Longtop-Financial-Technologies--A-

9-112-036REV:FEBRUARY5,2013________________________________________________________________________________________________________________ProfessorDavidF.HawkinsandResearchAssociateAnnelenaLobbandSeniorResearcherAldoSesiaoftheGlobalResourceGrouppreparedthiscase.Thiscasewasdevelopedfrompublishedsources.HBScasesaredevelopedsolelyasthebasisforclassdiscussion.Casesarenotintendedtoserveasendorsements,sourcesofprimarydata,orillustrationsofeffectiveorineffectivemanagement.Copyright©2011,2012,2013PresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessSchoolPublishing,Boston,MA02163,orgoto(A)ItwasApril2011,andWallStreethaditseyesonChina.AflurryofChinesecompanieshadlistedonU.S.exchangesinthepreviousyears,withinvestorscheeringthemonandsnappingupshares.Butsomeofthecompanieswerestartingtohaveseriousproblems.TheU.S.SecuritiesandExchangeCommission(SEC)hadrevokedseveralChineselistings.TroubledfirmsweretypicallysmallerChinesecompanies;manyofthemhadusedauditorswhosenameswerenotwell-knownintheU.S.Insomecases,companyauditorsresigned.Amidtheuncertainty,someinvestorsdecidedtoplacebets.TheytookacloselookatthefinancialstatementsissuedbymanyChinesecompaniestoevaluatetheirqualityofearnings.Iftheycouldtellthedifferencebetweenstrongfirmsandsuspectfirms,theycouldfindinvestmentopportunities,particularlytogoshort,orbetagainst,thetroubledcompanies.LongtopFinancialTechnologies(Longtop)hadlistedintheU.S.in2007inahugelysuccessfulIPO(LFT),hadabrand-nameauditorandcountedmajorU.S.financialfirmsamongitsinvestors.CompanyBackgroundLongtopsoldsoftwareandITservicestotheChinesefinancialservicesindustry.Longtopclientsincludedbigbanks,includingthreeofthefourlargeststate-ownedbanks,aswellasinsurancecompaniesandotherstate-ownedenterprises.Longtopbilleditselftoinvestorsasuniquelywell-positionedintheChinesemarket,offeringsuperiorproductsandservicestoChinesefirmsandpossessingahome-turfadvantageoverinternationalcompetitors.LongtopmadeawidevarietyoffinancialsoftwarethatrangedfromproductsforATMsandonlinebankingtobusinesssoftwarethathelpedbanksruncreditcardoperations,paymentsandsettlements,andothertransactions.1XiaogongJia,chairman,andWeizhouLian,CEO,foundedLongtopasasystemsintegrationcompanyin1996,andshiftedthecompany’sbusinesstosoftwarein2001.aBothhadresumesboastinglengthyexperienceinChina’sITindustry;LianhadbeenavisitingprofessoratXiamenUniversityaswell.DerekPalaschuk,aCanadianCharteredAccountant,cameonboardaschieffinancialofficerinSeptember2006afterleavingapositionasCFOofeLong.com,aChina-basedcompanylistedonNASDAQ.LongtopwasincorporatedintheCaymanIslands,headquarteredinChina,andconductedthevastmajorityofitsbusinessinChina.aSinceLongtopwentpublicin2007,XiaogongJiahadgivenaway,withoutapparentencumbrances,70%ofhisstockholdingstoLongtopemployeesandfriends.(CitronResearch,“CitronreportsonLongtopFinancial,”April26,2011).ThisdocumentisauthorizedforuseonlyinFinancingintheEquityMarketsbyWillyLiuatHONGKONGUNIVERSITYOFSCIANDTECHfromSeptember2013toMarch2014.112-036LongtopFinancialTechnologies(A)2InOctober2007,Longtopsold10.4millionAmericanDepositarySharesontheNewYorkStockExchangeinanIPOunderwrittenbyGoldmanSachsandDeutscheBank.Sharesdebutedat$17.50andclosedtheirfirstdayat$32.40,up85%.2Asecondaryofferingofsharesoccurredin2009.Longtopbegantoconsistentlyoutdothetechnology-heavyNASDAQcompositeindexinearly2009,anditssharepricepeakedabove$40inlate2010.(SeeExhibit1forLongtop’sstockperformancevs.NASDAQcompositeindex.)InaNovember2010earningsreport,grossmarginsfellasemployeecostsroseandbecauseoflowermarginsatrecentlyacquiredcompanies;3inMarch2011,thecompanyreportedthatitexpecteda15%increaseinwagesthatyear.4Forfiscalyear2010(April2009toMarch2010)Longtopreportedrevenuesof$169.1millionandnetincomeof$59.1million,whichrepresenteda59%and36%increase,respectively,over2009results.(SeeExhibit2forthecompany’sincomestatements,2008to2010.)Historically,muchofLongtop’sgrowthwasachievedviaacquisitions;thecompanyhadmadetenacquisitionsbetween2006and2010.5Thecompanyalsoreportedtotalassetsof$606millionandtotalliabilitiesof$116millionwith$490millionintotalequityattheendoffiscalyear2010(seeExhibit3forbalancesheets,2009and2010,fiscalyearend).Thefirm’scashbalanceincreased$93.6millioninfiscalyear2010(seeExhibit4forcashflowstatements,2008to2010).Longtopreportedagrossmarginof62.5%in2010,whichwassubstantiallyhigherthanitspeergroup(seeExhibit5).(Exhibit6providesLongtop’sperformanceratios,2006to2010.)Longtop’snetincomewasboostedbyalowerincometaxrateresultingfromcertaintaxincentivesgrantedtoqualifiedinformationtechnologyfirms.AccordingtoLongtop2010Form20-F,thesetaxincentiveshadtobeappliedforannually.Longtop’s2010Form20-Falsoindicatedthatthedistributionofthecompany’sretainedearningsmayberestrictedbyChineseforeigncur