Wednesday, March 23, 2011

The role of an auditor or why is China Hong Xing suspended

And you should beware the S-Chip

I won't lie to you and say that I do not enjoy bashing S-Chips. The reason that I do not like S-Chips is that they generally belong to crappy industries, have poor and declining ROEs as a result of huge cash piles, as well as a lot of supporters in the forums and the media (particularly small PR companies). I say generally because there are a few S-Chips that have managed to stay out of trouble. COSCO and Yangzijiang are two of them.

Given my dislike for this type of counters, I was taken aback to see that the CFO of China Hongxing, has come out to talk to the media even though the company is still pending suspension and a special audit. In an article written in TheEdge, Kelvin Yeung, CFO of China Hongxing, hinted that the problem might lie in the amount of information requested by the newly-appointed auditors, Ernst & Young, versus what the company was willing to disclose.

There are a few questions arising from his statement. One, why did not the previous auditors ask for the same questions? Two, there must be a way to work out with the auditor that the said material information would not be disclosed? Three, why is the CFO talking to the media rather than doing his job taking charge of financial matters?

The CFO is right to say that the newly-appointed auditors may have been overzealous in doing their jobs, but they are doing their jobs are not they not? Secondly, based on my limited understanding, assuming that the material requested is literally material and may cause the company to lose their competitive advantage, there must be a way that the company or the auditor can work it that it tells the truth without giving away everything. Some manufacturing companies do not present information like margins for certain business segments, but still get an all clear for their books.

Finally, why does the CFO find it necessary to talk to the press before matters are cleared up? If you re-read what was written, the article seems to imply that it is much ado about nothing. Someone can refresh my memory, not so long ago when another S-Chip had this cash issue and the independent director wanted to do a special audit, an executive director actually called David Gerald, the head of SIAS, to tell him that the money is there (which company is it?). While the reproduced article was a thinly veiled attempt to allay investors' aversion of buying S-Chips,  it actually raises more questions than it answers.

The biggest lie is the lie you tell yourself. Buyer beware.


  1. I used to own a S-share until I reviewed it's accounts and got suspicious with it's huge cash pile.

    Nothing wrong with that, except that it did a placement, and gave out dividend amounting to that placement a month later. and it earned 0.01% interest on it's cash balance in 2010.

    I immediately sold my holdings.

    Better to be safe than sorry eh?

  2. Reading about the amount of tomfoolery going on in S-Chips over the past 3-4 years, it strikes me that it's much better to be safe than sorry.

    You are right to say that many of these companies have (extremely) mediocre businesses with high debts and poor ROE, but are paying PR companies good money to promote themselves and drum up interest in their shares. For these CEOs and CFOs, share price is of utmost importance and the business can take a back seat.

    Why is this so? Just read the recent "Confessions of an S-Chip CEO" to understand the issue better.

    For China Gaoxian's case, I suspect it could be some irregularity which has caused the halt and it has been halted for nearly 3 days without news (as at this writing). Naturally everyone is starting to panic. If I was a punter/speculator, I would too!

  3. I'm giving up positing on the Next Insight forum. The people there are just too bullish. A little skepticism is healthy for your finances.

    In my opinion, the problems plaguing Hongxing, Hongwei and GaoXian are reflective of most S-Chips. How can you value invest if the figures in the books cannot be verified even by auditors, albeit over zealous ones.

    I do own S-Chips - China Animal Healthcare and C&O - so I believe that there are good S-Chips, just not those in the lousy textile or shoe making business.