Notorious short-seller Carson Block and his equity research firm Muddy Waters has accused Chinese education company GSX TechEDU ($GSX) of fabricating student numbers through the use of bots.
"We're regularly looking for things that are too good to be true," Block told Cheddar in an interview Wednesday. "GSX certainly fit the bill in that it claimed to have grown so fast in such little time, and that it's massively profitable."
Muddy Waters has made its core business holding short positions of Chinese companies on U.S. exchanges and exposing what they believe to be fraudulent activity.
Muddy Water's report details its allegations and explains how it found unusual patterns among droves of GSX students, leading the firm to believe that more than 80 percent of the company's claimed students are not real.
GSX refuted the claims in a statement, accusing Muddy Waters of lacking a "basic understanding of GSX's operations" and said that the unusual sign-on patterns were a result of students being switched between classes autonomously.
"The system will automatically switch classes for students, usually around the class start times, thus causing large groups of users to join classes at the same time," GSX explained.
Block responded to the denial, telling Cheddar that GSX is being dishonest "because there's no downside to them lying further," citing the lack of oversight of Chinese companies on U.S. exchanges.
He did acknowledge that this information has Muddy Waters reviewing its data so it can respond specifically to this defense but said it doesn't fully explain other anomalies like overlapping IP addresses.
Block also questioned GSX's claim that it only found an overlap of 0.78 percent of IP addresses and said his firm's research directly contradicts that figure.
"We found 15,000 overlaps in a sample of 54,065, so they are, on the face of it, lying in their response there," Block said.
In the report, Muddy Waters also cited the testimony of an unidentified former manager, who told them that GSX has a room dedicated to the practice of fraudulently boosting student numbers. According to the witness, that was how GSX initially attracted teachers to the platform.
Muddy Waters is preparing more documentation of GSX's alleged wrongdoing, specifically whether the Chinese company is underreporting its expenses.
As for GSX's flat denial, Block says he's seen this response many times before.
"We have had six of them delisted...They all do the same thing. This is the same playbook. They deny. They lie some more," Block said regarding companies from China. "It's our intention to just put this thing away."
On the same day of this interview, the U.S. Senate passed a bill that would prevent some Chinese companies from listing on U.S. exchanges unless they followed American regulations.
Muddy Waters applauded that decision on Twitter.
As it stands, the SEC cannot investigate Chinese companies. In fact, it is against the law in China to forfeit documents in compliance with orders from the United States.
