AACTech

Release Date: 6 June 2017
AAC Technologies Holdings Inc.

Hong Kong Deserves a Better Hero
Ticker: 2018.HK We believe Gothams short report on AAC

is grossly misleading, and contains shoddy
Market Cap: HK$92 billion research, demonstrably false statements,
and a seemingly willful ignorance of what
Recent OTC Price: HK$75.00 constitutes a disclosable related party
Target Price: HK$111.00 under Hong Kong listing rules.
The entirety of Gothams short thesis
Expected Return: 48% alleging undisclosed related parties
appears not only false, but it doesnt even
Opinion: Strong Buy make sense from a valuation perspective.
We believe Gotham has made a series of
unfortunate mistakes in sourcing evidence
and properly translating Chinese entity
names to their English equivalent.
You should have expected us
aainfo [@] neomailbox.ch

Twitter: @anonanalytics
www.anonanalytics.com
Disclaimer
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Dont be stupid and invest in the public markets unless you are prepared to do your own homework and due diligence.
1
Introduction
The Gotham City Research short report on AAC was simply terrible.
In our six years publishing short reports we have read a lot of critical research. Some we didnt agree with,
but we at least understood the underlying road that took them to their conclusion. But the GCR report
doesnt even pass the basic test of common sense. Its not even a matter of their thesis being
questionable, its that the very foundation of their report seems based on misleading evidence and claims
that are demonstrably and verifiably false.
That a short report came out on AAC did not surprise us per se. This time last year we started hearing
rumors of AAC using undisclosed related parties to hide costs effectively the same thesis put forth by
GCR. We decided to investigate. We spent considerable time and resources trying to figure out if there
was any merit to these claims.
Hundreds of hours were spent pulling numerous SAIC filings, conducting on-the-ground due diligence, and
talking to dozens of former employees and industry sources. To anyone who bothered to spend the time,
it became readily apparent that the short thesis was critically flawed.
Thats not just our opinion. Another source told us they were also aware of the AAC short thesis, but after
conducting their own research came away rather impressed with AAC. This source operates their own
website and has previously published short reports on Hong Kong companies.
We suspect that a number of Hong Kong short-sellers had previously been informed of the AAC thesis,
but none of them published because none of them found the arguments convincing. Perhaps it then fell
on GCR, a short seller with no previous history in Hong Kong and completely unaware of what they were
walking into.
The manner in which GCR released their report is also telling. First there was a five-page teaser, then a
report, then the promise of a second report. We think they decided on this approach partly because they
knew their evidence was weak and were hoping to scare shareholders into a fear trade.
Its easy to be frightened of the unknown.
When Muddy Waters took down Sino-Forest, they did it with a single killing blow. Carson Block knew the
power of his evidence. No teaser, no promise of multiple reports just take the dog out back and shoot
it. Done.
Short sellers and those who publish critical research are already hated by everybody. But when one of us
is this wrong, we all end up paying the price.
2
Table of Contents
Executive Summary . 4
... 5
Overview . 8
Zhongbeitong Magnetic Materials 10
Suqian Qixiang 17
Shuyang Lisheng 26
Xuan Ying Tong . 30
Lian Tai Precision . 32
Margins 34
Other Accounting Concerns . 39
Apple Investigation Claims . 42
GCRs Second Report . 45
Valuation . 47
Conclusion . 48
3
Executive Summary
We believe GCRs short report on AAC is grossly misleading, and contains shoddy research, demonstrably
false statements, and a seemingly willful ignorance of what constitutes a disclosable related party under
Hong Kong listing rules.
GCR claims that AAC has used at least 23 undisclosed related party entities to hide over RMB1.5 billion in
costs. However:
Of these 23 entities, only two of them are disclosable related parties under Hong Kong listing
rules. Both of them have been disclosed by AAC in its annual reports under their alternative
English names. It seems GCR did not realize that these entities have more than one English name.
17 of these 23 entities generated combined revenue of RMB157 million in 2015, according to SAIC
filings. This represents only 1.3% of AACs RMB12 billion in revenue for that year. GCRs report
omitted these revenue figures perhaps because they knew readers would dismiss these entities
as small and economically meaningless.
GCRs report only focused on the remaining 6 entities, 5 of which generated a combined revenue
of RMB1.5 billion. GCR claims this RMB1.5 billion figure represents costs that AAC is secretly
booking off balance sheet. Unfortunately, what GCR does not mention is that these entities
combined generated positive operating profits. If they were to be fully consolidated into AACs
accounts, they would be accreditive to AACs earnings. Since AAC is valued as a multiple of
earnings, this would increase AACs share value, not decrease it.
GCRs short thesis is not only flawed from an undisclosed related party perspective, it does not
even make sense from a valuation perspective.
The following table provides the name of all 23 entities GCR claims are related parties, revenue they
generated in 2015, and our remarks:
4

GCR
23 15
23 2
2

23 17 2015 1.57
2015 120 1.3%

23 6 6 5 2015
15 15

23 2015
5
2015
Company name Company name Violation of
Revenue GCR claims Remarks
(English) (Chinese) Chapter 14A?
(RMB MM)
SuQian QjXiang 553.62 Manager is assistant to AAC NO Discussed in this report, pg. 17
CEO + Colocated with AAC
ShuYang LiSheng 479.84 Shareholders are AAC NO Discussed in this report, pg. 26
executive and uncle of AAC
CEO
XuanYingTong 348.53 Manager is uncle of AAC NO Discussed in this report, pg. 30
Electronics CEO
ZhongBeiTong 292.43 Wife of AAC CEO is NO Discussed in this report, pg. 10

Magnetic shareholder and board
Materials member
LianTai Precision 0 Subsidiary of ShuYang NO Discussed in this report, pg. 32

LiSheng
ChangZhou 3.57 Subsidiary of ShuYang NO Discussed in this report, pg. 29

LiSheng LiSheng
JiangSu 13.13 Subsidiary of ShuYang NO See Shuyang Lisheng as discussed

Boruitong LiSheng in this report, pg. 26
WuJing TianMa 8.51 CEO family member is NO Fully exempt under de minimis
shareholder transactions per rule 14A.76

YangTai 0 Uncle of AAC CEO is NO Mr. Pan is not an uncle, therefore
Electronics shareholder not a connected person per rule
14A.21(1)
ChangZhou 0 Subsidiary of ShuYang NO See Shuyang Lisheng as discussed
RuiNan LiSheng in this report, pg. 26
GangSheng 39.54 Mother-in-law of AAC CEO is NO Ye Huamei (mother-in-law) holds

Packaging shareholder 20%, not a connected person per
rule 14A.21(1)
Hao Han 24.92 Sister-in-law of AAC CEO is NO A what? Former shareholder?

Electronics former shareholder Get lost
DongGuan 36.97 Shareholders are AAC NO Li Xiang and Mr. Pan are not
RuiSheng executive and uncle of AAC connected persons per rule 14A.07
Electronics CEO and rule 14A.21(1), respectively
HeSheng Established Uncle of AAC CEO is NO Mr. Pan is not an uncle, therefore
Precision in 2016 shareholder not a connected person per rule
14A.21(1)
WuJin Special 0.1 Father of CEO is shareholder NO Fully exempt under de minimis
Electronics transactions per rule 14A.76

6
NingBo NengJie 30.38 Sister of CEO is shareholder NO Sister is not a controlling
Electronics shareholder, therefore not a
connected person per rule
14A.12(2)
RuiSheng New JV between AAC and CEO's NO Already disclosed in the annual
Resources - father's companies reports under alternate English
name (AAC New Power)
WuJin Temple 2.58 CEO family member is NO Fully exempt under de minimis
Packaging shareholder transactions per rule 14A.76

LiBeiTe Special 0 CEO family member is NO Fully exempt under de minimis

Materials shareholder transactions per rule 14A.76
JinLi Packaging 0.53 CEO family member is NO Fully exempt under de minimis
shareholder transactions per rule 14A.76

WuJin Temple 0.02 CEO family member is NO Fully exempt under de minimis
Colored Metals shareholder transactions per rule 14A.76

SuQian JinLong 0 Colocated with AAC and NO Discussed in this report, pg. 22
claims to be subsidiary
HuaZhao 0 Manager of AAC subs is NO Fully exempt under de minimis

Electronics shareholder transactions per rule 14A.76
Source: SAIC filings, former employee interviews, company filings, GCR report
7
Overview
GCR claims that AAC has used at least 23 undisclosed entities to hide over RMB1.5 billion in costs. The
report provides the following chart to show these purportedly undisclosed related parties:1
This looks like scary stuff.
Except, we pulled the SAIC filings of every single one of these entities and found that almost all of them
are companies with operations so small they would be considered rounding errors in the context of AACs
RMB16 billion revenue.
Furthermore, almost none of these entities are actually disclosable related parties. For example, a man
named Mr. Pan Shinan has ties to nine entities (outlined in red) and is brought up several times in the GCR
report. GCR claims Mr. Pan Shinan shares the same last name and is the uncle of AACs CEO, Mr. Pan
Zhangmin. However, our background check shows that the shared last name is just a coincidence, and
Mr. Pan Shinan is not an uncle or a connected person under Hong Kong disclosure rules.
1
https://www.scribd.com/document/348704555/AAC-Technologies-LTD-Ticker-2018-Why-are-AAC-s-reported-
profit-margins-higher-AND-smoother-than-Apple-s-Part-I-Full-Report#from_embed pg. 9
8
Furthermore, the GCR report provides no motive to lend credibility to its various allegations.
If AAC is offloading costs to overstate profits, what is the end-game?
AAC went public in 2005 in an IPO that raised HK$852 million. It was the only money AAC has ever raised
in its history as a public company.2 However, since 2009 the Company has maintained a 40% payout ratio
and returned RMB5.4 billion to shareholders through dividends. As far as corporate governance goes, this
makes AAC one of the most shareholder-friendly companies on the Hong Kong Stock Exchange.
Moreover, the founding Pan family has maintained their holdings in AAC at ~40% since 2012. Thats well
before the 2014-2016 period that GCR focuses on.
Looking at it another way, GCR suggests that only 25% of AACs earnings are real as per the following
screengrab:3
With ~60% of AAC held by outside investors, and a 40% payout ratio, it means that 24% (60% x 40%) of
reported earnings go to outside investors. If GCR is to be believed, the 24% is effectively ALL the income
AAC generates, which would mean that there are no earnings left to pay dividends to the Pan family. Add
in the fact that the Pan family has kept their ~40% stake since 2012 and it would mean that they havent
made any money on this alleged fraud in six years.
It would also mean that there would be no money left over to make any capital investments, which means
AAC would not have been able to grow in tandem with Apple and Samsung as a key supplier.
Clearly, the money trail does not support a fraud thesis.
This report will take a closer look at the 6 main entities GCR alleges are undisclosed related parties. Using
SAIC filings, on-the-ground due diligence and extensive interviews (and just a sprinkle of common sense),
we will unravel GCRs critically flawed allegations.
Lets get right into it
2
Morgan Stanley research dated 15 May 2017
3
9
Zhongbeitong Magnetic Materials
Key GCR claims:4
Zhongbeitong makes magnetic components for electric devices that are sold to AAC.
Zhongbeitong declared itself a related party supplier to AAC.
Ingrid Wu, one of the units main shareholders and board members, shares the same name as the
woman who is the wife of AAC CEO Mr. Pan and an AAC board member.
In contrast, AAC hasnt made the same disclosure in its annual reports.
Zhongbeitong estimated that it would enter into RMB150 million worth of transactions with AAC
in 2016.
*****
Every material claim that GCR makes with regard to Zhongbeitong to support its short thesis is not just
wrong they are demonstrably and verifiably wrong. There isnt even any room for interpretation of facts
or opinions here.
GCR underscores the materiality of Zhongbeitong by referring to an announcement the company made
on 29 February 2016 stating an anticipated RMB150 million worth of business with AAC in 2016:
Source: http://www.neeq.com.cn/disclosure/2016/2016-02-29/1456739347_398178.pdf pg 1-2
4
10
However, GCR makes no mention of the fact that two weeks later, on 15 March 2016, Zhongbeitong issued
a follow-up announcement removing the expectation of any transaction with AAC for the year:
Source: http://www.neeq.com.cn/disclosure/2016/2016-03-15/1458034443_691319.pdf pg. 1-2
There was even a separate announcement explicitly clarifying the error:
Source: http://www.neeq.com.cn/disclosure/2016/2016-03-15/1458034444_271535.pdf
11
We find it unforgivable that GCR would not even bother to mention this material change in the expected
transaction between Zhongbeitong and AAC.
And just to be clear, all of this information both the original announcement, and the subsequent
clarification announcement two weeks later were on the neeq.com website, and all were made public
long before GCR published its research report.
More to the point, Zhongbeitong is a publicly-traded company on the New Third Board in China under the
ticker 830913, and as such is required to make general disclosures. In its 2016 annual report, Zhongbeitong
provides a list of the total transactions conducted with each of its top five customers. As we can see, none
of these top five customers are of material size, and certainly not anywhere close to conducting
RMB150 million in transactions:
Source: http://www.neeq.com.cn/disclosure/2017/2017-04-25/1493109040_310444.pdf pg. 12
Through industry interviews we learned that Zhongbeitong became one of several magnetic materials
suppliers to AAC in 2013 by way of an open bidding process. According to a former production manager
and a former sales manager, Zhongbeitong only supplies 20-30% of AACs magnetic materials, with the
balance shared by four other suppliers. These four other suppliers also won contracts through an open
bidding process.
Two former employees also said that the production cost of Zhongbeitong is about 10% higher than
market average due to its superior quality. AAC usually decides whether to purchase from Zhongbeitong
based both on requirements and the willingness of end-clients to pay for the extra costs.
According to a former production director, AAC was a top client of Zhongbeitong in 2014 and 2015, but
even still, the annual transactions were only valued in the tens of millions of RMB. One source even
believed that the transaction values actually decreased in 2016 because Zhongbeitong has been having
production troubles and AAC has been looking at other suppliers.
Given Zhongbeitongs own disclosures and industry interviews, as well as the open bidding process that
established the business relationship, it should be clear that the transactions between Zhongbeitong and
AAC are based on normal commercial terms, trivial in size, and certainly nothing close to RMB150 million.
12
Undisclosed Related Party Claims
GCR claims that AAC has not disclosed that Ms. Ingrid Wu, the wife of the CEO, was a shareholder and
board member of Zhongbeitong. Here is the section straight from the report:5
All these claims are false. Here is the disclosure from AACs 2016 annual report stating that Ms. Wu is a
director of Shenyang General Magnetic:
Source: AAC 2016 annual report, pg. 15
Shenyang General Magnetic is another name for Zhongbeitong (the Chinese names are one and the
same). GCR obviously did not realize this entity has another English name.
5
13
Furthermore, the claim that Ms. Wu held shares of Zhongbeitong is also false. Zhongbeitongs 2016 annual
report shows that Ms. Wu held 0% share interest in the company:
Source: http://www.neeq.com.cn/disclosure/2017/2017-04-25/1493109040_310444.pdf pg. 26-27
We do not know where GCR got the idea that Ms. Wu was a Zhongbeitong shareholder considering their
report provides no sources.
The only other possible link we could find (that was not mentioned in the GCR report) is that the mother-
in-law (Ms. Ye Huamei) of AACs CEO (Mr. Pan Zhengmin) indirectly purchased an 8.7% stake in
Zhongbeitong through a holding company back in 2015.
Now, the question is whether this constitutes a disclosable related party and should have been disclosed
according to Hong Kong Stock Exchange listing rules.
The answer: no.
According to Chapter 14A of the HKex listing rules, Zhongbeitong only needs to be disclosed as a related
party if Ms. Ye Huamei individually or together with other relatives held more than 50% controlling
interest in Zhongbeitong. Therefore, total ownership of 8.7% interest does not trigger a disclosure
requirement.6
6
https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf rule 6(23) and rule 21(1)
14
Even though Ms. Yes interest in Zhongbeitong does not require disclosure, we still wanted to find out on
our own if AAC or the Pan family has any unofficial or unstated influence or control over Zhongbeitong
which could lead to dubious business dealings.
Our investigation could find no connection between the other board members of Zhongbeitong and the
Pan family. In fact, according to interviews with a former sales manager and a former production director
of the company, neither Ms. Ye or Ms. Wu have any managerial control over Zhongbeitong. Ms. Ye
appears to simply be a financial investor.
So, not only has AAC not broken any disclosure requirements nor attempted to hide Zhongbeitong as an
undisclosed related party, our research shows that the Pan family does not even have any discernable
unstated influence or managerial control over this supplier.
And just so were clear, GCRs error-riddled analysis of Zhongbeitong is not just a small piece of its short
thesis that was snuck into the latter pages of the report it is featured prominently on the very first page,
even before the legal disclaimer, table of contents, and executive summary:
15
GCRs decision to highlight this specific analysis on the very front page of its report is a reflection of how
great they must have thought their research was. Unfortunately, the fact that they got every single
material point of this section factually wrong speaks to how unprepared they were to take on a Hong Kong
blue chip.
16
Suqian Qixiang
Key GCR claims:7
AAC may have created this entity to offload the huge development costs that are often associated
with a new smartphone launch.
Suqian Qixiang generated RMB554 million in revenue in 2015, making it one of AACs largest
component suppliers.
Suqian Qixiang is estimated to employ ~1,000 people.
Suqian Qixiang was established in 2015, at the same time that AAC began selling haptic motors
with anomalously high profit margins relative to its peers.
Suqian Qixiang is owned by Huang Yong Dong, per local filings. A man by the same name is
described as AAC Chairmans assistant.
AAC hasnt disclosed that the unit seems to be owned by the assistant to AACs chairman.
Suqian Qixiang appears to operate within AACs manufacturing complex.
AAC posted 50% gross profit margin on haptic motors in 2015 while Suqian Qixiang only earned a
15% gross profit margin on RMB554 million worth of haptic motor sales to AAC in the same year.
*****
GCRs assertion that AAC may have created Suqian Qixiang at the same time that AAC purportedly entered
the haptics market to offload development costs makes no sense because they got the timing wrong. Here
is the exact screengrab from the GCR report:8
GCR seems so confident of when AAC began selling haptic motors with purportedly anomalously high
profit margins that it even took the liberty of bolding and underlining the 2015 establishment date of
Suqian Qixiang.
The glaring problem with this assertion is that AAC actually entered the haptics market in 2014 not 2015.
Here is a screengrab from the 2014 annual report showing that AAC was already reporting industry-
leading margins of 46% from its Haptics segment that year:
7
8
17
AAC Segment Revenue
Source: http://www.hkexnews.hk/listedco/listconews/SEHK/2015/0415/LTN20150415511.pdf pg. 72
The 46% margins reported in 2014 are not anomalously different than the 51% and 40% margins
reported in 2015 and 2016 respectively, particularly when ramp-up costs are taken into consideration.
So already the short thesis is not off to a great start.
Then there is the assertion that Suqian Qixiang is an undisclosed related party. Suqian Qixiang is 100%
owned by an individual named Huang Yong Dong. According to GCR, Mr. Huang is:
a) An assistant to the Chairman of AAC.

b) The listed supervisor of an AAC subsidiary named Ruixun Changzhou (
).
GCR believes that these connections make Suqian Qixiang a related party and should therefore have been
disclosed by AAC. However, neither connection triggers disclosure requirements according to HKex listing
rules.
First, we note that AAC has denied that Mr. Huang is an assistant to the CEO and claims that this
information is from a misreported donation signing ceremony from Peking University. 9 But even if
9
CLSA research note dated 15 May 2017, pg. 2
18
Mr. Huang was an assistant to the CEO or the Chairman or whomever, it wouldnt make a difference.
An assistant to the CEO/Chairman (or any other type of assistant/employee for that matter), simply does
not fall within the purview of connected persons as defined in Chapter 14A Connected Transactions
rules. Therefore, Mr. Huangs position as assistant to the Chairman/CEO in of itself would not trigger
disclosure requirements.
Where GCR may have a point is with respect to Mr. Huang being listed as the supervisor of an AAC
subsidiary. According to the listing rules, a connected person includes a supervisor of a PRC issuer or any
of its subsidiaries. Mr. Huang may fall into this category:
https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf pg. 5
However, these rules also have an exemption if an individual is a supervisor of the listed issuers
insignificant subsidiary:10
Source: https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf pg. 6
10
https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf rule 9(1)
19
To determine if AAC may have broken Hong Kong listing rules, we need to find out if Ruixun Changzhou is
a significant subsidiary.
To do so, we pulled its SAIC filings. As the following page shows, this subsidiary reported de minimis
operating income, assets, and registered capital, and only one employee in 2016:
Ruixun Changzhou 2016 Financial Data
Source: SAIC filings
By any definition (including the HKex rules), this would be considered an insignificant subsidiary to a
~HK$100 billion company, and therefore exempt from disclosure requirements.
So far, we have found nothing here that suggests AAC broke related party disclosure requirements with
regard to Suqian Qixiang.
A recurring theme that will emerge throughout this report is that GCRs undisclosed related party
assertions are based on intuition rather than a full understanding of the HKex listing rules. Sure, an
assistant to the Chairman or a listed supervisor of a subsidiary may intuitively sound like a related party.
But gut-feeling cannot act as the underlying evidence of fraud accusations.
20
Another proximate issue concerning potential related party transactions is that Suqian Qixiang operates
in AACs manufacturing complex. GCR suggests that because Suqian Qixiang reports low PP&E relative to
AAC and Goertek, this may imply that AAC books Suqian Qixiang at the parent level instead of the Suqian
Qixiang level whatever that means. As GCR puts it:11
Its true that Suqian Qixiang operates in AACs manufacturing complex. But lets be clear Suqian Qixiang
isnt just operating there freely as some sort of subsidiary rather, its renting the facilities from AAC.
In a 2015 report submitted to the local government, Suqian Qixiang reveals that it employs 1,500 workers
in a leased 20,353 m2 area floor space with capital investments of US$25 million:
Source: http://www.jssthj.com/data/upload/file/20150914/1442199346155622.doc
Given that Suqian Qixiang only leases these facilities, the associated PP&E would not show up on Suqian
Qixiangs books. Rather, they ultimately belong to AAC as the lessor and would show up on AACs books.
This is accounting 101. Any nefarious conclusions drawn as to why Suqian Qixiang reports a relatively low
PP&E balance are obnoxiously contrived.
11
21
Subsidiary-like Relationship
GCR claims that Suqian Qixiang describes itself as a division of AAC in an online job posting:12
Suqian Jinlong
Address
We believe GCR has made a mistake here. This job posting is actually for an entity named Suqian Jinlong,
not Suqian Qixiang. Its hard to make any credible accusations against Suqian Qixiang when this posting
isnt even recruiting on their behalf.
Furthermore, this job posting itself is of dubious providence. The posting lists Suqian Jinlongs address as
AACs manufacturing complex ( 8 ). However, a public records search reveals
that Suqian Jinlongs registered address is actually located in :
12
22
Source: SAIC
This address is over 80 km from AACs manufacturing complex:
Source: Baidu Maps
Whoever put up this job posting was clearly unfamiliar with AAC, Suqian Qixiang, and Suqian Jinlong.
GCRs report relies heavily on online job postings as evidence. However, in China, job postings are often
carried out by third-party recruiters whose compensation is tied to how many recruits they can find.
Recruiters often tend to embelish the position or the hiring company to attract talent. It would not be
unusual to have a recruiter name-drop Apple or AAC, or imply certain connections in order to get more
responses. Using these types of job postings as key evidence of impropriety is questionable at best.
23
Marvel Comics Presents: What If?
As a fun exercise, we want to assume that GCR is correct
about Suqian Qixiang being an undisclosed related party and
take this scenario to its logical conclusion what would that
actually mean in economic terms?
Lets start with Suqian Qixiangs size. GCR claims that it

generated RMB554 million in 2015, which makes it one of
AACs largest component suppliers. 13 However, we believe
this RMB554 million figure is misleading.
Based on interviews with former employees, we learned that Suqian Qixiang is a component
manufacturer. According to these sources, Suqian Qixiang has been having trouble producing quality parts
that are acceptable to clients. Although it had 1,500 employees and generated RMB554 million in revenue
in 2015, there were only hundreds of employees left in 2016.
In other words, Suqian Qixiang has materially wound down its production.
We were able to independently confirm Suqian Qixiangs status through government tax information.
According to the local Suqian Economic Information Technology Bureau, Suqian Qixiang generated taxable
revenue of RMB501 million in 2015. However, in 2016 the entity only generated taxable revenue of
RMB195 million:
Source: http://jmw.suqian.gov.cn/sjxw/tzgg/201704/385e345fb31747b294de570fe6362c37.shtml
13
24
In effect, the headline revenue figure of RMB554 million used by GRC to bolster the material relevance of
Suqian Qixiang had already declined to RMB195 million in 2016. So even if Suqian Qixiang was the
undisclosed related party that GCR claims, it is currently a much smaller entity than it was in 2015, which
means its materiality to AACs business has dissipated into triviality.
Then there is the issue of margins. Recall that GCR believes Suqian Qixiang was set up to offload AACs
R&D expenses for its haptics business. We already explained on page 17 that this assertion doesnt make
sense given that AAC was reporting industry-leading margins well before Siquan Qixiang was even set up.
But whatever
according to GCR:14
This difference in gross margins is meant to lend credibility to the claim that AAC is offloading costs onto
Suqian Qixiang. However, what GCR curiously neglects to mention is that Suqian Qixiang reported
operating margins of 13.5% in 2015, which means it generated operating profits of RMB75 million.15
If, as GCR asserts, Suqian Qixiang is an undisclosed related party 100% owned by a connected person, the
implication is that it would have to be fully consolidated into the financial statements of AAC to provide a
more accurate picture of AACs economics. That means AAC would have to consolidate the RMB75 million
operating profits into its own accounts.
Sure, during consolidation AACs gross margins would slightly decrease, but AAC is not valued as a multiple
of gross margins it is valued as a multiple of earnings and if it were to add Suqian Qixiangs profit to its
own then AAC shares would actually be worth more not less.
GCRs fixation on gross margins is misleading without taking profitability into account. Indeed, we believe
the entire short thesis against Suqian Qixiang is neither factual correct nor does it make economic sense.
14
15
Based on SAIC filings
25
Shuyang Lisheng
Key GCR claims:16
Shuyang Lisheng reported ~RMB480 million of revenue, making it one of AACs largest suppliers.
Its operating margin of 2.4% is a tiny fraction compared to AACs operating margin.
Shuyang Lisheng is owned by two shareholders. Mr. Li, a name shared by an AAC executive, and
Pan Shinan, a name shared by the uncle to AACs CEO.
AAC has never disclosed the unit as a related party.
The unit produces the same products from the same location as AAC and seems to recruit new
employees under AACs banner.
Shuyang Lisheng has four unconsolidated subsidiaries, two of which may be linked to AAC, namely
Lian Tai Precision (discussed later) and Changzhou Lisheng (discussed in this section).
*****
Shuyang Lisheng is not an undisclosed related party.
According to interviews with multiple former employees of both companies, Shuyang Lisheng acts as an
outsourcing arm for AAC for small batch, low margin orders. These sources stated that it doesnt make
economic sense for AAC to take small orders because of the costs associated with casting molds. All these
sources claim that AAC is able to achieve high gross margins because of its advanced automatic production
lines. However, these lines require large volume orders to offset the high cost of mold casting.
When AAC gets a small, low margin order, the order is referred to Shuyang Lisheng because it does not
have the same tooling costs.
More importantly, these sources also explicitly stated that AAC deals with Shuyang Lisheng based on
market rates. When AAC outsources orders to Shuyang Lisheng, both AAC and Shuyang Lisheng generate
some profit on the order Shuyang Lisheng through production mark-up to AAC, and AAC through further
mark-up to the end-customer.
By GCRs own admission Shuyang Lisheng has positive operating margins which supports our findings that
Shuyang Lisheng is a profit generating entity and not simply set up to offload costs from AAC.
Former employees also stated that Shuyang Lisheng has other customers and is not completely dependent
on AAC. For example, in 2015, Shuyang Lisheng generated revenue of RMB480 million, up from
RMB365 million the previous year, according to SAIC filings. This revenue growth was mainly driven by a
large order received from a separate customer during the year.
16
26
Undisclosed Related Party Claims
According to GCR:17
It is true that Shuyang Lisheng is 60% owned by an individual named Mr. Pan Shinan who shares the same
last name as AACs CEO, Mr. Pan Zhengmin. However, our own research shows that Mr. Pan Shinan is not
an uncle to the CEO and not a connected person within the definitions of Chapter 14A of the HKexs rules.
The fact he shares a last name with the CEO is only a coincidence.
Specifically, we learned that Mr. Pan Shinan is only very distantly related to Mr. Pan Zhengmin, and falls
well outside any Chapter 14A disclosure rules encompassing even extended family members/relatives.18
Mr. Pan Shinan is the son of Mr. Pan Zhengmins mothers, mothers, brother which makes him a second
cousin once removed. In effect, Mr. Pan Shinan is so far removed that he is barely a family member and
certainly no uncle. Furthermore, since the two are only distantly related on the mothers side and last
names are passed through paternal lineage, the fact that they share a last name is only a coincidence.
In fact, based on their age (53 and 49),19 Mr. Pan Shinan and Mr. Pan Zhengmin are said to be closer as
friends than as family.
If it seems like we did extensive work on this relationship, its because we did. Mr. Pan Shinans name
popped up several times over the course of our investigation as surely as it popped up several times in
the GCR report. The difference is that we spent the time and resources to dive into the actual extent of
this relationship instead of just hearing a culturally vague term like uncle and concluding that AAC must
be hiding disclosable related parties.
In addition to Mr. Pan Shinan, a Mr. Li also owns a minority stake in Shuyang Lisheng. GCR believes that
this is the same Mr. Li as an AAC high level executive.
High-level or low-level, there are no rules in Chapter 14A that make an executive a connected person,
except for a CEO. Connected persons are generally limited to those who can have outsized influence in an
organization, such as a CEO, director, or substantial shareholder of the listco, or their families.20
Again, GCRs accusations seem based on gut-feel assumptions rather than an actual understanding of
Hong Kong listing rules.
17
18
https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf rule 21(1)
19
We derived this information from SAIC filings and the annual report.
20
https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf rule 7
27
Tangent to the topic of undisclosed related parties, GRC also claims:21
As with Suqian Qixiang, Shuyang Lisheng is located within one of AACs production complexes but not
as a free-wheeling subsidiary. SAIC filings show that Shuyang Lisheng has a lease contract with an AAC
subsidiary to rent 20,000 m2 of floor space in an adjacent building.
According to former employees of both Shuyang Lisheng and AAC, the close proximity allows Shuyang
Lisheng to benefit from the same low-cost raw material and components procurement as AAC. When
Shuyang Lisheng processes these materials into parts, it can then sell the parts to AAC on regular
commercial terms.
Our investigation could find nothing improper about this relationship or the close location of the factories.
Furthermore, GCRs claim that Shuyang Lisheng recruits under the AAC banner appears to be based solely
on an online job posting:22
However, this job posting wasnt even posted by Shuyang Lisheng. It was posted by an entity named
Changzhou Chengsiyuan Management Company, as per the blue box. A quick public records check with
the SAIC will show that this is an HR recruiting company. As we explained on page 23, recruiting companies
tend to embellish connections to attract recruits. AAC or Shuyang Lisheng can hardly be held responsible
for the accuracy of third-party online content.
21
22
28
Changzhou Lisheng
GCR claims that Changzhou Lisheng has a possible relationship to AAC because it is a subsidiary of Shuyang
Lisheng.23
But, if Shuyang Lisheng is not a disclosable related party to AAC, then simply being its subsidiary does not
make Changhzou Lisheng one either. Even if Changhzou Lisheng was a related party, it would still be fully
exempt from disclosure requirements per the de minimis transactions exemption of the HKex rules.
SAIC filings show that Changzhou Lisheng was set up in 2014 and only generated RMB3.6 million in
revenue in 2015. (Despite its small size, it was actually profitable with operating margins of 7.3%).
According to employee interviews, Changzhou Lisheng was set up by Shuyang Lisheng to act as an OEM
for orders that were ultimately too small for AAC to bother with. These orders came from clients including
Amazon, Dell, and Google. However, Changzhou Lisheng recently received a massive RMB100 million
order from LeTV for earphones, which further reduced Changzhou Lisheng and Shuyang Lishengs
dependence on AAC as a customer.
We believe its clear from our research that Shuyang Lisheng and Changzhou Lisheng are both profitable
entities with their own customer base. Again, we find the whole notion that AAC is offloading its costs
onto these entities to report higher gross margins to be economically nonsense. As we previously stated,
AAC is not valued as a multiple of its gross margin, but as a multiple of its earnings. Given their positive
operating profit, both Shuyang Lisheng and Changzhou Lisheng would be accreditive to earnings if they
were fully consolidated into AAC, and thus would actually make AAC shares more attractive, not less.
23
29
Xuan Ying Tong
Key GCR claims:24
Xuan Ying Tong (XYT) seems like an AAC distributor of cell phone speakers, receivers,
microphones.
XYT produces the same products as AAC and even describes itself as part of AAC in public records.
In 2015, XYT generated revenue of RMB349 million.
XYT generated an operating loss, even while AAC generated a best-of-class 27.4% operating
margin in the same year.
XYT has de minimis property plant and equipment (less than RMB1 million).
For some reason, XYT generated a loss in 2015 even though AAC simultaneously reported industry
leading profits margins.
*****
GCR claims that XYT generated a loss on RMB349 million of revenue in 2015. However, according to SAIC
financial data, XYT actually generated a profit of RMB11 million in 2015, and RMB10 million in 2014. The
company even paid taxes in both years:
Xuan Ying Tong Financial Data (2015)
Total assets Owners equity

Total revenue Profit before tax
Core revenue Net profit
Total tax Total liabilities
Xuan Ying Tong Financial Data (2014)
Total assets Owners equity

Total revenue Profit before tax
Core revenue Net profit
Total tax Total liabilities
We are not sure where GCR got their financial information from given that they cite no sources. However,
the disparity between what they claim and these SAIC filings does not inspire confidence in their report.
24
30
GCR also claims that XYT produces the same products as AAC. However, based on our research, including
interviews with former employees, XYT is simply a sales agent of AAC. We were not able to find any
credible evidence that XYT produces anything. This may explain why GCR found that XYT had less than
RMB1 million in PPE. In fact, SAIC filings show the registered address of XYT is No. 2205, Building A, Jinniu
Square, Shenzhen.
This address is an office building, not a manufacturing plant:
According to two former employees of a local telecom company in Shenzhen, customers who are too
small to purchase directly from AAC have to purchase through XYT:
AAC products are very popular in Guangdong Province. Local telecom product
manufacturers are too small to purchase from AAC directly. AAC has contracts with big
fellows like Apple, Samsung, Huawei, and OPPO. Therefore, small local mobile producers
need to purchase from distributors like XYT, who can get AAC products through their
relationship. But these products are usually lower quality than those sold to Apple and
Samsung.
- Former structural engineer of a local telecom company
These sources also made it clear they were not aware that XYT had any production facilities, as is
consistent with our own research. Clearly, the notion that AAC somehow offloads costs onto XYT doesnt
make sense given that XYT is not a manufacturer of any kind. We have no idea what GCR is talking about.
And finally, GCR questions why XYT and AAC have such different operating margins. But suggesting the
possibility of fraud by comparing the operating margins of a distributor that sells lower quality products
to small-time customers VS a top-tier manufacturer that sells mass-volume products to Apple and
Samsung is just fucking stupid.
31
Lian Tai Precision
Key GCR claims:25
In 2016, Lian Tai generated revenue of RMB104 million and -RMB33.7 million of operating losses.
Lian Tai is described as employing between 1,800-4,000 people.
Lian Tai is supposedly an independent AAC supplierAAC has never disclosed the unit as a related
party.
Lian Tai may be owned by the uncle of AACs CEO
In addition to Huang Yong Dong and Pan Shinan who may have ties to AAC there is a man by
the name of Sun Wenjing who may be connected to AAC as well.
Lian Tai could be a prime example of AACs apparent modus operandi whereby AAC may be using
a parallel off balance sheet entities to produce identical products during the ramp stage of
production.
*****
According to GCR, Mr. Huang Yong Dong, Mr. Pan Shinan, and a man named Sun Wenjing are all connected
to Lian Tai Precision, which makes it an undisclosed related party.
We already explained in detail how Mr. Huang and Mr. Pan Shinan are not connected persons to AAC on
page 18 and 27, respectively. The only new figure here is Mr. Sun Wenjing, who is the registered general
manager of Lian Tai Precision. According to GCR, an online article claims that Mr. Sun represented AAC
Group during an awards ceremony.
It should go without saying that this evidence is pretty flimsy. Representing an entity during an awards
ceremony does not necessarily mean you have any official capacity with that entity.
Regardless, our research shows that Mr. Sun is not a connected person. Through employee interviews we
learned that Mr. Sun may have been an HR executive of AAC prior to 2015, but he is no longer with the
Company. Even still, an executive would not be considered a connected person under Chapter 14A,
especially because Lian Tai was only established in November 2015, well after Mr. Suns departure.
In bold lettering, a confused GCR asks:
The answer is simple: GCR conducted poor research. Perhaps they should have sought to answer their
own question before releasing a report.
25
32
What Exactly is Lian Tai Precision?
So, if Lian Tai Precision is not an undisclosed related party meant to be used as AACs off-balance sheet
entity as GCR suggests, then what exactly is it?
Through industry interviews, we learned that Lian Tai is a newly established entity that acts as an
outsourcing manufacturer for AAC. Specifically, it produces mobile phone metal casings for Shuyang
Ruitai, an AAC subsidiary.
According to sources, transactions conducted between Lian Tai and Shuyang Ruitai are all at commercial
and comparable rates, and both entities operate independent of each other.
Lian Tai can only semi-manufacture mobile phone shell parts. These half-finished
products will be assembled in Ruitai. Lian Tai has nearly the same cost of semi-
manufacture products as Ruitai. The prices of these products are sold to Ruitai rather
fairly.
- Former quality engineer at Shuyang Ruitai
Lian Tai has the same suppliers of raw materials as Ruitai, but it is completely
independent of Ruitai. Their purchase prices are the same.
- Former production director of Lian Tai Precision
In an over-the-top fashion, GCR suggests:26
Oh, really? This entity is the poster child for AACs purported fraud?
Lian Tai was established on 26 November 2015 and only began operating in March 2016.27 It is a small-
scale operation that only generated RMB104 million in revenue with a tiny loss in 2016. In fact, of all the
manufacturing entities questioned in GCRs report, this is the only one that posted an operating loss.
How prime of an example can Lian Tai possibly be given its immaterial scale and non-existent operating
history, in the context of a blue chip that reported RMB16 billion in revenue last year and has been posting
+40% margins since at least 2009 and paying those earnings out as dividends?
26
27
According to GCR report
33
Margins
GCR suggests that their purported undisclosed related party findings ultimately manifest themselves in
the financial statements of AAC. Specifically, GCR believes that AAC is offloading as much as RMB1.5 billion
of costs into these undisclosed entities which allows it to report exceptionally high and smooth
margins.28 GCR provides the following benchmark analysis to support its view:
Source: GCR Report
28
34
According to GCR:
First, it should be noted that using only a three-year window as GCR has done barely constitutes a trend.
Second, if youre an investor and are shocked by the idea that a company might smooth margins to make
them more predictable for analysts, you probably shouldnt be an investor. But in any case, most analysts
view the recent margin smoothness as a reflection of AACs highly automated production (we discuss
AACs automated production in the next section).
As far as the margins themselves are concerned, +40% gross margins are not even unusual for top-tier
Apple suppliers, despite GCRs claim to the contrary. Here is a table from CICC showing that there are
several Apple suppliers that report equal or higher gross margins than AAC:
From this table, we can see that the leading suppliers of any given component have materially larger
margins than their second-place direct competitors. For example, Largan Precision and Genius are both
lens suppliers. However, as the industry leader Largan reports gross margins ~30% higher than Genius.
Likewise, Catcher and Casetek are both casing suppliers. As the industry leader, Catcher reports gross
margins ~20% higher than Casetek.
As the leader in acoustics, AAC also reports gross margins ~20% higher than GeorTek, its closest industry
competitor. There is nothing suspicious about that.
35
In fact, as part of our research, we called GoerTek to learn more about AAC and their respective margins.
According to an IR representative, the difference between GoerTek and AACs gross margins for their
acoustic segment stems mostly from the fact that AAC has a much longer history operating the business,
and so their processes are more streamlined. We were told that GoerTeks acoustics business started off
producing basic microphones, and has developed very fast in the last few years so their processes were
relatively inefficient.
Moreover, GoerTek stated that they utilize the components they produce in their acoustic segments
internally with their smart devices business, which also affect margins. This is a key point, because AAC
focuses on components, which typically generate higher margins, whereas GoerTek focuses on
assembly.29 The IR representative finished off by saying that GoerTek has recently improved margins in
the last few quarters to reach ~30%.
The difference between GoerTek and AAC can also been summed up by their respective R&D spend. AAC
has spent ~7% of its revenue on R&D over the last ten years, compared to GoerTeks ~5%. Its only in the
last two years that GoerTek has increased its R&D to the same ratio as AAC:30
R&D spending
(as a % of revenue) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
GoerTek 4.1% 4.5% 5.8% 4.6% 4.9% 3.8% 4.6% 6.1% 7.1% 6.9%
AAC 4.5% 5.5% 7.2% 6.4% 8.8% 7.4% 6.8% 7.4% 7.3% 7.5%
Source: company filings
AACs automated production facilities
29
Morgan Stanley research dated 15 May 2017
30
As a side note, R&D costs are really easy to hide. If AAC really wanted to inflate margins, they would have likely
done so by minimizing R&D expenses on the income statement, not by off-loading production costs as GCR
suggests. But clearly that is not the case.
36
37
AACs Procurement System
In addition to its sophisticated automated production, we also learned from former employees of both
AAC and GoerTek that AAC has an advanced procurement system that materially reduces costs and waste.
According to several sources, AAC has been able to maintain consistently higher gross margins because it
has a robust, multi-step bidding system that makes it difficult for either AAC employees or suppliers to
personally benefit from kickbacks. AAC has two separate teams that develop new supplier relationships.
One is the development team, which identifies suitable suppliers to meet the requirements of the
production department. A second, separate team is the pricing team which will then negotiate pricing
with the potential suppliers.
Once a potential supplier is identified and can meet the required pricing, a confidential outside party is
used to evaluate potential bids. The final evaluation is then delivered to Mr. Pan Zhengmin or a lieutenant
for approval.
Two former employees of AAC and one former employee of GoerTek believed AAC has a significant
advantage on procurement compared to GoerTek, and most other acoustics component producers:
AAC has been producing acoustics components for over 20 years. The listco is the leader
of acoustics business and could win plenty of orders. It has stronger bargaining power
than other competitors. The procurement price is rather low, and I do not believe there
will be any space to benefit [via kickbacks] through purchasing.
- Former development engineer and production manager at GoerTek
38
Other Accounting Concerns
Key GCR claims:31
Free cash flow has been consistently lower than net income since 2007 (only about 24% of profits).
Despite its highly-touted investment in automation, employee count growth actually exceeded
revenue growth from 2013 to 2016.
Capex vs automation explanation AAC completed the major phase of automation production.
Its unclear how much of an automation edge AAC has over its peers, given that AACs automation
development has been ongoing since 2007, according to Credit Suisse.
*****
GCR provides the following table which shows that AACs free cash flow was only 27% of net income in
the last ten years, claiming it a reflection of AACs poor earnings quality:32
The problem with this logic is that AAC is a hypergrowth entity in a hypergrowth industry. The last ten
years have been nothing short of revolutionary in the world of smartphones weve come a long way
since the Motorola Razr. And so of course AAC has had to invest heavily into CapEx, which naturally leads
to depressed free cash flow. But AAC is not alone in this. GoerTek, the closest competitor to AAC, has
actually reported NEGATIVE free cash flow over the last ten years:
GoerTek Analysis
RMB millions 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007-2016
Free cash flow (92) (214) (178) (521) (905) (1,465) (132) (180) 373 (1,071) (4,385)
Net income 77 123 100 276 528 925 1,325 1,684 1,240 1,609 7,888
FCF as % of income -119% -174% -178% -189% -171% -158% -10% -11% 30% -67% -56%
Source: company filings, our analysis
31
32
39
Oddly, GoerTek is used multiple times as a peer comparable in the GCR report, yet is omitted when it
comes to the above analysis. We find the inconsistency of GCR dubious when it comes to picking and
choosing which company it compares to AAC in order to put AAC in the worst possible light.
Employee Count vs Automation Claims
To support their claim that the free cash flow/net income differential is suspect, GCR also suggests that
AACs investment in automation (aka CapEx) is not reflected in the financial statements because employee
count is purportedly growing faster than revenue. Specifically, GCR states:33
When we first read this passage, we were confused as to why GCR only referenced the 2013-2016
time frame when the table they provide is from 2012-2016. If GCR had used the 2012-2016 time frame,
they would have been forced to admit that revenue grew by 147% while employee count only grew by
75% in the same period. Using GCRs own logic it would be vindication that AACs automation investments
are paying off.
After deciding that GCR has a penchant for arbitrarily picking and choosing data points and time frames
to serve their arguments, we decided to extend the above analysis back to 2007, which is the same starting
period GCR used in their FCF/net income analysis (as per the previous page). Coincidentally, 2007 is also
the same year that AAC began investing heavily in automation, according to Credit Suisse:
Revenue vs Employee Growth a More Holistic View

Revenue in RMB millions 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Revenue 1,952 2,256 2,203 3,349 4,060 6,283 8,096 8,879 11,739 15,507
Employees 10,762 9,928 8,034 12,431 13,789 26,575 23,011 32,172 35,687 46,396
Revenue growth - 16% -2% 52% 21% 55% 29% 10% 32% 32%
Employee growth - -8% -19% 55% 11% 93% -13% 40% 11% 30%
Source: Company filings, our analysis
33
40
From this table we can see that since 2007, revenue has grown by nearly 700%, while employee count has
only grown by 331%. Clearly, AACs investment in automation is not made up. (This analysis holds true
even if we include the 6,000 employees that GCR claims belong to undisclosed related parties.)34
In fact, since 2007 there have only been three years where employee growth outpaced revenue growth
(highlighted in red), and only two of those years have differentials that are material: 2012 and 2014.
In 2012, AAC reported the biggest sales growth in its history as a publicly traded company on the back of
a massive refresh cycle (including the launch of the iPhone 5, the first iPad Mini, and Samsung Galaxy SIII).
In 2014, AAC launched its highly successful haptics business. Both years provide valid reasons for AAC to
ramp up hiring irrespective of CapEx investments.
No part of these financial statement analyses suggests accounting fraud by AAC. But it may suggest an
attempt by GCR to pick and choose data points to fit their narrative.
34
41
Apple Investigation Claims
Key GCR claims:35
AAC has used these hidden entities to evade Apples labor standards specified in the Apple
Supplier Code of Conduct.
Apple (and other parties) will conduct independent investigations, & validate our findings. As a
result, AACs profit margins will decline, converging to its peers levels.
AAC is in violation of Hong Kong listing rules, Apples supplier code of conduct, and its own
representations.
*****
GCR vaguely suggests that Apple (and other parties) will conduct independent investigations to validate
their claims. As it so happens, we are an independent party and we did conduct a deep, detailed
investigation into AAC that spanned several months. Our investigation found that AAC is a well-managed
company that makes quality products that are highly sought after. At least one other publisher of short
research we have talked to found the same.
GCRs only claim of labor issues is with regards to Lian Tai Precision.36 However, by GCRs own admission,
Lian Tai Precision is not even in the Apple supply chain.37
AAC and the other entities mentioned in the GCR report are mainly based in Jiangsu. Jiangsu is a small,
but rich coastal province with the highest GDP per capita in China. Jiangsu has a sprawling electronics and
manufacturing economy with an abundance of jobs and foreign direct investment.38
The type of systematic labor violations GCR imagines are highly unlikely to happen in Jiangsu. Workers in
the province have options in terms of employment and would not stand for mistreatment. Indeed, AAC is
one of the better employers in the region and does a lot to retain workers, including company talent
competitions, providing sports facilities, and organizing outings:
35
36
https://www.scribd.com/document/347990769/2017-05-10-AAC-Technologies-Report-I-Preview-
Final#from_embed pg. 1
37
Ibid
38
https://en.wikipedia.org/wiki/Jiangsu#Economy
42
Talent competition
Sports facilities for staff and their families
War games
43
Scour the internet and you will ALWAYS find isolated complaints of labor issues. Manufacturing plants are
by their nature not the best places to work. But corrective action is easy to take. Remember the string of
suicides in 2010 when workers were throwing themselves off Foxconns buildings, so Foxconn decided to
put up nets? Of course you remember, because the suicides were international news. Yet, despite the
publicity, the incident didnt cause Apple to cancel its supplier relationship with Foxconn. Steve Jobs even
defended Foxconn, insisting that the factory, with swimming pools and cinemas, was far better than
required.39
Furthermore, switching suppliers is not like changing underwear. There are daunting quality, supply-chain
and capacity challenges to overcome, especially when it comes to a top-tier supplier. Switching out a
supplier of AACs scale would not only be time consuming and costly for Apple, but completely unrealistic.
In any case, AAC is not Foxconn. There are no wide-spread abuses or suicides, and Apple is not going to
cancel a contract just because a short seller doesnt know what a disclosable related party transaction is.
39
http://www.cbsnews.com/news/what-happened-after-the-foxconn-suicides/
44
GCRs Second Report
GCR has promised a second report. Given the quality of the first report, we wouldnt be too worried about
the second one. Anyone who writes short reports knows the importance of putting your best evidence
out first. Subsequent reports usually get lost in the noise.
In any case, we have reason to believe that the second report will focus on AACs taxes. Specifically, we
believe the second report will question AACs net profit margins by make the following key claims:
AACs effective tax rate has averaged 9% over the past 10 years.
AAC may be using a subsidiary in Singapore to utilize an undeserved local tax scheme.
AAC may be overreaching in its use of Singapores tax incentives.
The Singapore tax incentive expires in 2018 and may not be extended.
If this is the focus of the second report as we have reason to believe, then truly it is an even less relevant
report than the first one.
First, using tax incentives is nothing new. Apple is notorious for this kind of thing. Second, AAC makes no
secret that it uses jurisdictional tax incentives. We can see this from their annual report:
Source: annual report 2016, pg. 90
45
More specifically, AAC acknowledges that it uses a Singapore tax program that expires in 2018:
On this topic, AAC has already guided analysts higher concerning its effective tax rate according to a
research report dated 12 May 2017 issued by JP Morgan:
If this sounds like a non-issue unworthy of a report, it is. But so was the first report. If GCR does ultimately
decide to publish a second report, we will be there to make sure its not misleading.
46
Valuation
Trading in AAC shares were halted at HK$82.60 in order to give the Company time to publish a clarification
announcement. However, in the over-the-counter (OTC) market, which sophisticated investors have
access to, shares are currently trading hands at ~HK$75.00, representing a 9% discount to the halt price.
In our experience, this is a relatively small discount which may speak to the weakness of the GCR report.
When shares are halted due to allegations of improprieties, the OTC discount tends to be much steeper
because sophisticated shareholders are convinced by the allegations and are eagerly looking to get rid of
their shares. Discounts of 30% are not uncommon.
A share price of HK$75 represents 15x 2017 earnings and a PEG ratio of 0.61.
Since GCRs allegations are frivolous and have no implications on valuation, we believe AAC shares will
return to their previously market-determined price of HK$111, representing potential upside of 48%.
At HK$111, shares would be valued at 22x 2017 earnings and a PEG ratio of 0.9, which would be
considered closer to fair value.
Notably, 4.5% of AAC shares outstanding have been sold short, representing 7.5% of the free float. This
values the short position at HK$4.6 billion. Someone bet really big on a really bad report:
Source: https://webb-site.com/dbpub/short.asp?i=4613
At some point, the shorts are going to have to cover or risk getting crushed by a company that has grown
earnings an average of +30% per year over the last five years and pays healthy dividends.
We believe AAC will resume trading next week. It took us this long to compile a report even though we
were well versed in the short thesis, had already conducted an investigation, and had all the SAIC filings
on-hand. We imagine it will take AAC slightly longer to respond given that they were caught off-guard.
When the stock does resume trading, we expect the tattered short thesis to force the stock higher.
To reiterate, we expect AAC shares to rebound to HK$111. With shares currently trading at HK$75 in
the OTC market, this would suggest potential upside of 48%.
47
Conclusion
GCR takes their ignorance of what constitutes a disclosable related party transaction in Hong Kong, and
provides their own unique doomsday conclusion to reach the worst possible scenario.
Instead of looking at a glass as half full or half empty, GCR claims there is no water in the glass except
for some backwash and the backwash is poison and also there is no glass.
Even if GCR was right in their undisclosed related party claims, their short thesis would still make no sense
from a valuation perspective. GCR claims the following:40
These six entities collectively generated revenue of RMB1.5 billion, which GCR claims are undisclosed
related parties used to hide RMB1.5 million in costs.41
We have already shown that none of these entities are disclosable related parties. But even if they were,
these six entities collectively generated positive profits. If they were to be fully consolidated into AACs
accounts they would actually be accreditive to earnings, which would increase the value of AAC shares.
There obviously must have been a reason no one who has a history of publishing short reports in Hong
Kong decided to publish on this name. As we stated in our introduction, the short thesis has been floating
around for at least a year.
40
41
GCR sneaks Lian Tai Precisions 2016 revenue into the 2015 revenue of the other five entities to inflate its
RMB1.5 billion number. Lian Tai Precision did not have any revenue in 2015 because it was not operational until
2016. If GCR wants to use 2016 revenue figures, they would have to reduce Suqian Qixiangs revenue to RMB195
million. Either way, the RMB1.5 billion is overstated. Its further overstated because these entities are also
collectively profitable.
48
Of all the targets GCR could have picked as its Hong Kong debut, it probably picked the worst one. AAC is
a reputable, blue chip name with perhaps some of the best shareholder-friendly corporate governance
practices among all Hong Kong listed stocks. AAC is also a member of the Shanghai through-train, was
recently inducted into the Hang Seng Index, and has a global investor base.
If you are going to go after a company like that and knock it down over 30%, you better make sure your
research is not factually wrong and economically meaningless.
We dont imagine this ending very well for GCR.
-Nuff said
49
Source: Nightwing #30
50

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Release Date: 6 June 2017

AAC Technologies Holdings Inc.

Ticker: 2018.HK We believe Gothams short report on AAC

You should have expected us

aainfo [@] neomailbox.ch

Its easy to be frightened of the unknown.

ZhongBeiTong 292.43 Wife of AAC CEO is NO Discussed in this report, pg. 10

LianTai Precision 0 Subsidiary of ShuYang NO Discussed in this report, pg. 32

ChangZhou 3.57 Subsidiary of ShuYang NO Discussed in this report, pg. 29

JiangSu 13.13 Subsidiary of ShuYang NO See Shuyang Lisheng as discussed

GangSheng 39.54 Mother-in-law of AAC CEO is NO Ye Huamei (mother-in-law) holds

Hao Han 24.92 Sister-in-law of AAC CEO is NO A what? Former shareholder?

LiBeiTe Special 0 CEO family member is NO Fully exempt under de minimis

HuaZhao 0 Manager of AAC subs is NO Fully exempt under de minimis

This looks like scary stuff.

If AAC is offloading costs to overstate profits, what is the end-game?

Clearly, the money trail does not support a fraud thesis.

Lets get right into it

Source: http://www.neeq.com.cn/disclosure/2016/2016-02-29/1456739347_398178.pdf pg 1-2

Source: http://www.neeq.com.cn/disclosure/2016/2016-03-15/1458034443_691319.pdf pg. 1-2

There was even a separate announcement explicitly clarifying the error:

Source: http://www.neeq.com.cn/disclosure/2017/2017-04-25/1493109040_310444.pdf pg. 12

Source: AAC 2016 annual report, pg. 15

Source: http://www.neeq.com.cn/disclosure/2017/2017-04-25/1493109040_310444.pdf pg. 26-27

The answer: no.

Source: http://www.hkexnews.hk/listedco/listconews/SEHK/2015/0415/LTN20150415511.pdf pg. 72

So already the short thesis is not off to a great start.

a) An assistant to the Chairman of AAC.

Source: https://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_14a.pdf pg. 6

Ruixun Changzhou 2016 Financial Data

Source: SAIC filings

This address is over 80 km from AACs manufacturing complex:

Source: Baidu Maps

Lets start with Suqian Qixiangs size. GCR claims that it

Shuyang Lisheng is not an undisclosed related party.

Xuan Ying Tong Financial Data (2015)

Total assets Owners equity

Xuan Ying Tong Financial Data (2014)

Total assets Owners equity

This address is an office building, not a manufacturing plant:

In bold lettering, a confused GCR asks:

- Former production director of Lian Tai Precision

In an over-the-top fashion, GCR suggests:26

Source: GCR Report

AACs automated production facilities

- Former development engineer and production manager at GoerTek

Employee Count vs Automation Claims

Revenue vs Employee Growth a More Holistic View

Sports facilities for staff and their families

Source: annual report 2016, pg. 90

Source: annual report 2016, pg. 89

Source: annual report 2016, pg. 89

We dont imagine this ending very well for GCR.

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