MEDIA: Baofeng Rallies on Troubling Layoff Reports

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Bottom line: High-flying video player maker Baofeng represents the irrational sentiment now pervading China’s stock markets, and its recent layoffs hint at underlying troubles that will undermine the company over the next year.

Baofeng layoffs hint at troubles

When the history books are written, video player maker Baofeng Technology (Shenzhen: 300431) could well become the poster child for China’s version of the dot-com bubble that saw the country’s stock markets soar and then crash in 2014 and 2015. In the latest twist on Baofeng’s story, the company has reportedly just laid off 30 percent of its workforce, in what looks like signs of major problems.

But rather than tumble on the reports, the company’s stock actually rose by the daily 10 percent limit in the latest trading session at the end of last week. It’s not completely unheard of for companies’ stocks to rise after layoffs are disclosed, even though the job cuts really do look like a sign of major troubles brewing at Baofeng. But in China, no one really seems to ever read beyond the headlines, and often they don’t even bother reading the headlines at all.

Welcome to China’s version of the dot-com bubble, which in my view still has plenty of froth left. The main things supporting China’s stock market right now are a steady series of monetary easing moves by Beijing, and a misguided belief by investors that the government has the resources and ability to prevent steep corrections. While the government may indeed want to stabilize the market, it may soon have no choice but to let it decline as pressures mount due to China’s slowing economy.

All that said, let’s zoom in on Baofeng, which provides a nice microcosm of what’s happening in China’s broader stock market. The latest reports buzzed through the headlines at the end of last week, and cited a Baofeng employee who wrote on his microblog that the company was implementing the massive layoffs. (Chinese article) Some 30 percent of employees were being cut altogether, with layoffs across a wide range of divisions from customer interfaces, to product development, the post said.

The post was later deleted, and Baofeng has made its own response to all the noise. It hasn’t outright denied the layoffs, though it does say the reports are incorrect. It says the company conducts adjustments each year to improve its workforce, and this year is no different. Baofeng added it continues its regular and college campus recruiting programs.

Profit Warning

Perhaps the scale of the layoffs is exaggerated, as regular company employees aren’t always the most reliable sources for this kind of information. But clearly something is happening at Baofeng. The company issued a statement 2 weeks ago warning that its profit would drop 15-35 percent in the first 3 quarters of the year, citing its early stage of development and costs related to a stock incentive plan. (company announcement) While that may sound bad, it does seem to mark an improvement over the first half of the year when the company’s profit tumbled 70 percent.

The fact of the matter is that these financial reports are all suspect, as Chinese companies often use accounting tricks to hide losses and make their results look better than they really are. But that doesn’t seem to matter to Chinese investors, who have bid up Baofeng’s shares by more than 200 percent since mid September as China’s stock market showed signs of stabilizing after a massive summer sell-off.

Baofeng’s stock made headlines earlier this year when it broke records for its meteoric rise after its IPO in late March. (previous post) The shares rose as much as 20 times above their IPO price at one point, before falling sharply, and now rebounding. They still are well below their all-time high, but even so currently trade at a sky-high price-to-earnings (PE) ratio of about 500. The latest layoffs are probably just the beginning of a rocky period for both Baofeng’s business and its stock, and I do expect the company’s shares and China’s broader stock markets will fall well below their current levels by this time next year.

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