prices do not fall significantly.”
  • Reports “…that present new facts previously unknown to investors (e.g., resulting from on-the-ground detective work) result in longs selling and rapid price corrections whereas reports that merely reinterpret known data do not.”
  • The three largest publishers of reports analyzed by L&Q were Citron Research (106), Alfred Little (37), and Asensio & Co. (34).
  • Chinese companies accounted for 51.3% of the sample.  However, L&Q asserts that their findings were “qualitatively unchanged” if they remove the Chinese companies from their sample.
  • The three short sellers with the “largest immediate market impact” were Chimin Sang (-19.9% on 3 reports), Alfred Little (-19.2% on 7 reports), and Muddy Waters (-18.0% on 5 reports).
  • The three short sellers with the largest market impact measured over three months were Asensio & Co. (-58.9% on 4 reports), Absaroka Capital Management (-54.1% on 2 reports), and GeoInvesting (-39.8% on 8 reports).
  • Short sellers “…also face the risk of being sued by their targets.”  However, the “…very real risk of lawsuits will, to some extent, keep the [shorts] from making claims they cannot substantiate.”
  •  The “…mean cumulative abnormal return is -56.8% over the 12 months following the release of a report, with 80 of the 113 targets experiencing negative abnormal returns.  This suggests that the information the [shorts] release usually proves correct.”
  • L&Q independently analyzed each short seller’s track record to gauge the credibility of the reports.  L&Q’s calculated an 81% credibility rating for the entire group of short sellers and a 100% credibility rating for Alfred Little.

L&Q’s research “…illustrates why financial markets need short sellers to function well.”  Furthermore “…the short sellers in our sample are information producers who help correct mispricing and thereby help make markets more efficient. This is all the more remarkable given that many targets in our sample were held by highly sophisticated investors who apparently did not spot the overvaluation until it was too late.”

I strongly concur with L&Q’s findings and believe their detailed analysis proves the value of the reports published on Alfredlittle.com.  I welcome L&Q to update their analysis at some point to include 2012 and 2013 short seller reports, as well as to calculate the price declines of short seller targets over even longer periods of time (such as one or two years after publication).  This is imperative given that over longer periods of time the “market” more accurately gauges the merits of any valuation dispute.

It is in the best interests of investors that the exchanges and the SEC find ways to better engage small activist short sellers in their fight against securities fraud.   The current Dodd-Frank Whistleblower program has, to date, failed to substantively reward short seller whistleblowers.  The exchanges are less interested in protecting investors and more keen to protecting themselves from legal entanglements that may arise from delisting any given company as a result of short seller allegations.  Yet the short sellers, as L&Q have conclusively shown, are usually right.

Note: All quotations in this review are copyright 2014 by Alexander Ljungqvist and Wenlan Qian.  The public may purchase L&Q’s report online in .pdf format from SSRN.com ($5) for electronic delivery.  Journalists can obtain copies for free.

[1] Alexander Ljungqvist is the Ira Rennert Chair of Finance and Entrepreneurship at NY University Stern School of Business.

[2] Wenlan Qian is an assistant professor in the department of finance at the National University of Singapore Business School.

A*L Responds to BCSC Allegations

Yesterday, the British Columbia Securities Commission (BCSC) announced it would hold a hearing to determine whether I fraudulently made certain statements in my September 2011 reports questioning the resources and grades of the SGX mine owned by Silvercorp Metals (SVM).

The BCSC’s allegations are false and without merit.  I am taking legal action to both defend my reports and to hold accountable those public servants at the BCSC who have ignored my warnings about SVM.

I am preparing a point-by-point rebuttal of the BCSC’s allegations that I will file in due course.

I have used Alfredlittle.com for 3 years to publish my investment insights, both long and short.  Directly as a result of my efforts, all 7 of the companies I accused of fraud were delisted by the U.S. exchanges.  The SEC charged 3 of the companies with fraud.  I have saved thousands of investors hundreds of millions, perhaps even billions of dollars from the hands of fraudulent Chinese companies.

Jon Carnes

FAB Universal Media Kiosks: A Fundamental Misunderstanding?

After an unnecessarily long delay, on 12/10/13 FAB Universal (FU) finally responded, in part, to the numerous issues raised by others and myself.  FAB admitted that one of their Chinese “VIE” subsidiaries sold $16.3 million in Chinese bonds without disclosing the issuance to the SEC and U.S. shareholders in violation of numerous Federal securities laws.

The illegal bond issuance was first exposed on 11/15/13.  On 11/19/13 FAB CEO Chris Spencer acknowledged receipt of an email from me that contained a copy of the bond prospectus, clearly showing that FAB’s VIE subsidiary was the issuer.   Even though Chris had evidence in hand that proved the bonds were issued, he nevertheless authorized a press release the following day containing a “vehement denial” of all the allegations.

Chris’s reckless behavior lured investors into buying millions of more shares of FAB before trading was finally halted two days later.

In today’s report, I challenge FAB’s response point by point, showing:

  1. FAB has failed to take the most basic step allowing investors to verify the existence of its media kiosks.
  2. FAB does indeed guarantee a minimum return on franchisees’ investments.
  3. FAB has failed to acknowledge its removal pirated content from its media kiosks.
  4. FAB’s cash confirmations are meaningless.
  5. FAB’s independent directors have yet to agree to meet with me to review the evidence.

Click Here to Download Today’s Complete Report

FAB Management Caught Red-Handed Covering Up Piracy

On Monday, November 18th, 2013, my investigators caught FAB’s Chinese management in the act as they attempted a full-scale cover-up of the pirated U.S. movies on FAB’s kiosks.  In today’s report, I present “before” and “after” videos of FAB’s Beijing kiosks documenting the removal of the pirated U.S. movies.  My investigators interviewed FAB’s kiosk operators and discovered that FAB was removing all of the pirated U.S. movies over anti-piracy concerns after FAB’s “copyright licenses had expired.”  What a convenient coincidence!

Click the image below to download today’s complete report:

Untitled 3

FAB Universal: “Best Buy Meets iTunes Meets Redbox” Meets FRAUD

FAB Universal Corp (NYSE: FU) claims to be a global leader in the distribution of copyright-protected digital media.  FAB derives substantially all of its revenue and profit from its Chinese subsidiary, which, according to its FY2012 10-K filed on 3/18/13:

“… is engaged in marketing and distributing various officially licensed digital entertainment products under the ‘FAB’ brand throughout the PRC…”

At the core of FAB’s Chinese business are its “Intelligent Media Kiosks” allowing consumers to download copyright-protected movies and music to their portable storage devices.  FAB claimed to have 3,954 such “intelligent” kiosks in Beijing alone, according to its 6/1/12 proxy (DEF 14A, filed with the SEC on 6/15/12), with over 16,820 active kiosks deployed in 40 Chinese cities according to FAB’s 11/13/13 press release announcing 2013 Q3 financial results.

In today’s report I will show that:

  1. Contrary to FAB’s anti-piracy claims, FAB’s “Intelligent Media Kiosks” are in reality loaded with very obviously pirated U.S. movies.
  2. FAB’s kiosk manufacturers acknowledged that: a.)   They historically supplied around 1,600-1,700 kiosks to FAB, only 10% of the 16,820 units FAB claims to have deployed. b.)  One kiosk supplier helped FAB stage phony manufacturer site visits for FAB’s investors, reminiscent of the China Integrated Energy (CBEH) fraud I exposed in 2011.
  3. FAB’s director of franchisee sales acknowledged that: a.)   FAB has only around 1000 kiosks in Beijing (compared to 3,954 disclosed in the 6/1/12 proxy); and b.)  FAB promises kiosk franchisees guaranteed minimum returns on their investments and offers to buy back the franchised kiosks using FAB U.S. listed common stock.

Based on the interviews and evidence that I collected, I conclude that FAB’s business in China is a tiny fraction of what it claims in its SEC filings.  FAB’s actual profitability would be reduced even further if the company upgraded its pirated content to properly licensed content (assuming that is even possible).  Finally, FAB has potentially enormous undisclosed liabilities for guaranteeing minimum investment returns to franchisees and undisclosed potential dilution from common stock issuable to franchisees.

Click Here to Download the Complete Report


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