Cloopen destined for delisting, or a new Luckin set for comeback?

The cloud services provider was once worth as much as $8 billion, but has lost most of its value following an accounting scandal

Key Takeaways:

• Cloopen intends to appeal a New York Stock Exchange determination that the company is unfit for listing due to failure to file its last two annual reports
• The cloud services provider has hired two new outside auditors since its previous accountant uncovered about 30 million yuan in fabricated sales in 2021

By Doug Young

As we start the new week, the story of former cloud services highflyer Cloopen Group Holding Ltd.  provides an interesting case study in the brave new landscape shaping up under a stricter regulatory landscape for U.S.-listed Chinese companies. Cloopen’s shares were suspended from trading on the New York Stock Exchange’s main board for two days last week for failure to release any new financial reports since the third quarter of 2021.

The stock resumed trading over-the-counter on Friday, and, not surprisingly, lost 38% of its value in its first day. The stock actually fell as much as 90% during the Friday session before bouncing back, indicating some investors may still see some value in the company.

That raises the question of whether this company, whose woes date back to an accounting scandal first exposed in the fourth quarter of 2021, might be able to survive this brush with delisting and mount a comeback. Chinese coffee chain operator Luckin (LKNCY.US) was the subject of a much larger scandal uncovered in 2020 and has managed to come back since then after overhauling both its business model and its top management.

Cloopen differs from Luckin in a few ways, which we’ll review shortly. Still, investors with a big appetite for risk might find the stock an interesting proposition for a potential comeback if and when it finally gets its house in order, which it is trying to do now.

First, we’ll look at Cloopen’s brief history as a listed company, which began with a bang before quickly fizzling when the accounting scandal broke. The company raised a sizable $320 million when it listed its shares on the New York Stock Exchange in February 2021, making it one of the last major listings by a Chinese company in New York before new IPOs came to a near halt in the middle of that year due to several regulatory factors.

The company went on to release four quarterly reports before disclosing a year ago that its auditor at the time, KPMG Huazhen, had uncovered evidence of fraud in the form of inflated revenue in its second and third-quarter reports for 2021. The company conducted an investigation and last September reported that such revenue inflation had indeed occurred.

Specifically, the company said its revenue in the second quarter of 2021 was inflated by 11.6 million yuan ($1.7 million), while its third-quarter revenue was inflated by 17.8 million yuan. In percentage terms the inflation was relatively mild, equating to 4% of overall revenue in the second quarter and 6% in the third. By comparison, the fake revenue reported by Luckin was much higher as a percentage of its total revenue for the affected periods.

Nonetheless, the fraud spooked investors and sent Cloopen’s stock into a downward spiral. After the selloff last Friday, the company was worth just $118 million, a tiny fraction of the roughly $8 billion it was worth at the time of its IPO. The stock now trades at a price-to-sales (P/S) ratio of 0.8 based on our estimates for its 2021 revenue. That isn’t great but is still surprisingly high for a company now traded over-the-counter with limited prospects of returning to the NYSE main board.

Where from here?

All that said, we’ll look next at what has happened since the fraud was uncovered, and what Cloopen needs to do to bring itself back into compliance with NYSE listing rules, as well as the chances of whether it can succeed.

The company needs to file three reports that are past their deadlines: its 2021 and 2022 annual reports, and also its report for the first half of 2022. Cloopen said it has until June 1 to appeal the NYSE’s determination that the company is “not suitable for listing,” and that it intends to fight the delisting decision.

The company does appear to be making efforts to file the reports, which is reflected in its scramble to find an outside auditor necessary to certify those reports. KPMG Huazhu ended its relationship with Cloopen after uncovering the fraud. Since then the company initially engaged a smaller company called Yu CPA last July, before parting ways with that company and naming HKCM CPA & Co. as its new auditor in February this year.

This kind of auditor-hopping isn’t unexpected for such a “hot potato” company, since any financial reports submitted by Cloopen to regain compliance will inevitably be closely scrutinized by the U.S. securities regulator. The U.S. regulator will have even more power to review Cloopen’s submissions after receiving much better access to China-based accounting records under an information-sharing agreement it signed last year with China’s securities regulator.

In terms of operations, Cloopen looks like a relative strong company in a high-growth area, at least based on its final financial report from the third quarter of 2021. Its revenue grew 44% that quarter to 276 million yuan, though that figure would come down to about 265 million yuan after subtracting the fraudulent amount reported later. It lost 112.2 million yuan for the quarter, up modestly from the 93.9 million yuan loss a year earlier. The company said it had 12,244 active customers at that time, including 219 large enterprise customers.

Since the fraud was uncovered, the company has taken remedial measures, including the closure of the department that was the source of the fraud, and the firing or disciplining of responsible individuals. It said the investigation didn’t uncover any evidence that the CEO and CFO were aware of the fraudulent activity, and the company’s website shows those two executives are both still in their positions. That’s one major place where Cloopen differs from Luckin, which fired its two top executives and overhauled its top management after its fraud was uncovered.

So, where does all this leave Cloopen? Basically, the company appears to have found an accountant willing to help it file the necessary reports to maintain its listing. It’s also in a relatively hot industry, and has a fairly large customer base that presumably wasn’t scared off by the fraud. The main point against it is the continued presence of its pre-scandal leadership team. But if you believe that team was really unaware of the fraud, which was relatively small in terms of scale, the company just might be a good potential comeback bet for any investors with a big appetite for risk.

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