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CRACKS IN YOUR CHINA

27 September 2014

Flashback… in 2009, we shared with our readers on the possibility of “PRC listings coming to your market”.

Five years ago, we expressed concerns, “particularly about potentially watered down disclosure requirements under PRC (People’s Republic of China) accounting standards which would make it even more difficult for investors to assess risks. We also questioned whether the effectiveness of internal controls, which ensure proper financial reporting, can be ensured under the proposals. And, finally, given the growing number of PRC issuers potentially listed on the Hong Kong Stock Exchange and in the region, we are of the view that the proposals may lead to a decline in financial reporting standards and increase the risks that investors face”.

In 2011, we shared yet another quite extraordinary story “when the former chairman, who is the company’s single largest shareholder but who is also serving a jail sentence, wrote to the company’s board, asking it to hold a provisional shareholders’ meeting. This former chairman said he wanted the company’s shareholders to consider a few proposals, including a motion to remove from the board his foe, the current chairman and executive director.

The big question, of course, is how can someone serving a jail sentence exercise his shareholder’s rights from inside a prison cell? Not only should all his assets be frozen but one would assume that there would be limited visitation and communication rights to even be able to plan such a boardroom manoeuver”.

In April 2012, we reviewed a China listing in Singapore as a “war emerged between the regulator and the S-chip. The issue began at the end of last year when the regulators directed the company to appoint a special auditor. The regulator was dissatisfied with the responses to its queries about various interested-party transactions, and an aborted land deal. The regulator also wanted the special auditor to look into the transactions between the company and its audit committee chairman, whose own company provided some services. As the company failed to address the directive of appointing a special auditor, the regulator then publicly reprimanded the company and its board members for flagrantly disregarding its directive”.

The world’s rapturous reception to the recent initial public offering in New York might give you the impression that China companies listed elsewhere are really welcomed additions to the market.

But in the past five years, the regulators of both Singapore and Malaysia have received wake-up calls on such companies.

We took a hard look at the results of some of the 10 Bursa Malaysia-listed China companies.

At the end of 2013, a China-based company faced an enforced suspension for failing to announce its audited accounts by mid-2013. In April 2013, before that deadline, the company suddenly announced that a fire had engulfed its factory, destroying all its accounting books and financial records. As a result of this, its auditors were unable to:

  • Carry out a proper audit;
  • Undertake walk-in bank confirmations;
  • Have sight of fixed assets; and
  • Carry out all other relevant field work.

We have also seen regulators in both Singapore and Malaysia issuing notice after notice to such companies after the latter keep delaying releases of their audited financial statements. These delays should always be a red flag for investors.

In some cases, auditors too have raised the red flag on such companies, by issuing a qualified opinion for failure to verify the standing of a company. For example, some Malaysian auditors classified a China-based company listed in 2010 as being financially distressed in 2012. This company had been denoted a PN17 company by Bursa Malaysia; with PN17 referring to its Practice Note 17/2005, which deals with a company when it is financially distressed and requires additional oversight from the regulators.

In fact, the auditors of this errant company refused to seek re-election after issuing their qualified opinion on the company’s 2012 accounts. The auditors stated that they had to issue that opinion because they were unable to verify independently how much the company had left in its bank accounts.

In another case, a China-based company listed in Malaysia announced a huge loss, with a massive operating cash outflow. Its auditors similarly issued a qualified opinion on their client’s financial health, expressing doubts over whether or not the company could “recover its receivables that were past due but for which it had not provided for”.

A third case involving another such company saw analysts shocked when the company released its results for one quarter. In what should have been a period of strongest earnings, the company stated that it had incurred losses that were three times greater than analysts had projected.

Our back-of-the-envelope stock price review of such companies listed in Malaysia shows that only one such company is currently trading above its IPO price. The company is just a year-and-a-half old, and was listed on Bursa Malaysia in December 2013.

Nine of the other companies listed here have seen their share prices dropped between 50% and 95% since their listings. For the unfortunate investors, this not only means a loss of potential profits but also a substantial loss of capital deployed.

With such poor stock price performances, we have to ask ourselves if we really are attracting the right companies to be listed in both jurisdictions.




© CORSTON-SMITH ASSET MANAGEMENT SDN BHD 2014