Friday, October 3, 2014

Assessing the state of Nu Skin's China business - Part 2

In the last post we noted that the swings in Nu Skin's stock were dependent on the state of their business in China. Nu Skin is currently burning considerable amounts of cash and will likely need to renegotiate their debt covenants.

There is a huge range of potential outcomes for the stock. If the cash burn does not stop it might be difficult to renegotiate covenants and Nu Skin could potentially go to zero.

By contrast if the Chinese business were to resume at a rate faster than last year the stock could easily go above its previous high (of roughly $140 per share).

As the stock is currently in the low 40s this range of outcomes makes Nu Skin a worthwhile target for investigation. If you get the stock right you can make a lot of money. Symmetrically if you get it wrong you might lose a lot of money. And China is the issue.

One useful disclosure

Quoted in the last post the CFO of Nu Skin noted that they are currently quite restrictive in what they can do in China. For recruiting he states "we're still only allowing meetings inside our offices, generally speaking."

This is a very important disclosure because we can get a view on how good or bad the business is by visiting the offices and stores. We did just that. In some instances sites were locked and our correspondents in China talked to the guards but were not allowed inside. In other situations our correspondents walked around with permission snapping photos and videos on the trusty iPhone.

Retail stores are more easily open to the public.

Below we present what we have found so you, dear readers, can scale the business. Again alas there may be a large number of old sales leaders who are selling product and not visiting the offices. We have not seen these people but we cannot judge the likelihood (or otherwise) of their existence.

We may have also visited the offices on a bad day (though some places we visited more than once). The date and time of our visit may distort our observations.

Whilst we have an idea how many people are at the offices (very few relative to the scale of the facilities) we cannot tell how much these people are selling.

Below we present what we found with our on-the-ground checks. You can make your own estimates as to the sales this infrastructure supports.

No. 3000 West Huancheng Road

No. 3000 West Huancheng Road is the headquarters of Nu Skin in China, with the company logo prominent and dozens of people (some wearing Nu Skin apparel) onsite and within the building. There was also what appeared to be sales meeting with more than 100 people on the second floor.

However, large tracts of the building inside were devoid of people, particularly the third floor (apparently the Pharmanex area). Our visit took place on the afternoon of a weekday.

More detailed notes from our observer are as follows:

Nu Skin headquarters consists of three buildings connected together in a large “U” formation. Our observer toured the inside of these buildings and made the following comments:
  • On the First Floor Nu Skin logos, posters, promotional material and similar are widely in evidence. This floor appears to be mainly used as a canteen and staff leisure center. Dozens of people (many wearing Nu Skin signage) were eating at tables, playing table tennis, snooker or using nearby exercise bikes.
  • The Second Floor is comprised of several operational areas and meeting rooms. Our observer saw more than one hundred people on this floor, including what appeared to be both visitors and staff from Nu Skin.
  • The Third Floor was not widely populated at all and looks to be dedicated to R&D / similar. No signage was seen mentioning either Shanghai Pharmenex Research & Development Center or its Chinese equivalent (上海华茂研发中心).
This is clearly not devoid of people with more than 100 people probably attending a sales-training program upstairs. However this is a small number compared to the size of the building. According to the Wedbush Presentation the building cost about $65 million to complete last December. That is a lot of building for that number of people.

The campus is huge. Here are two videos taken about 1pm on a weekday afternoon. The first video is almost entirely devoid of people. Photos taken by friends who visited on a separate day are also almost entirely devoid of people.

The second video has people appear at about three minutes and there are about 100 people in total mostly seen at the end of the second video.

You cannot alas tell what sales are from these videos but you can tell one thing for sure. The campus was built at a scale much bigger than the scale of the business on these days.

In other words from these videos you can't tell whether the campus was built in anticipation of a business with three billion in sales functioning at say $600 million or whether it was built in anticipation of a business with one billion in sales functioning at (say) $200 million or even $50 million.

Whatever the site does not appear to be buzzing and was not buzzing on other days on which my friends visited. Indeed some people might find the empty space depressing.

And the second video:

Given that Nu Skin said in the Wedbush conference call quoted above that "still only allowing meetings inside our offices" this does not indicate a lot happening when the observer visited or on the other day at which my friend visited.

Part of what all successful multi-level-marketing companies do is create the "rah-rah" atmosphere that something important is happening and you want to be part of it. They create that with a feeling extravaganza (which other people interpret as cultish). We have - in two visits - seen no sign of the "rah-rah".

We have a lot of photographs of this facility taken on more than one day and mostly devoid of people. The most people we saw appear in the second video starting at about 3:40. If you wish to take the bullish side of the debate you should start there.

No. 29 Workshop, Longyang Industrial Park, Fengxian District, Shanghai

According to the form 10-K, Nu Skin does most of its Chinese manufacturing in China. Our on-the-ground gossip seems to indicate that they import their proprietary formulas in bulk and bottle/package them in China. This makes sense if the proprietary formulas actually contain anything proprietary as their are risks of intellectual property being misappropriated.

The facility at Longyang Industrial Park was not very active. As our observer visited midweek from 9.30 am to 10.30 am. Their notes:

The signage of Nu Skin (China) Daily-Use & Health Products Co Ltd was located at the entrance to an area which was comprised of two buildings. During our time onsite we saw a handful of staff – apparently wearing Nu Skin branded clothing, although it was hard to definitively ascertain this – enter one of the buildings. The other building appeared empty and we saw no one come in or out. Unfortunately, given that there was virtually no one else on site, it was not possible to make inquiries with regard to the current status of operations, and for how long it may have not been fully operational. It appears unlikely however that much activity takes place here.

Again we have no idea as to whether this facility was designed to start up in scale in anticipation of say $3 billion sales or this facility was highly active say eight months ago and was closed as a result of falling sales.

Here is a picture of the entrance to the industrial park.

And here is the entrance to the Nu Skin part of the industrial park:

And here is the other Nu Skin building:

We have a video here as well:


No. 12 Fengpu Avenue, Fengpu Town, Fengxian District, Shanghai

This is another Nu Skin facility that is seemingly devoid of people.

Here is some signage outside:

And here is the main entrance which was open:

Various photos of this building clearly show Nu Skin labelled but the photos in Baidu Maps (taken in October last year according to Baidu) do not have the Nu Skin logos on the building. So we figure it is a recent addition to the Nu Skin portfolio.

Our observer came to a similar conclusion:

Our observer confirmed that No. 12 Fengpu Avenue, Shanghai is indeed a Nu Skin facility. The signature board at the site entrance reads only “NU SKIN”, and note that no Chinese version of the name was included.  
Interestingly, the outside wall of the main building inside the facility has the sign “Dexin Building” (德昕大厦). This was explained via inquires with the entrance security guard, who told us that the old owners were Dexin Daily Chemical Co Ltd (德昕日化有限公司). Nu Skin apparently purchased this site “last year.” The security guard at the gate claimed that the Facility was operational, although during our visit [we] did not see any obvious evidence of activity from outside. Note we were not allowed into the site and no one walked in or out that we could interview.
Another friend of mine visited this facility on another date and was apparently told by the guard that the facility had never been opened. The guard had only had their position for a couple of months - so that information may have been faulty.

One manufacturing facility with activity: 819 Xinzhu Road, Economic Development Zone, Huzhou City

In fairness to Nu Skin we did find one facility with considerable signs of activity. It was a smaller facility (address above). Alas they were not permitted by security to enter the facility so all photos are taken from outside.

To quote:

[Our observer] confirmed that there is a Nu Skin facility at this address. Signage of both “Huzhou Branch of Nu Skin (China) Daily-Use & Health Products Co Ltd” (如新(中国)日用保健品有限公司湖州分公司)” and “Pharmanex (Huzhou) Health Products Co Ltd” (华茂(湖州)保健品有限公司) were visible at the entrance.
Although our observer did not see much human traffic during the working hours we were present on site, we noted that there are numerous private cars, motorcycles, and electric bicycles parked inside the facility. We were prevented from entering with facility by the security guard at the main gate. 

Here are the photos:

Main entrance gate:

Main entrance sign:

And peering through the gate - note the cars which were the main evidence of activity:

Photos of stores

Friends of mine have visited many Nu Skin stores. These photos of the main Beijing premises on a Saturday afternoon are typical. There were no customers, only staff:


Other stores were similarly devoid of customers. Visits were made to several stores at different times of day.

I did a comparison by visiting the only mock-up store in Sydney - which is at their Australian headquarters. It was in an industrial park with only modest access to public transport. The internal presentation was similar (though the Australian store was smaller). On a weekday morning a handful of distributors came through the Australian store.

Scale of Nu Skin's China business - time for a guess

Given what we have been told about the size of the business, it seems to have facilities that are
rather large relative to its current operations. It seems fair to say that the facilities weren’t bursting
with activity on the days our observers visited.

There are three obvious hypotheses: either (a) the business was built in anticipation of a much larger scale than it had at the end of 2013 when most of these buildings were commissioned or (b) the business which once required facilities of this size has collapsed or (c) the substantive activity happens outside the limited (though sometimes multiple) times we visited.

Alas I can't tell which - but it would be very nice if Nu Skin were to give us more accurate data about the month-by-month sales and month by month numbers of sales leaders.

But other explanations are possible. The factories could be very idle because as Nu Skin has admitted they built up an enormous pile of excess inventory in China and it would make sense to idle factories whilst that excess inventory is worked off.

I have another hypothesis - and it is a hypothesis born of the cynicism of someone who has spent a lot of time looking at Chinese companies. In this hypothesis there never was a billion dollars in sales in China - and the Chinese management just lied to the US management to get a $30 million cash incentive they were promised if they could get sales to a billion dollars. In any country other than China I would dismiss this as impossible a fraud that audacious. But in China I am not sure. Financial controls in China are seldom up to Western standards. In this scenario, the cash burn this year is also not real - the negative cash flow in China just squares the cash balances to reality. [In this hypothesis management in the US are victims of any misstatement in China.]

Whatever: all these hypotheses are just guesses. Even after having spent some money visiting multiple Nu Skin facilities I really do not know.

I for one am looking forward to Nu Skin management giving a clearer explanation of the state of their Chinese business.



MohanV said...

Thanks for the investigative piece! These pictures are golden.

Martin said...

this is not cynicism from my point of view, but based on facts.

Nic said...

Some people find beauty in art, landscape, women - but to me, this is a an intellectual beauty.

Dmitry Kozlov said...


for starters let me point out that your intellectual prop... erm, capabilities seem to be appropriately allocated to not just making money off stocks but writing this good stuff for us all to enjoy, too!

Then I would like to do a small bit of devil's advocate too, despite the fact that I tend to agree with you. (Something that looks like a duck, swims like a duck and quacks like a duck is definitely more likely to turn out to be a duck then Mother Therese). However, you wouldn't want to miss anything, would you?
Specifically, your investigation hinges on a line spoken by US management - the one about "only allowing meetings in the office". However it is concluded with the suggestion that information flow between US and China brunches is... less then ideal. This is internally inconsistent.
if it is possible for US management to be deceived regarding the fundamentals of China business, it is definitely equally possible for him to be deceived regarding the form of operations, nature of regulatory action and, more specifically, compliance. (Same holds true if he's deceiving us outsiders).

Therefore we also have to consider a hypothesis that Nu Skin's Chinese activity proceeds outside the premise and the statement which was at the roots of your investigation is false.

Give Mother Therese a fair fighting chance, man!


Dmitry Kozlov said...

P.S. Kind of an addition: as an alternative to the misinformation, other possible reason for the "root" statement to be out of touch with reality is it not being a "disclosure" i.e. an attempt to convey factual information, but an ad-lib, i.e. a random line brought in to sweeten/cover/provide credibility to other things being said. Specifically, a made-up excuse for the slow business which shouldn't sound apocalyptic.

Will said...

Just curious after Dmitry's comments, would their buildings be leased space or wholly owned by NuSkin or NuSkin's in country mgmt? Keep us posted on what institutions fund this scheme!

Unknown said...

John, it is my understanding that a well known HF (DL) mgr took a short position in NUS around the time Ackman posted his initial hit piece on HLF. Their thesis at that time was that the NUS business in China was a fraud. They pulled sales tax/income tax data on the ground in China to see if they could substantiate the sales. Supposedly they corroborated the sales data with the Chinese tax data and moved on from NUS but with a nice profit thanks to the HLF negativity.

I assume the business is a cash business so it should be pretty simple for the NUS CFO to produce a report on what his cash sales tax paid to the government is to prove that sales are valid.

Can you feet on the ground dig up sales tax data to put a nail in the coffin and prove or disprove their claimed sales numbers?

BTW, always appreciate your writing. Your blog is a great place to learn how to think about and investigate a thesis.

Anonymous said...

Could the cash burn be sales tax payments for sales that didn't happen? Usually overpaying your taxes isn't a crime. Could it be a cheap way to build evidence of a billion dollar business flow to protect the business brand/reputation and appearance of accounting integrity? Could it be a protection of their stock value and filings with the SEC? Just other potential explanations as speculation. No proof of this.

Anonymous said...

Interesting piece, but one observation... It is currently Golden Week in China - the major holiday week of the year. When were these photos and videos taken?

Eric said...

Seems odd that an amendment of covenants or extension of duration would result in L+95 pricing on a "risky" security.

John Hempton said...

I did not do the visits in Golden Week and some visits took place in different weeks.

Andrew said...

Hi John,
Noticed your penchant for 'same store sales' estimating like your piece.

The next time you're metering property foot traffic, check out for your agents/friends to deploy.
Now you can track 24/7/365 vs only in person <8hr/day,
record at the entrance/exit/neighbor level and all at a consumer level pricing. Could be compelling. See more at;

I'd be surprised if there weren't serious limitations within China however, but the metering reporting by;
(a) time of day,
(b) neighbors comparisons,
(c) volume, time, trend, average, max/min, etc...
is all very compelling for your purposes.

Your old smartphone now = property pedestrian tracker aka same store sales estimator, worldwide, in real-time.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.