Micro-cap NetSol (NASDAQ:NTWK) is not a smart play
NEW YORK – NetSol (NASDAQ:NTWK) is a NADSAQ listed micro-cap stock with a market capitalization of just under $ 85 million as of today’s opening. The Lahore, Pakistan based company, specializes in automotive leasing software with their core product being software for use by companies primarily engaged in the lease financing. While the management has touted Pakistan as a stable business environment, most investors have a different opinion. In August, the U.S. Government ordered all ‘departure of non-emergency U.S. government personnel from the U.S. Consulate General in Lahore’ and on 16 September, the Government issued a warning against ‘all non-essential travel to Pakistan’ citing ‘the presence of several foreign and indigenous terrorist groups.’
Risk of terrorist attack might not be the company’s biggest concern. According to reports, NetSol has potentially been implicated in the use of questionable accounting standards when accounting for development costs. For example, Microsoft (NASDAQ:MSFT) will expense everything including ‘payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development’ – taken from page 33 of the Microsoft’s annual report. However, NetSol has been taking an aggressive approach to the accounting of the company’s R&D costs, instead of showing on the income statement as an expense the company opts to capitalize R&D expenses, which in turn inflates the company’s reported EPS. In doing so, NetSol has continuously reported earnings in excess of industry norms.
In addition, it appears that NetSol has accounts payable issues. According to the company’s own financial statements, receivables are broken into two lines ‘Accounts receivable, net’ and ‘Revenues in excess of billings.’
To make matters worse, sell-side analysts will normally take an earnings number and apply a P/E multiple to devise a price target. In NetSol’s case, this approach distorts the targeted share price. Interestingly, NetSol was previously a client of the sell-side firm RedChip, a firm which has represented several notable frauds in the past including Longwei Petroleum and Puda Coal. The company’s auditors, Kabini & Company, have received several power marks on their last two Public Company Accounting Oversight Board inspections.
Furthermore, the comments of Salim Ghaauri, the brother of NetSol’s CEO and head of the Pakistan office, allude to the fact the Kabini and NetSol might have less than an arm’s length relationship.
In conclusion, NetSol’s earnings statements are largely a work of fiction and red flags such as a close outside-of-work relationship with the auditors and outlandishly high receivables makes one question more broadly, the quality of any reported figures put out by the company. If you have a position in this company, you should rethink your investment strategy.