Canaan Technology is bearish on Wall Street: related-party transactions, lawsuits, and clients involved in major commercial fraud

• Editor’s Note:

As the first Bitcoin mining machine manufacturer to enter the securities market, Canaan Creative has always been surrounded by controversy and doubts.

On February 21, Schall Law Firm, a Los Angeles-based shareholder rights litigation firm, announced that it is investigating claims on behalf of investors of Canaan Inc. (NASDAQ: CAN), which has been accused of violating securities laws.

Recently, an investment analyst named Marcus Aurelius wrote a bearish survey report on Canaan Technology. The main contents are:

1. Canaan Inc. has numerous transactions with related parties and fictitious entities that have not been disclosed to regulators, and is suspected of artificially inflating its revenue or falsifying its financial condition.

2. Canaan Inc.’s previous major customers were involved in major business fraud and violations.

3. Canaan Inc. deleted information about seven major distributors because the information indicated that Canaan Inc.'s business situation was much worse than investors believed.

4. Compared with Bitmain and Shenma mining machines, Canaan Technology's products lack competitiveness.

summary

We view Canaan Inc. (NASDAQ: CAN) as the latest Chinese company to defraud U.S. investors.

After failing to list on Asian exchanges three times since 2016, Canaan took full advantage of these frothy markets and completed its Nasdaq IPO in November 2019. Shares surged more than 80% in a single trading day last week, luring thousands of unsuspecting retail investors to participate in the speculative hype.

However, our investigation into the bitcoin mining machine maker revealed a dangerous mix of undisclosed related-party transactions, irregularities involving many of its customers and distributors, and what we believe is a broken business model. Regardless of your outlook on bitcoin’s future, we believe Canaan’s business is more than it seems.

The sharp drop in the price of Bitcoin, from nearly $20,000 in 2017 to below $5,000 in 2018, has led to a sharp drop in revenue for Bitcoin mining machine manufacturers such as Canaan Technology.

Since 2016, Canaan has also tried to go public, but failed in three different capital markets:

• In 2016, Canaan Inc. wanted to go public through a backdoor listing on the A-share market through Luyitong, but the plan was aborted due to China’s “tightening regulatory environment.”

• In 2017, Canaan Technology applied for listing again and applied to be listed on the New Third Board, but failed to be successfully listed due to issues such as its nature.

• In 2018, Canaan Inc. submitted an application for listing on the Hong Kong Stock Exchange, but the application expired in 2019, with the CEO of the Hong Kong Stock Exchange stating that "cryptocurrency mining machine manufacturers do not meet the Hong Kong Stock Exchange's 'suitability' listing principles."

In this context, NASDAQ became the company's last choice. It is worth noting that Canaan Technology suddenly lost its lead underwriter Credit Suisse shortly before the listing, which is very unusual. As we all know, investment banks are usually reluctant to give up fees. Secondly, the size of the offering was also greatly reduced. Canaan Technology originally intended to raise $400 million in funds, but only received $90 million. Canaan Technology (NASDAQ: CAN)'s stock was priced at the lower end of the range.

Canaan’s auditor, PWC Zhong Tian LLP, doesn’t provide much additional comfort, as the firm was accused by the SEC in 2012 of violating U.S. securities laws by refusing to provide documents related to audits of Chinese companies that were under investigation for fraud.

Transactions with related parties and/or fictitious entities have long been a hallmark of suspected fraudulent Chinese companies listed in the U.S., which often use these transactions to artificially increase revenue or falsify their financial position.

We found such transactions in two Chinese companies we were exposed to, Golden Phoenix Jewelry (KGJI) and Pingtan Ocean (PME), whose share prices subsequently plunged by more than 80% and 70%, respectively, since the report was released.

We found that one month before Canaan Inc.’s (CAN) Nasdaq IPO, a small-cap Hong Kong stock called Xiong’an Technology (1647.HK) announced a so-called “strategic partnership” with Canaan Inc. and agreed to purchase up to $150 million worth of equipment in 2020, which is almost equivalent to Canaan Inc.’s entire revenue of approximately $177 million in the past 12 months.

We find this deal ridiculous on the surface, as Xiong'an Technology has a market cap of just $50 million and reportedly has only $16 million in cash on hand, far less than what is needed to purchase the equipment. Even the Hong Kong analysts mentioned in this Chinese media article have expressed doubts that the deal can be completed. Documents show that Xiong'an Technology is a clear related party, as its chairman Yao Yongjie is an "angel investor" in Canaan and owns 9.7% of Canaan's outstanding shares through entities he controls. However, there is no mention of this transaction in Canaan's SEC filings.

Shortly before the Xiong An Technology transaction was executed, in October 2019, Bitcoin Magazine published an article touting Canaan’s potential to achieve sales revenue of more than $1 billion in 2020. We are skeptical and do not think this is a coincidence.

The article states that Canaan’s sales director announced that the company had “received letters of intent for a total of 500,000 of its latest, powerful A10 and A11 mining machines, a number they expect to exceed 1 million by 2020.”

Therefore, we question whether the Xiong'an Technology Letter of Intent, which we consider to be essentially false, is used by Canaan Technology as a tool to promote its financial prospects to investors.

Related-party transactions also boosted Canaan Inc.’s sales ahead of its attempted listing in China.

Canaan Inc. once attempted a reverse merger (backdoor listing) on ​​the Shenzhen Stock Exchange. The documents submitted showed that an entity called Hangzhou Weitu Information Technology Co., Ltd. (hereinafter referred to as Weitu) suddenly became one of Canaan Inc.'s largest customers in 2016 and contributed to the rapid growth in Canaan Inc.'s reported sales.

Weitui is a clear related party because the documents show that it was initially controlled by Kong Jianping, co-chairman of Canaan, and later transferred to Sun Qifeng, one of Canaan’s “independent” board members, in 2017, who can “oversee Canaan’s sales and marketing activities in China.” Although Weitui’s related party nature is disclosed in Chinese documents, it is not mentioned in Canaan’s SEC filings.

Disturbingly, we question whether Weitui exists solely to do business with Canaan. According to a media article, Weitui even registered its address in the same building “just one wall away” from Canaan’s headquarters. Industrial and commercial documents show that Weitui has only four employees in total and increased its registered capital from RMB 1 million to RMB 50 million shortly before becoming a Canaan customer, but reduced its capital to RMB 1 million in 2017 after Canaan’s reverse merger failed.

Similarly, employees of a Canaan subsidiary established an entity called Shimian County Huajing Electronics Communication Industry Service Co., Ltd. in a remote county in China’s Sichuan Province in 2016. Huajing Electronics became a customer in 2016 but then abruptly dissolved in 2018, the filing states.

One of the top five companies with the highest accounts receivable in 2017, 2016 and 2015 is a company called Tianjin Garment Import & Export Co., Ltd. The company’s official website (shown below) states that its products are mainly “clothing, fabrics, blankets and stone sculptures.”

Another of Canaan's top five accounts receivable in 2017 is a company called Guangdong Xuntong Technology Co., Ltd. However, the company's official website states that it has sold video surveillance products to Chinese government companies.

In a 2016 report, the Beijing News pointed out Canaan’s transactions with Weitui and Tianjin Garment, and questioned why several of the company’s other major customers were listed as natural persons:

Canaan’s largest customer in 2016 was an individual named Chen Jian, who we believe is likely an investor in the now-defunct Chinese ICO scam site 3ico.com.

Canaan also has some “legitimate” customers. For example, the largest accounts receivable in 2017 came from an individual named Wu Gang, who is believed to be the founder of Bixin. However, Bixin noted that its Bitcoin mine has since been shut down.

Although we cannot find out the list of current top customers in the documents for listing in Hong Kong or the documents submitted to the SEC, we found that Canaan Technology was extremely irregular. Shortly after the company was listed on NASDAQ, it suddenly deleted 11 important distributors that were previously announced on its website.

One of the removed distributors, Nova Bit Mining Solutions, is apparently controlled by Andres Romero, one of Canaan’s sales representatives. Romero’s own LinkedIn profile lists him as “global sales” at Canaan and CEO of Nova Bit.

In a 2018 Youtube video, Romero identified himself as Canaan Inc.’s vice president of marketing and invited viewers to an event in Dubai.

At some point in the past few weeks, Canaan suddenly removed Romero from its website as the company's former "agent." Nova Bit's website then went on to state that it was Canaan's "official distributor," and we received no response to multiple calls to the phone number listed on Nova Bit's website.

We continued our investigation of the other seven removed distributors and found that most of them seemed to be very small, so small that they had gone out of business or were unable to purchase large quantities of products from Canaan Inc. (NASDAQ:CAN):

• Minerwarez: The website provides very little information. There is no phone number or address listed, and the information that can be found online is also very limited.

• Distribufied: The official website shows "Please enter your email address to receive our official notification" and is out of service. In addition, the website does not list any phone number or address.

• Bitmart: A cryptocurrency retailer in South Africa (pictured below) with a billboard that reads: “Invest in cryptocurrency mining and earn 6% to 15% monthly returns.”

• AMC: Both the official website and Twitter account have been deactivated. According to archived versions of the official website and Twitter, the company once promoted a digital currency related to flight miles.

• Mybtcmining: No operating entity, only an inactive website.

• Miners Gate: According to a website of the same name, it is currently selling a Bitcoin mining pool product with a daily return of 150%. It is unclear whether this is the same company as Canaan’s partner. If so, it has published a false UK registration information and claims that its license number is "123456".

• New Mining Company: This is a Russian company of unknown size that requires a contract of at least $50,000 to install mining equipment at its location.

We find this deleted information highly problematic as it suggests that Canaan’s business is in much worse shape than investors believe. We also note that the remaining distributors currently listed on Canaan’s website are also quite small:

• CryptoUniverse: As Canaan’s only official partner in Russia and Asia, its website invites investors to join a mining pool in exchange for a cartoon marketing video featuring models. It has a physical presence in Europe, but according to an industry operator we spoke to, the company is likely to be small.

• Blokforge: As Canaan Inc.’s only listed distributor in the United States, the company operates a store in Arizona, and we could only find 3 employees of the company on Linkedin.

• P2P: Based in Siberia, the company recently reappeared on Canaan’s website after being removed from its previous posts. The company advertises “fully equipped 40-foot shipping containers for mining” on its website.

After Canaan's reported sales grew from about $182 million in 2017 to $377 million in 2018, sales had plummeted to $132 million in the first nine months of 2019.

However, the existence of related-party transactions, irregularities with customers and distributors, and other findings raised in our report make us question whether its business is really as “good” as Canaan wants investors to believe. For example, we also found that Canaan was sued by a Chinese supplier in 2019 for allegedly not paying a check of approximately $1.7 million. The seller stated that Canaan was unable to pay due to “sales issues and market conditions.”

Canaan reportedly had $36.2 million in cash on its balance sheet at the end of 2018. Why couldn't Canaan pay such a small check at the time?

At a minimum, we believe that the Bitcoin price crash that began in late 2017 had a devastating effect on Canaan’s business. A government crackdown on Bitcoin miners operating illegally or without approval, which resulted in equipment seizures, may have exacerbated Canaan’s problems.

This combination may also partially explain why many of Canaan’s “official partners” appear to no longer exist. Canaan’s own SEC filings even note that “the decline in Bitcoin prices in 2018 also led us to offer credit sales, and the decline in Bitcoin prices also led our customers to purchase our products through credit and were less willing to pay directly” (emphasis on our customers).

In our opinion, Canaan’s business model is problematic, as using Canaan’s equipment for Bitcoin mining does not appear to be economically attractive at current prices. ASIC Miner Value, a website that estimates the profitability of various manufacturing equipment/models, estimates that as of this week, none of the Canaan models tracked by the site are currently profitable:

The site estimates that other companies produce 66 models that are more profitable than Canaan. In contrast, Bitmain has 16 models that are estimated to generate profits:

However, even if the price of Bitcoin surges, we think Canaan will continue to struggle. As mentioned above, many other machines are more profitable, and our research shows that Canaan's mining equipment is not particularly popular in the industry.

One industry operator we spoke to believes that Canaan “always seems to be playing catch-up” to competitors such as Bitmain and Shenma Miner, and that Canaan’s sales team is “completely inferior” to other companies. In January 2020, a customer filed a lawsuit, claiming that two of Canaan’s machines caught fire immediately after they were first powered on, and “in the next six months, the rest of the machines stopped working, and many machines were still in obsolete mode and not even powered on” (see the picture below). The customer said Canaan had been “going in circles”, so he sued them.

While Canaan promotes itself as a “leading supercomputing solutions provider,” the company disclosed that it spent just $26.5 million on research and development in 2018, far less than the $86.9 million that Bitmain reported for the first six months of that year.

It is therefore difficult to believe that Canaan will be able to close the gap with its competitors, which is problematic because Canaan's existing market share already appears to be smaller than the company would like investors to believe. Although Canaan's filings with the SEC claim that the company has a 23% market share, a closer look reveals that this calculation is based on total shipments in the industry (page 106). However, when viewed on a revenue basis, data included in Bitcoin's IPO prospectus (below) shows that Canaan's market share fell to just 6.2% as of 2017 (below is "Company E", which we believe is OK).

Furthermore, we were struck by the unusually low online search activity for Canaan and its Avalon miner, which is almost nonexistent relative to Bitmain and its Antminer. Likewise, Canaan’s Twitter account has only 3,900 followers, compared to Bitmain’s 97,000.

Despite these factors, Canaan’s stock surged more than 80% in a single trading session last week, on no news. The “catalyst” was likely an opinion piece published on an industry website suggesting the stock’s sell-off was overblown and that coronavirus disruptions would hurt Canaan no more than other manufacturers.

Regardless, thousands of retail investors appear to have been drawn into the stock, as can be seen from data from Robintrack, which lists the number of Robinhood users holding specific stocks over time, adding more than 3,000 investors last week amid the parabolic move:

Even if you believe Canaan's financial statements (at its current market cap of approximately $900 million), Canaan shares trade at over 5x earnings. In our view, this is a huge premium for a company that has seen a significant drop in revenue and operating losses of over $50 million in the first nine months of 2019 alone. But worse, our research has uncovered various irregularities and undisclosed transactions that lead us to believe that Canaan deceived investors about its business.

Therefore, we believe the stock is not worth investing in and are strongly bearish.

*DeepFLow reminds all investors to guard against the risk of chasing high prices. The views expressed in this article do not constitute any investment advice.