By Elizabeth Wine, Financial Times, April 12, 2004
Investors are having a touch of accounting deja vu, but the less-than-forthcoming financial statements are not coming from American companies this time but from Chinese ones.
Reports have been trickling out that some of the hottest Chinese initial public offerings misled investors with false or incomplete financial statements, leaving some experts murmuring about the bursting of another market bubble.
Tom Taulli, a U.S. securities lawyer and an expert in corporate finance, said investors were right to tread very lightly around the new crop of public Chinese companies.
“The Chinese government is involved in taking a lot of deals public together pretty quickly,” he said. “I don’t think I’d trust the numbers. I think there’s an Enron in the making in China.”
After being whipped into a frenzy by months of hype, investors were disappointed last month after several Chinese stocks stumbled.
“The appetite has turned to nausea,” said David Menlow, president of Millburn, N.J.-based IPO Financial Network, a research group specializing in young companies. “Clearly at this point investors have said, ‘We do not want to be involved in virtually any of these companies at the valuations afforded to them.’ ”
But the wariness is not only because of rich valuations — that was the case for many technology stocks for much of last year, with little ill effect. Investors took fright this month because the specter of accounting issues raised its head.
Netease.com Inc., an Internet technology company, announced last month that it was under regulatory investigation for allegedly overstating its 2000 revenue. The shares fell 12%.
China Life Insurance Co., which set off the IPO frenzy with a $3.5-billion offer in December, was hit by an investor lawsuit that alleged it had concealed financial mismanagement during the marketing of its offering. Its shares dropped 3%.
Then Semiconductor Manufacturing International Corp., the country’s largest chip maker, went public with a dual listing in December. Its shares plunged 8.7% on its debut in New York and 8% on its Hong Kong opening.
As with many Chinese companies, concern about what was left unsaid in the firm’s financial statements was already present. These worries increased when SMIC’s chief financial officer, in comments to investors, contradicted its filing with U.S. regulators. She said the company would need less capital to meet expenditure than stated.
In another sign of aggressive accounting, one investor noted that the company was taking five to 10 years to depreciate the value of its assets — a substantial increase from the industry average of four to five years. The difference, which pays little heed to the rapid pace of technological change in the chip industry, will serve to boost the company’s earnings.
An additional worry about SMIC has been that its legal base is the Cayman Islands — leaving investors unable to sue in case of misdeeds. Some investors have been especially irked by the timing that has helped young Chinese companies. Several said China Life’s IPO came at the tail end of market enthusiasm for riskier fare.
The stock went public after several months of strong IPO performance had primed investors to expect a healthy first-day gain as the norm.
Linktone Ltd. and Tom Online Inc., two companies catering to users of cellphones and the Internet, have posted lackluster performance since their recent IPOs. Linktone has slipped 46% since its IPO in early March, while Tom Online has shed 14% since its debut last month.
“The only one that came and worked was China Life,” said Ben Holmes, a money manager at Protege Funds who specializes in IPOs and secondary offerings. “That set the tone and set people up to buy China. China is this cash inferno now. They’re raising money in our markets and leaving scorched people behind. I’m going to stick to the U.S. market, where I can get the nuts and bolts.”
Among the nuts and bolts investors expect are more transparent accounting and more legal protection for minority shareholders.
A few critics warned even before the much-anticipated China Life IPO that investors should tread carefully, citing the skimpy financial statements as one of the reasons.
There is also concern that companies in which the Chinese government still holds a stake, such as China Life, could get a boost from their big shareholder. The critics warned that it would be difficult to know how much the government was helping, and what the consequences would be when it stopped.
Menlow noted the disconnect between investors’ high expectations for the future of Chinese business, with its 1.8 billion consumers, and the performance of the stocks.
“This is a difficult concept for us to accept because of how the Chinese stocks were being supported by all the hype,” he said. “People thought this was going to be the second coming of a strong foreign market. But these deals have had pitiful performance. These have been successful for the issuer only.”