Will the Real Short on Let's Gowex Please Stand Up?

Much has been made of Gotham City Research’s recent expose on Let’s Gowex (GOW:SM), a Spanish WiFi business that, by all accounts, appears to have been a complete fraud of a company. Since the piece was first published on Gotham’s site on July 1st, the company’s CEO admitted to at least some level of wrong-doing, trading on the stock was suspended, the media jumped on the story, the Founder went to jail, and the price of shares went effectively to $0. You can read more about the extraordinary situation in this recent WSJ article: http://online.wsj.com/articles/gotham-city-research-works-in-the-shadows-1404842379.

One major and quite notable fact about this thesis, however, is that SumZero member Ajoy Reddi published a similarly insightful and robust analysis of the company on June 24th, a full week before the Gotham piece originally appeared. We are pleased to highlight this extremely high-quality pitch, full of primary-level due diligence by Reddi and his team of Spanish MBA students, particularly in the wake of the company’s situation over the past two weeks. Mr. Reddi deserves a least a little recognition for his work on the name, and the fact that he was on it well before others.

What follows is Mr. Reddi's full pitch on Let's Gowex that appeared well before the Gotham post:

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I first got to know Let's Gowex on July 19, 2013, when the CEO, Jenaro Garcia, came to New York on a sell-side arranged roadshow. Let's Gowex purports to be a global provider of free WiFi hotspots on behalf of municipalities and transit authorities worldwide. Their business model is to provide city residents free WiFi through an ad-supported model; essentially a user will access their WiFi by viewing a free advertisement that they sell to ad agencies who represent various brand customers. The company claims that there is a positive network effect created by their hotspots in that the more users who access the web through their hotspots the more ability they have to monetize the user data that is generated. The company has ambitious plans to sell advanced services such as We2, which they claim to be a "social-WiFi service" that will "to boost the interaction between people, businesses and the city itself." The company currently has set up WiFi hotspots in the US in New York, San Francisco and now Chicago. Prior to entering the US, the company has indeed set up hotspots in many Spanish cities such as Madrid and Barcelona as well as other major European metros.

At the time, Gowex's stock price was in the single digit euros and it sported a market capitalization of less than 500 MM euros. It was barely covered by the sell-side (only two firms had published on it) and the company's valuation was attractive. Admittedly, I did not do much work on it as the company's story seemed to make sense and I thought there was not much downside to initiating a small position in our fund. I also liked the anecdote the CEO told me at the end of the meeting: a year ago he decided to sell his home in central Madrid to buy more of the stock, which he felt was undervalued. After that, Gowex became one of the best performers in our portfolio as it proceeded to almost quadruple by the end of 2013. However, despite the stock becoming one of the highlights of my year, I started having doubts about the company because after subsequent meetings with the CEO I always saw some subtle inconsistencies in the data points he would share with me. I also spoke to a fellow investor whose firm was skeptical about the company's business model so I decided to do more in-depth analysis of the company. My skepticism was also bolstered by the fact that when I tried to access their free WiFi service near my office, it rarely ever worked and I also noticed that the company made users to download an app to access the service.

Earlier this year, the stock was at an all-time high and continued to be the best performer in our fund. In my last meeting with the company, the CEO again gave me inconsistent data points and I also saw that another Spanish broker, JB Capital Markets, started to publish research on the company. The data points in the analyst's report pertaining to the company’s growth and profitability in the company’s various business segments seemed to contradict what the CEO himself had told me. As a former sell-side analyst myself, I know that a sell-side analyst will rarely ever publish his own estimates of a company’s profitability without some input or blessing from the company’s management. I became suspicious that the CEO was essentially making up numbers to make his company’s growth story look more compelling and that they had a very inconsistent disclosure policy. Essentially, they would tell me the investor one thing and tell others something else. Another company official (and significant shareholder), Javier Solsona, in a meeting in October 7, 2013 would tell me that they do not disclose to the level of granularity that would later be presented in JB’s initiation report that would subsequently be published in February 2014. However the CEO Mr. Garcia had no problem giving me various nuggets of information that put his company in a favorable light.

With all that being said, what was the “smoking gun” that brought me to the conclusion that this company is a FRAUD and caused me to tell my colleagues to completely sell out of the stock in early April 2014? I decided to read through the company’s annual report cover to cover. But there was one problem, the annual report was only published in Spanish and I did not “habla espanol”; however, one thing did standout in the annual report, the name of their auditor, “M&A Auditores”. I had never heard of this auditing firm, but by itself that does not indicate fraud. It could be a local Spanish auditor but I then decided to see whether this audit firm audited other public companies by conducting a search on Bloomberg’s corporate filings database. No other public companies in Spain were audited by M&A. In fact, I had met another small cap Spanish company, Carbures, which was smaller than Gowex in terms of its market capitalization and revenues and it was audited by global Big Four, KPMG. And then I looked up the company’s website atwww.ma-auditores.es. What I saw was laughable; the website was amateurish at best with stock footage. It was only three pages and there was no phone number and e-mail contact info—only an office address. Why would a company that audits one of the best performing stocks in the world (a company now worth about $2 BN) not want to make itself available to new potential customers? I looked at various websites of local auditors in many other countries and they all had much more detail than M&A’s paltry website.

Prior to selling the stock, I decided to delve deeper into Gowex’s purported relationship with the city of New York where it had—with great fanfare—trumpeted its WiFi hotspot footprint in the Big Apple. There was even a picture of Mr. Garcia shaking hands with Michael Bloomberg (who looked slight perturbed in the picture—he has the expression that he has no idea who he is shaking hands with).

(See attached link, http://www.lavidawifi.com/wp-content/uploads/2014/03/jenaro-garc%C3%ADa-michael-bloomberg1.jpg)

I contacted the New York Economic Development Corporation, which is a private corporation that works with the city of New York on various citywide development initiatives. Gowex had signed up with the EDC to provide free WiFi as part of the a pilot project to provide free connectivity across several corridors throughout the five boroughs of New York. What stands out in the EDC press release is that Gowex was selected along with four other organizations that are not technology companies: “the Downtown Brooklyn Partnership, Alliance for Downtown New York, Brooklyn Academy of Music, GOWEX, and the Flatiron 23rd Street Partnership.” Source: http://www.nycedc.com/blog-entry/expanded-public-wifi-nyc

Why would EDC select four other organizations that were basically non-profits to provide the same service as Gowex, which is supposedly a leader in “WiFi Smart Cities”? I spoke with Kat Lau, a project manager at EDC, and they told me that Gowex was selected because of their relationship with New York’s City Hall. However, I have done an extensive search of New York City’s official website and I could not come across any official press release that the City of New York had a formal relationship with Gowex. Clearly there is a WiFi signal that says “FreeGowexWifi” which you will find in various locales in Manhattan but Gowex has clearly stated to me that they were contracted by the City of New York to put these hotspots in. I have found no evidence that this is the case. And remember what I had said previously about accessing Gowex’s WiFi hotspots—the only way to access them is by downloading the company’s mobile app. If that is the case, why has there been no formal announcement by the City of New York that this free WiFi service is available? And why has not Gowex or the City of New York engaged in a basic marketing campaign on the typical mediums to inform the average resident of the City that this service now exists? Recently, I decided to conduct a raw, unscientific straw poll of users of mobile devices who were sitting in Madison Square Park whether they were aware of Gowex’s free WiFi service and that they needed to download the Gowex app to access the service. Of the twenty people I surveyed, only ONE person was aware of the Gowex app. Everyone else indicated that they saw the Gowex signal but had no idea what it was or how to access it.

Gowex, a purported leader in free WiFi, claims to investors that it offers a game-changing service that will form the foundation for “Smart Cities” and will enable “the Internet of Things” (source: http://www.gowex.com/en/gowex-and-cisco-announce-global-strategic-relationship-to-boost-smart-wi-fi-connectivity-solutions-for-cities/). But its clear that no one really knows about the service and the company is essentially trying to run an affinity scam on investors by claiming all these major relationships with cities and municipalities. Gowex has claimed relationships with Cisco and ZTE, which are major telecom equipment vendors. I have not verified these but even if these relationships are true—these relationships should not be considered real proof of the company’s bonafides. These companies rarely engage in forensic due diligence on who they partner with and its clear that Gowex WiFi signals exist; the real questions are whether there are true user benefits and whether the network effects they company claims are reality or ethereal puffery.

But here is the real coup de grace. I wanted to conduct due diligence on M&A—their low profile auditor in Madrid. But how was I to meet them since there was no phone number or e-mail address? I contacted a business school professor at IE Business School, a prestigious business school in Madrid, and asked for his assistance (the professor wanted his assistance to be off the record as he is an adjunct professor and he works as a local investment banker in Madrid); the professor was kind enough to assign four masters students to work with me on a forensic valuation of Gowex. Herein I gratefully acknowledge their assistance in conducting the due diligence on the auditor as well as analyzing the company’s Spanish-only financials. Their names are Maryam El-Hassani, Rita Mensuardo, Julia Gil and Elena Ilieva.

When the group went to check out the auditor’s offices, I will quote verbatim from the e-mail they sent me describing what they found:

“Regarding the project, last week, on Thursday afternoon, we went to the MA Auditores. On the website there is no information of phone number or mail contact, just address. Thus, we couldn’t schedule a meeting. We went directly to the indicated address. Outside of the building, we had no indication (name on the door bell for instance) that the company was actually there, which seemed a bit odd. To find out if the company was there we rang the doorbell of several floors until someone opened the door. Once inside, we discovered the number of the floor by checking the names in the mailbox. Hence, we rang at the company’s door and a gentleman attended us and invited us in. The office is small, with two or three rooms, and did not have any other employee working. The gentleman who attended us said it would prepare a summary of activities and maybe customer for the week after the break. Before we leave, we asked for his mail to get more information, but he hesitated and said was not necessary.” Source (e-mail correspondence to ajoy.reddi@gmail.com dated April 16, 2014)

Does this sound like a legitimate auditor to you? I am reminded of Bernie Madoff and how had anyone actually looked into his auditor (which was a small outfit located in a strip mall in Long Island) they would have immediately blown the Ponzi scheme right out of the water. I believe this auditor is major red flag and signs off on whatever financial statements the senior management of Gowex presents to them and does not conduct a traditional audit, as do most other audit firms in the world. From my own background, I used to work as a strategy consultant at PricewaterhouseCoopers (PwC) early in my career and I used to work in the same offices as the auditors of PwC. I know that companies that conduct their business all over the world have auditors who also have the ability to travel and verify contracts and revenue recognition. I find it incredulous that a small local auditor in Madrid (assuming at most they have three employees) can conduct a robust audit of Gowex’s operations.

I asked the CEO in my last meeting with him on March 25, 2014 why they would use a small auditor. He said that he wanted to be loyal to the people at the auditor who grew with him and his sell-side enabler, the analyst at JB, justified it by saying that “Jenaro is a cheap guy and he does not want to spend more money on a big name auditor”. But the CEO did promise me that he would change to a Big Four auditor when they listed on the NYSE in 2016! Indeed.

Further, my affiliates in Madrid also went through Gowex’s financials and discovered a few red flags in their financials. First, they discovered that their cash balance is overstated by 5.45 million euros. (I refer to their attached report). I was also shocked to hear that the company as long-term debt and does not even have basic debt schedules disclosed in their financial statements. (Most Internet companies have no debt and iPass, which is one of their publicly listed peers, does not have any debt whatsoever). The lack of proper debt schedule is worrying and the students contacted Gowex’s investor relations and the company representative was not able to give even basic color in terms of the duration and coupon rates for this debt. Second, the company does not explain why their capex increased so much in proportion to revenue growth (even the basic detail on capex—what they were spending money and the tangible life of the assets purchased was not disclosed); this indicates that, at best, the company was not accurately portraying its true returns on capital invested. Third, the company does not include any detail on its revenue recognition policy nor the duration of its contracts with municipalities and telecom operators. Finally, there is no detailed segment reporting within the core business segment of the company, which it describes as “Wireless” revenue.

I mentioned before the inconsistencies that frequently arose from my meetings with Gowex’s management. More recently, the company seems to be increasing the aggression of its long-term operational and financial targets. When I first met the CEO in July 2013, he stated that it was his goal to rollout WiFi projects in 300 cities worldwide by 2018. Now, less than a year later, Gowex now has a target of 600 cities by 2018. This new target lacks credibility in my view—but I can understand why they put this new target out there. Gowex’s management wants to increase their long-term growth targets to support the massive appreciation in their stock price! (please refer to the report by the IE students, who have clearly stated that Gowex’s own math does not support how this target can be attained).

To this point, I have presented the red flags in the company’s dodgy financial statements and I hope that I have convinced you that their auditor cannot possibly be a legitimate entity that conducts audits at arms length from the company. Now I will explain how the company is conducting its fraud on investors. Their scheme is a simple “pump and dump”. The CEO Jenaro Garcia and his affiliated insider, Javier Solsona, together control about two-thirds of the company’s stock. They have three investment vehicles (Jenaro Garcia ownership is through Cash Devices [27%] and Biotelgy[25%] and Mr Solsona's vehicle Alvasebi [10%]) that control the stock, however we investors have no idea if they have sold stock in the last two years! Why? Gowex is listed on the MAB, which is an alternate exchange in Madrid. The MAB is marketed as an exchange for small capitalization companies that are typically faster growing. (A related market is the AIM exchange in London). The MAB has less stringent reporting and disclosure requirements, therefore the insiders may in fact be selling while exuberant investors are bidding up the stock. In fact, one anecdote I will share that I heard through the “grapevine”. When the company was visiting the West Coast they canceled a meeting with an investor because they were “going to visit with Mark Zuckerberg at Facebook”. That rumor alone accounted for an extra pop in the stock the following day.

Further, the IE students also were able to discover the following: (I quote from their report).

"The shareholder structure also raises some question marks, as the status of the company Biotelgy (through which Mr. Jenaro Garcia owns 27% of the stock), is dissolved (Appendix VII) as of the 14th of December 2012. Also, there is no information with regards to the nature of its ex-operations. During the meeting with investor relations, our enquiry apropos the dissolved status of the company was casually dismissed, stating “no it is not”, followed by a nervous laugh. Also, the high concentration of ownership by insiders can become an issue in the event of misrepresentation. In the worst case scenario, it is possible that management are diffusing overly positive news about the company’s growth potential, driving up the share price, and simultaneously (secretly) selling their stake. In fact, the MAB and Alternext on which Gowex is listed are unregulated and have less stringent reporting requirements on insider transactions. As such, insider transactions cannot be scrutinized. This poses a significant risk to investment prospects."

In summary, Gowex is a fraud and I believe that this stock is worth ZERO.

Addendum: I have attached the final report of the IE Students put together under my guidance. I was tasked with supervising them on the project and to give them feedback on the model and report in exchange for their assistance on researching Gowex. I consider the majority of the labor to be theirs but with significant feedback from me. The students were relatively green to equity research and clearly there are signs of this in the work products. And their academic project was to value Gowex as a going concern; they were not tasked with proving it is a fraud (however they do hint it at it in their report). I would primarily refer you to the portion of their report where they analyze Gowex's financials. I have also included a copy of JB Capital Markets' research report on Gowex primarily to highlight the divergence in our analysis versus the sell-side report which was probably published at the behest of Gowex's senior management--no doubt they (JB Capital Markets) want to earn fee business from Gowex. The report should only be treated as background material on Gowex but it is not a work product that is part of my pitch on Gowex.

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