Handle with care

Profit warnings, auditor disputes and delistings involving Chinese companies trading on foreign exchanges are fuelling investor distrust, wiping out valuations and poisoning the market for new listings.

Profit warnings, auditor disputes and delistings involving Chinese companies trading on foreign exchanges are fuelling investor distrust, wiping out valuations and poisoning the market for new listings.

The 180 Chinese firms that went public in New York, Hong Kong and on other global exchanges since the start of 2010 are trading on average 21 per cent below their offer prices.

The MSCI World Index has gained 10 per cent in the same period, while the 407 initial public offerings in the US since the beginning of that year have risen on average 4.4 per cent.

At least six disputes have broken out this year between auditors and Chinese companies listed in Hong Kong. More than a quarter of Chinese firms that went public on the city's main board in 2010, a record year for volume, have lowered forecasts since they started trading, compared with less than 10 per cent of non-Chinese companies that had IPOs there that year.

"Investors have been concerned: are these companies accurately portraying themselves?" said Kevin Pollack, a fund manager at Paragon Capital in New York who invests in US-listed Chinese stocks. "There has absolutely been collateral damage. Unfortunately, having big-name auditors and bankers behind a company doesn't guarantee it's free of issues."

Investor enthusiasm that allowed a record number of Chinese companies to go public abroad in 2010 has evaporated as the accuracy of financial reporting and the quality of due diligence by IPO underwriters has been called into question. That contributed to making the first quarter for global first-time offerings the weakest since the depths of the financial crisis.

Confidence in overseas-listed Chinese stocks had already been undermined by scandals involving companies that went public in the US through so-called reverse mergers. Now investors are shunning firms based in the world's fastest-growing major economy: of the 57 IPOs in the US this year, only one came from China, compared with seven in the first quarter of 2011.

Four Hong Kong-listed Chinese firms, including Boshiwa International, the Shanghai-based Harry Potter apparel licensee, said their auditors resigned this year because of disputes over financial data. That is four times the number in the same period last year and in the first quarter of 2010.

Boshiwa, whose shares have falled 66 per cent from their September 2010 listing price, was suspended from trading after the accounting firm Deloitte Touche Tohmatsu resigned.

The disclosures caused Hong Kong's Financial Reporting Council to announce that it had identified 13 Chinese companies in need of closer monitoring.

Chinese companies listing on global exchanges in 2010 set a record: 110 IPOs, up from 67 in 2009 . That prompted Hong Kong regulators to warn at least eight times since early 2011 about inadequate due diligence on the part of investment bankers who underwrote the listings.

Overseas IPOs by Chinese firms in 2010 accounted for 16 per cent of the $US199 billion ($192 billion) in global IPO proceeds, excluding mainland China deals. In the first quarter of this year, foreign Chinese offerings fell to 5.7 per cent of the $US11 billion raised worldwide.

Equity markets in China are closed to foreign investors, except as part of investment quotas granted to qualified institutional investors. Chinese domestic stocks also have fared poorly since the beginning of 2010, with the benchmark CSI 300 Index down 27 per cent.

With China's economic growth target revised down by the government to 7.5 per cent this year, the lowest in eight years, investors may be less willing to tolerate risk.

"Chinese companies in the private sector are bearing the brunt of the country's economic slowdown, leaving investors nervous about their growth prospects," said Ronald Wan at China Merchants Securities.

More than a quarter of the 56 Chinese firms that raised a combined $US32 billion in Hong Kong in 2010, including cellulose producer Sateri Holdings and manganese miner Citic Dameng, have lowered forecasts, saying they expected "significant" or "substantial" declines in revenue.

Sateri shares have fallen 66 per cent since its December 2010 debut, and Citic Dameng has dropped 61 per cent since listing in November that year. Both companies, with headquarters in Hong Kong, get more than 70 per cent of their revenue from China.

The 56 companies have declined an average of 27 per cent from their IPO prices, while the benchmark Hang Seng Index is down 3 per cent from its 2010 average.

"There's a lack of confidence in some of the issuers," the chief executive of the Bank of Singapore, Renato de Guzman, said. "That fear creates a lot of undervalued shares."

Chinese stocks listed in New York have fared worse. The 40 companies that completed IPOs there in 2010 are down on average 39 per cent from their offer prices compared with a 22 per cent gain for the S&P 500 Index from its 2010 average.

In Singapore, the third-biggest market for such listings after Hong Kong and New York, eight Chinese companies that went public in 2010 have declined an average of 47 per cent from their offer prices.

The number of Chinese firms completing IPOs in the US last year fell to 15 from 41 in 2010.

Of the 10 Chinese firms listing outside China this year, the lowest number since the first quarter of 2009, eight were in Hong Kong, one was in New York and one in Malaysia.

China Auto Rental, the nation's largest car-rental company, is scheduled to list in the US next week, seeking to raise as much as $US137.5 million on the Nasdaq exchange.

Chinese enterprises that completed foreign IPOs in the early 2000s have done better. The 91 companies that sold shares overseas from 2001 to 2004 and are still trading have gained on average 289 per cent from their offer prices. That compares with the MSCI World Index's 32 per cent gain from its average in those four years.

The 61 Chinese firms that listed overseas in 2011 are down 6 per cent on average from their offer prices. The MSCI World Index is up 2 per cent from its 2011 average.

The disclosures of financial irregularities or auditor resignations last year by Chinese businesses that went public in the US through reverse mergers resulted in "significant negative sentiment" towards companies based in China, Paragon Capital said.

The US Securities and Exchange Commission cautioned investors in June about buying stakes in such firms, saying they may be prone to "fraud and other abuses".

Sino-Forest Corp lost $C3.3 billion ($3.2 billion) of its market value after Carson Block, founder of the research firm Muddy Waters, accused the company of overstating its timber holdings last June. The Toronto Stock Exchange will delist Sino-Forest next month.

Also recently delisted was Longtop Financial Technologies, a Hong Kong-based maker of financial software whose lead underwriters for its 2007 IPO were Goldman Sachs and Deutsche Bank.

The Hong Kong Monetary Authority, which regulated five financial institutions that sponsor initial share sales before supervision was transferred to the SFC, also has urged bankers to increase due-diligence standards and improve internal supervision of the IPO process.

The city's central bank conducted onsite examinations between the fourth quarter of 2010 and the second quarter of 2011 and found cases where guidance on how to deal with "suspicious scenarios" was deficient and where investment bankers did not review their employees' due diligence.

Singapore's stock exchange went to court to enforce its listing rules for the first time after a Chinese company ignored a deadline to appoint a special auditor. The exchange sued China Sky Chemical Fibre and four of its Chinese directors to compel the company to have a special auditor investigate "interested party transactions", a failed land acquisition and certain costs.

In Hong Kong, Deloitte resigned as Boshiwa's auditor after the company failed to provide information it requested.

Deloitte also resigned as auditor for Daqing Dairy Holdings. The Chinese milk producer, which raised $US200 million from an October 2010 Hong Kong IPO, said it had a disagreement with the auditor about the accuracy of its financial statements. Daqing Dairy has fallen 62 per cent from its offer price.

In February, Crowe Horwath resigned as auditor for Mayer Holdings after the Hong Kong-based producer of steel pipes failed to provide information related to a court case. China Forestry Holdings, based in Chaoyang, and suspended from trading since last year because of accounting irregularities, said its auditor, KPMG, had resigned citing valuation concerns.

Doing due diligence is beyond the capabilities of many investors who remain positive about China's future growth, said Paragon Capital's Pollack. "We're still very bullish on the China story as a whole, but I think all investors are exercising a lot of caution," he said. "There are certain red flags an investor needs to look for, and there are certain positive indicators too."

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