Silverlake Axis *Official* (SGX: 5CP)
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Shion
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EvilPaladin
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wa shortists covering or what?
trepies
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recovering a bit is good.. sold off my remaining 1000 shares at 1.08.
exit totally liao. a bit worry about this, better to cut my lost of about 500 now.
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In case anyone think I'm liking both sellers and buyers, let me explain.
I think one should only hold counters which one is comfortable with, if it affects you everyday, best to sell it. For those who are confident in their counter, buying more on dips makes perfect sense.
Hope everyone get what they want.
I think one should only hold counters which one is comfortable with, if it affects you everyday, best to sell it. For those who are confident in their counter, buying more on dips makes perfect sense.
Hope everyone get what they want.
trepies
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agree with you on this. the thing is you must able to sleep well at night without thinking of what will happen. for me, i been thinking about this the whole weekend so best to cut loss
EvilPaladin
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master shortist!
Keverus
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yes i shorted it.
dont come and call me a horse behind cannon cos I have been making this short call the whole long wkend.
there will be people who are full of hot air and empty talk, saying certain people spam and bring no value.
hey guess what Mr President-wannabe, those who took my advice made quite a pile today I reckon. so get off your bloody high horse.
dont come and call me a horse behind cannon cos I have been making this short call the whole long wkend.
there will be people who are full of hot air and empty talk, saying certain people spam and bring no value.
hey guess what Mr President-wannabe, those who took my advice made quite a pile today I reckon. so get off your bloody high horse.
Keverus
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sry, was busy at work. i rly not okt, tell u all so many times le.
today silverlake axis gained back abit. but if you notice, it opened with a gap up ($1.06) and then up further to $1.08.
subsequently, it hit lows of $1.02. this is the true value of today's closing. just before closing, we saw the stock gap up and closed at $1.05.
the gap ups across the day are done by shortists who have to cover their shorts. they have profited (albeit some lesser than others since they force cover their shorts).
what happens next for Silverlake? today is bound to not have further downside. this is mainly due to covering of shorts.
however, expect it to continue to slide downwards tomorrow. it will test $1.
for those who want to short, this is your last chance.
today silverlake axis gained back abit. but if you notice, it opened with a gap up ($1.06) and then up further to $1.08.
subsequently, it hit lows of $1.02. this is the true value of today's closing. just before closing, we saw the stock gap up and closed at $1.05.
the gap ups across the day are done by shortists who have to cover their shorts. they have profited (albeit some lesser than others since they force cover their shorts).
what happens next for Silverlake? today is bound to not have further downside. this is mainly due to covering of shorts.
however, expect it to continue to slide downwards tomorrow. it will test $1.
for those who want to short, this is your last chance.
http://webcache.googleusercontent.c...ase-guide-to-detect-accounting-fraud-in-asia/
link to google cache of silver lake article that was removed (a internet history copy), read it before its gone if u are a serious SL shareholder
link to google cache of silver lake article that was removed (a internet history copy), read it before its gone if u are a serious SL shareholder
original link which is now down after being sued
http://asianextractor.com/2015/04/2...ase-guide-to-detect-accounting-fraud-in-asia/
http://asianextractor.com/2015/04/2...ase-guide-to-detect-accounting-fraud-in-asia/
taken from
http://webcache.googleusercontent.c...ase-guide-to-detect-accounting-fraud-in-asia/
do note that I AM NOT THE WRITER
These cases are unique, original and bold, in the spirit of the Bamboo Innovator, pushing beyond the usual western-based techniques and tools in financial statement analysis that experience limitations to detect the underlying economic heartbeat. For instance, is highflying stock darling and high-margin-high-ROE banking software firm Silverlake Axis (SILV SP) the next Satyam?
Consider this: Is it possible for a company to generate >100% ROE, even if it were an asset-light software company? The case on Silverlake Axis examines the numerous opaque and complex related-party transactions and related-party acquisitions of companies with high profits-high ROE but weak balance sheets that belong privately to the software billionaire controlling owner Goh Peng Ooi at inflated valuation; possible abuse of the pooling-of-interest method involving acquisition of entities under common of Goh to report higher earnings in 2006 and 2010, enabling Silverlake Axis to bounce back from relatively weaker financial performance in 2005 and 2009 respectively; the aggressive and improper revenue recognition policies; the investment in associates in complex transactions to potentially shift expenses to these entities to inflate profits at Silverlake Axis, and so on. To highlight a few of these red flag transactions:
The assets of these acquired Bermuda-incorporated companies using pooling-of-interest method – Silverlake Adaptive Applications & Continuous Improvement (SAACIS) in 2006, and Silverlake Solution (SSB) and QR Technology (QRT) in 2010 – comprise of amount due from related parties, including customer maintenance contracts. The revenue of these related private entities are generated from contracts given by the listed Silverlake Axis at potentially artificially inflated prices to carry out systems integration and maintenance work for their banking customers. Fraudulent opportunity is presented in shifting costs from the listed Silverlake Axis to these private entities to artificially inflate the profit and market value of the listed Silverlake Axis. Subsequently, funds are raised to acquire these private entities at inflated valuation by shifting back the costs to the listed Silverlake Axis in the form of “other payables”, “other current liabilities” and to other associates (e.g. Global InfoTech GIT, ePetrol Silverswitch Sdn Bhd) that are not consolidated. Interestingly, prior to the acquisition of QRT, profit margins more than tripled suddenly to bring about >100% ROE to command a higher acquisition price in paying more back to the private owner Goh. The same goes for SSB in which a sharp increase of RM22m in revenue and RM12m in profits in 2009 is generated, with a corresponding decline in overall profit at the listed Silverlake Axis – and a sharp increase in other liabilities in the form of unearned revenue of RM 20m and other payables of RM10m.
The acquisition of a 24.5% associate interest in ePetrol Silverswitch in 2008 also raises red flags. The purchase was satisfied through the RM21m sale of SIBS licensing software to the new associate. The result of the creative structuring of the deal is that an investment in associate, a related-party entity controlled by Goh Peng Ooi, leads to an increase in revenue by RM21m and a profit by RM13.9m. The transaction not only accounts for the entire increase in the segmental revenue of the SIBS licensing software revenue in FY08 but also is the key contributor to the overall revenue increase. Subsequently in FY14, Silverlake Axis impaired the investment in the loss-making ePetrol by RM4.7m in the balance sheet, booking in RM0.3m share of loss in associate in the income statement, but revenue and profit have already been recognized in a highly improper revenue recognition transaction.
SILV1SILV2SILV3
Post-acquisitions, the potential “Deals Potion fraud” at Silverlake Axis is complete with the original operating expense capitalized into goodwill and intangible assets in the balance sheet, with the holes plugged using external funds raised largely from US$193m in Nov2005/May 2006 and US$90m in Jun 2013.
Notice how this total cash inflow amount correspond to the total net increase in revenue and profit from FY04-14 of US$195.4m (= RM467.5m + RM230.7m) and the US$91.1m cash investment outflow for the dizzying number of related-party acquisitions: (1) Unisoft Holding (Jul07), (2) QR Technology Sdn Bhd ($21.34m, Sep09/Mar10), (3) SAACIS (May/Jun10), (4) SBI Card Processing ($5.12m, Oct/Nov09), (5) ISIS International ($14.28m, Mar/Jul11), (6) Merimen Ventures Sdn Bhd ($16.86m, Mar/Apr13), (7) Cyber Village Sdn Bhd ($14m, Mar/Jul13), (8) Finzsoft Solutions ($16.99m, Dec14/Mar15).
Notice also how the total increase in operating expense of US$66.2m (= RM467.5m – RM230.7m) over FY04-14 corresponds eerily roughly to the total increase in Goodwill, intangible asset and investment in associates of US$66.4m (RM237.3m).
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Collecting cash upfront from customers, including regular maintenance fees, before selling the product years later sounds like a great business model – and also invites opportunistic manipulation in accounting numbers. Consider the case of a company that collects money upfront from customers for the sale of the product and maintenance fees of the product. Revenue from the sale of the product is recognized when the right to use the service has passed. Revenue from the provision of maintenance services is deferred and amortized on a straight-line basis over the remaining service period. In other words, customers would pay the maintenance fee of the deferred income upfront, and it would appear as the unearned revenue account in the balance sheet. A certain percentage of this is then recognized as the revenue each year as the maintenance is executed.
The above describes the revenue recognition policy of Fu Shou Yuan (1448 HK) (“FSY”), the largest listed funeral care services company in China who sells burial plots and cemetery maintenance services. Logically, the recognition of the cemetery maintenance revenue should be relatively stable and adds to around 4% of the sales of cemetery. However, the recognition of the cemetery maintenance revenue has been on an increasing trend with respect to the average balance of deferred income, rising from 4.5% in FY09 to 7.8% in FY13, raising red flags for overly aggressive recognition of deferred income when the basis and trigger for the higher conversion rate is opaque and undisclosed.
FSY1
The long-term project nature of constructing the cemetery burial plot for sale also provides the opportunity for the opportunistic manipulation to aggressively capitalized costs to inflate gross profits. FSY’s capitalized costs under the “Cemetery Assets” account include prepaid leases, development cost and general public area. These accumulated costs incurred to build the cemetery are amortized on a straight-line basis. Upon commencement of the development of cemetery with the intention of selling cemetery in the near-term, the cemetery assets are transferred and reclassified to the inventory account and treated as normal COGS when sale is generated.
However, when compared with the general percentage-of-completion (POC) method of revenue and cost recognition, there are several problems. FSY amortized the capitalization of costs at a mere 3% per annum of what would normally have been expensed, as compared to the how incurred development costs are capitalized and amortized over the years under the POC method. In the scenario-building case analysis, the overall impact is that the gross profit can be overstated by over 20%. In addition, the basis of transfer for cemetery assets into inventory is opaque and unknown, creating the room for management to manoeuvre around with the recognition of inventory costs and hence COGS and the consequent gross profit margins.
FSY2 FSY3 FSY4
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How do you sell expensive equipment while riding out industry cyclicality? The case analysis of Sany Heavy Equipment (631 HK) exposes the critical hidden vendor-financing risk in the construction equipment industry – and the accounting tunneling fraud carried out using the HK-listed entity of the Sany Group, with the consequent value-destruction since the seemingly innocuous corporate announcement on 14 November 2011 on HKEx. Sany Group is controlled by Liang Wengen, formerly the richest man in China in 2011. Since this announcement, essentially an agreement on facilitating potential accounting tunneling fraud between the Sany Group and the HK listed entity, the HK listco is down 70%, as compared to a decline of 22% for the A-share listed Sany Heavy Industry, a 12% decline for Caterpillar and a 46% rise for the Hang Seng Index.
Stock Price Performance Nov 2011-Apr 2015: Sany Heavy Equipment (631 HK) vs Sany Heavy Industry (600031 CH), Caterpillar (CAT US), Hang Seng Index
Sany
Because construction equipment is an expensive big-ticket purchase item, customer financing is essential and takes on three forms: instalment, bank loan mortgages and finance lease guarantees. For the latter two, companies are obliged to make payments to banks and finance lease companies in the event of the customer default. This is a common financing practice in the industry but the problem is in the accounting, as most of these high-risk arrangements are recorded outside the balance sheet. These are commonly termed as “off balance-sheet financing.”
Sany Heavy Equipment has been engaging in customer financing for a long time but there has been a blatant lack of disclosure on this material item until 2014. Even then, Sany’s off-balance sheet receivables or guarantee could be as high as RMB650m instead of the disclosed RMB264m in 2014, using the industry benchmark of off-balance sheet receivables estimated at 30% of revenue.
On top of the possible understatement of guarantees, another key accounting issue relates to the inadequate bad debt provision for these off-balance sheet receivables. In the event of customer default, Sany Heavy would pay cash to the bank for the outstanding loan amount and record an increase in trade receivables on its balance sheet. The accounting that goes behind the process is as follows:
Sany2
As such, subsumed in the trade receivables is actually an amount generated through defaults, and not just the “regular” receivables arising from credit sales. Receivables generated from default have a lower chance of recovery, which is contingent upon the resale value of repossessed machines in the second-hand market, and therefore carry higher credit risks than ordinary trade receivables. Most of these machines can only be disposed at a huge discount of 30 to 40% of the original price, which translates into a loss or reversal of previously recognized revenue for companies. The loss is the difference between the amount paid on defaulted loan and the residual value of the machines. Companies should anticipate the loss and write-off the loss upfront. Caterpillar usually takes a 30% write-off ratio on receivables generated from default. Sany Heavy Equipment only provides impairment of 8% on trade receivables, which reflects imprudent accounting that conceals the true risk associated with customer defaults.
Worse still, companies within Sany Group have resorted to selling repossessed machines internally to minimize reported loss on the receivables arising from defaults. Herein lies the critical announcement on 14 Nov 2011, essentially an agreement of potential accounting tunneling fraud. The Company enters into a Equipment Purchase Agreement with a subsidiary of Sany Group. There is a follow-on announcement in December 2014 in which the Company entered into a Master Purchase Agreement with Sany Group to purchase second-hand machinery equipment from Sany Group. Minority investors of the HK-listed entity lose out when the company overpays on the second-hand machine acquisition from other related entities who can avoid recognizing losses. These assets end up sitting on the balance sheet of the buying company with no recourse as they are essentially valueless in the market. The minority shareholders of Sany Heavy Equipment are clearly at the losing end when controlling shareholders of Sany Group tunnel money out of the HK listco through inflating PPE purchase prices.
Sany3
Sany Group is where all the wealth and IPO proceeds from the Company’s HK listing is being tunneling to and stored. Sany Heavy Equipment seems to be a vehicle concocted to raise funds to support the operations and financial performance of Sany Group. When sales are weaker in Sany Group and its subsidiaries, the HK listco would increase “purchases” from these entities. The controlling shareholders are less concerned about the performance of Sany Heavy Equipment, with their primary interest in Sany Group and the A-share listed flagship vehicle Sany Heavy Industry.
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In the Table of selected HK-listed and US-listed Chinese companies in this compiled Special Case Report with deceptively attractive statistics and some of the corresponding measures to detect accounting tunneling fraud, we are able to see the accounting echolocation measures have been sensitive enough as a systematic analytical framework and tool to detect accounting fraud in Asia.
We have highlighted three cases out of the 19 – SGX-listed Silverlake Axis (SILV SP), HK-listed Fu Shou Yuan (1448 HK) and Sany Heavy Equipment (631 HK) to give the reader a flavor of the richness of this Special Case Report compilation “The Daredevil’s Case Guide to Detect Accounting Fraud in Asia”. They are not the disguised case studies describing events unfolding in chronological events based on short-seller reports and news articles; they are analytical cases that seek to go beyond a list of red flags with a underlying story about the deeper accounting fraud issues that serve to inform and educate the readers in a deeper way to enable the adaptation of the lessons and tools of each case in different Asian contextual situations.
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The Daredevil does not ask: What do I want from life? The Daredevil asks a different set of questions: What does life want from me? What are my circumstances calling me to do? The Daredevil does not create her life; she is summoned by life.
The Daredevil’s perspective begins with an awareness that the problem of accounting fraud in the Asian capital jungle is not only prevalent but also distinctive from the usual western-based cases primarily because the fraud perpetuators are the controlling insiders themselves (the principal-principal governance problem) as opposed to managers (the principal-agent problem).
Lurking beneath the deceptively attractive financial ratios and valuation metrics from the western-based financial statement analysis, wildness lie in wait in the complex related-party transactions manifested in artful accounting tunneling fraud using “roll-away sins”, “grand capex fraud”, “deals potion fraud” and “all-in-the-family asset/liability shift” to expropriate corporate wealth at the expense of the abused minority shareholders.
After a decade-plus journey in the Asian capital jungles, it has been somewhat disheartening as we observe many fraud perpetrators go away scot-free and live a life of super luxury on minority investors’ hard-earned money. And these perpetrators make tempting offers to various parties in the financial community to go along with their schemes. When investors have knowledge in their hands, we have a choice to stay away from these people and away from temptations and do the things that we think are right. With knowledge, we have a choice to invest in the hardworking Asian entrepreneurs and capital allocators who are serious in building a wide-moat business.
Thus, the Daredevil’s job is to figure certain things out: What does this environment need in order to be made whole? What is it that needs repair? What tasks are lying around waiting to be performed? Thus, to become a Daredevil is to become an instrument for the performance of the job that has been put before her. She molds herself to the task at hand. While serving as an instrument in the fight against Soviet tyranny, Alexander Solzhenitsyn put it this way:
“It makes me happier, more secure, to think that I do not have to plan and manage everything for myself, that I am only a sword to cleave and disperse them. Grant, O Lord, that I may not break as I strike! Let me not fall from Thy hand!”
We hope this “Daredevil’s Case Guide to Detect Accounting Fraud in Asia” will serve as an introductory guide for value investors caught in a web of deception and evil to navigate through the struggle of these powerful forces and to experience the deep satisfaction of generating sustainable investment performance with true craftsmanship and values.
PS: The Daredevil’s Case Guide to Detect Accounting Fraud in Asia is exclusively only for our Moat Report Asia subscribers.
Content
Case 1: Silverlake Axis: The Next Satyam?
Case 2: Fu Shou Yuan: A Funeral Service Company with Skeletons in the Closet?
Case 3: Sany Heavy Equipment: Off-Balance Sheet Receivables Accounting Fraud?
Case 4: China Taifeng Beddings: Accounting Tunneling Fraud with Prepayment to Suppliers, Loan Agreements and Finance Lease Agreements
Case 5: Muda Holdings Berhad: Potential Accounting Fraud at Paper Mill?
Case 6: Zhongmin Baihui: Overvalued S-Chip Retailer with Potentially Cornered Stock, Weak Performance and Questionable Related-Party Transactions
Case 7 and 8: Opaque and Complex Water Stocks – Beijing Enterprise Water Group and SIIC Environment
Case 9: Rongsheng Heavy Industry: A Story about the 21st Century Titanic
Case 10: Rexlot: Breakdown of Deal Machine with Impairment and Write-Downs
Case 11: Bracell: Accounting Tunneling Vehicle to Fund Tycoon’s Private Business Empire
Case 12: China XD Plastic: Potential Accounting Fraud at Automotive Plastics Trader
Case 13: Pingtan Marine: Something Smells Fishy in Here
Case 14: Nature Home: Be Wary of Unstable Flooring – Unrealistic Revenue from Trademark and Distribution Network Usage Fees
Case 15: Cordlife: Suspected Accounting Irregularities and Accounting Tunneling Activities
Case 16: Celltrion Inc: Case Study of Price- and Action-based Manipulation
Case 17: Transmile Holdings: Case Study of a Stock Darling Turned Bad
Case 18: China Eratat Sports: Case Study of Accounting Tunneling Fraud with Opaque Distribution Network
Case 19: Dukang Distillers: Intoxicated by Capex- and M&A-Fraud Catalyzed by Toxic ** Issuance
Warm regards,
KB
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http://webcache.googleusercontent.c...ase-guide-to-detect-accounting-fraud-in-asia/
do note that I AM NOT THE WRITER
These cases are unique, original and bold, in the spirit of the Bamboo Innovator, pushing beyond the usual western-based techniques and tools in financial statement analysis that experience limitations to detect the underlying economic heartbeat. For instance, is highflying stock darling and high-margin-high-ROE banking software firm Silverlake Axis (SILV SP) the next Satyam?
Consider this: Is it possible for a company to generate >100% ROE, even if it were an asset-light software company? The case on Silverlake Axis examines the numerous opaque and complex related-party transactions and related-party acquisitions of companies with high profits-high ROE but weak balance sheets that belong privately to the software billionaire controlling owner Goh Peng Ooi at inflated valuation; possible abuse of the pooling-of-interest method involving acquisition of entities under common of Goh to report higher earnings in 2006 and 2010, enabling Silverlake Axis to bounce back from relatively weaker financial performance in 2005 and 2009 respectively; the aggressive and improper revenue recognition policies; the investment in associates in complex transactions to potentially shift expenses to these entities to inflate profits at Silverlake Axis, and so on. To highlight a few of these red flag transactions:
The assets of these acquired Bermuda-incorporated companies using pooling-of-interest method – Silverlake Adaptive Applications & Continuous Improvement (SAACIS) in 2006, and Silverlake Solution (SSB) and QR Technology (QRT) in 2010 – comprise of amount due from related parties, including customer maintenance contracts. The revenue of these related private entities are generated from contracts given by the listed Silverlake Axis at potentially artificially inflated prices to carry out systems integration and maintenance work for their banking customers. Fraudulent opportunity is presented in shifting costs from the listed Silverlake Axis to these private entities to artificially inflate the profit and market value of the listed Silverlake Axis. Subsequently, funds are raised to acquire these private entities at inflated valuation by shifting back the costs to the listed Silverlake Axis in the form of “other payables”, “other current liabilities” and to other associates (e.g. Global InfoTech GIT, ePetrol Silverswitch Sdn Bhd) that are not consolidated. Interestingly, prior to the acquisition of QRT, profit margins more than tripled suddenly to bring about >100% ROE to command a higher acquisition price in paying more back to the private owner Goh. The same goes for SSB in which a sharp increase of RM22m in revenue and RM12m in profits in 2009 is generated, with a corresponding decline in overall profit at the listed Silverlake Axis – and a sharp increase in other liabilities in the form of unearned revenue of RM 20m and other payables of RM10m.
The acquisition of a 24.5% associate interest in ePetrol Silverswitch in 2008 also raises red flags. The purchase was satisfied through the RM21m sale of SIBS licensing software to the new associate. The result of the creative structuring of the deal is that an investment in associate, a related-party entity controlled by Goh Peng Ooi, leads to an increase in revenue by RM21m and a profit by RM13.9m. The transaction not only accounts for the entire increase in the segmental revenue of the SIBS licensing software revenue in FY08 but also is the key contributor to the overall revenue increase. Subsequently in FY14, Silverlake Axis impaired the investment in the loss-making ePetrol by RM4.7m in the balance sheet, booking in RM0.3m share of loss in associate in the income statement, but revenue and profit have already been recognized in a highly improper revenue recognition transaction.
SILV1SILV2SILV3
Post-acquisitions, the potential “Deals Potion fraud” at Silverlake Axis is complete with the original operating expense capitalized into goodwill and intangible assets in the balance sheet, with the holes plugged using external funds raised largely from US$193m in Nov2005/May 2006 and US$90m in Jun 2013.
Notice how this total cash inflow amount correspond to the total net increase in revenue and profit from FY04-14 of US$195.4m (= RM467.5m + RM230.7m) and the US$91.1m cash investment outflow for the dizzying number of related-party acquisitions: (1) Unisoft Holding (Jul07), (2) QR Technology Sdn Bhd ($21.34m, Sep09/Mar10), (3) SAACIS (May/Jun10), (4) SBI Card Processing ($5.12m, Oct/Nov09), (5) ISIS International ($14.28m, Mar/Jul11), (6) Merimen Ventures Sdn Bhd ($16.86m, Mar/Apr13), (7) Cyber Village Sdn Bhd ($14m, Mar/Jul13), (8) Finzsoft Solutions ($16.99m, Dec14/Mar15).
Notice also how the total increase in operating expense of US$66.2m (= RM467.5m – RM230.7m) over FY04-14 corresponds eerily roughly to the total increase in Goodwill, intangible asset and investment in associates of US$66.4m (RM237.3m).
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Collecting cash upfront from customers, including regular maintenance fees, before selling the product years later sounds like a great business model – and also invites opportunistic manipulation in accounting numbers. Consider the case of a company that collects money upfront from customers for the sale of the product and maintenance fees of the product. Revenue from the sale of the product is recognized when the right to use the service has passed. Revenue from the provision of maintenance services is deferred and amortized on a straight-line basis over the remaining service period. In other words, customers would pay the maintenance fee of the deferred income upfront, and it would appear as the unearned revenue account in the balance sheet. A certain percentage of this is then recognized as the revenue each year as the maintenance is executed.
The above describes the revenue recognition policy of Fu Shou Yuan (1448 HK) (“FSY”), the largest listed funeral care services company in China who sells burial plots and cemetery maintenance services. Logically, the recognition of the cemetery maintenance revenue should be relatively stable and adds to around 4% of the sales of cemetery. However, the recognition of the cemetery maintenance revenue has been on an increasing trend with respect to the average balance of deferred income, rising from 4.5% in FY09 to 7.8% in FY13, raising red flags for overly aggressive recognition of deferred income when the basis and trigger for the higher conversion rate is opaque and undisclosed.
FSY1
The long-term project nature of constructing the cemetery burial plot for sale also provides the opportunity for the opportunistic manipulation to aggressively capitalized costs to inflate gross profits. FSY’s capitalized costs under the “Cemetery Assets” account include prepaid leases, development cost and general public area. These accumulated costs incurred to build the cemetery are amortized on a straight-line basis. Upon commencement of the development of cemetery with the intention of selling cemetery in the near-term, the cemetery assets are transferred and reclassified to the inventory account and treated as normal COGS when sale is generated.
However, when compared with the general percentage-of-completion (POC) method of revenue and cost recognition, there are several problems. FSY amortized the capitalization of costs at a mere 3% per annum of what would normally have been expensed, as compared to the how incurred development costs are capitalized and amortized over the years under the POC method. In the scenario-building case analysis, the overall impact is that the gross profit can be overstated by over 20%. In addition, the basis of transfer for cemetery assets into inventory is opaque and unknown, creating the room for management to manoeuvre around with the recognition of inventory costs and hence COGS and the consequent gross profit margins.
FSY2 FSY3 FSY4
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How do you sell expensive equipment while riding out industry cyclicality? The case analysis of Sany Heavy Equipment (631 HK) exposes the critical hidden vendor-financing risk in the construction equipment industry – and the accounting tunneling fraud carried out using the HK-listed entity of the Sany Group, with the consequent value-destruction since the seemingly innocuous corporate announcement on 14 November 2011 on HKEx. Sany Group is controlled by Liang Wengen, formerly the richest man in China in 2011. Since this announcement, essentially an agreement on facilitating potential accounting tunneling fraud between the Sany Group and the HK listed entity, the HK listco is down 70%, as compared to a decline of 22% for the A-share listed Sany Heavy Industry, a 12% decline for Caterpillar and a 46% rise for the Hang Seng Index.
Stock Price Performance Nov 2011-Apr 2015: Sany Heavy Equipment (631 HK) vs Sany Heavy Industry (600031 CH), Caterpillar (CAT US), Hang Seng Index
Sany
Because construction equipment is an expensive big-ticket purchase item, customer financing is essential and takes on three forms: instalment, bank loan mortgages and finance lease guarantees. For the latter two, companies are obliged to make payments to banks and finance lease companies in the event of the customer default. This is a common financing practice in the industry but the problem is in the accounting, as most of these high-risk arrangements are recorded outside the balance sheet. These are commonly termed as “off balance-sheet financing.”
Sany Heavy Equipment has been engaging in customer financing for a long time but there has been a blatant lack of disclosure on this material item until 2014. Even then, Sany’s off-balance sheet receivables or guarantee could be as high as RMB650m instead of the disclosed RMB264m in 2014, using the industry benchmark of off-balance sheet receivables estimated at 30% of revenue.
On top of the possible understatement of guarantees, another key accounting issue relates to the inadequate bad debt provision for these off-balance sheet receivables. In the event of customer default, Sany Heavy would pay cash to the bank for the outstanding loan amount and record an increase in trade receivables on its balance sheet. The accounting that goes behind the process is as follows:
Sany2
As such, subsumed in the trade receivables is actually an amount generated through defaults, and not just the “regular” receivables arising from credit sales. Receivables generated from default have a lower chance of recovery, which is contingent upon the resale value of repossessed machines in the second-hand market, and therefore carry higher credit risks than ordinary trade receivables. Most of these machines can only be disposed at a huge discount of 30 to 40% of the original price, which translates into a loss or reversal of previously recognized revenue for companies. The loss is the difference between the amount paid on defaulted loan and the residual value of the machines. Companies should anticipate the loss and write-off the loss upfront. Caterpillar usually takes a 30% write-off ratio on receivables generated from default. Sany Heavy Equipment only provides impairment of 8% on trade receivables, which reflects imprudent accounting that conceals the true risk associated with customer defaults.
Worse still, companies within Sany Group have resorted to selling repossessed machines internally to minimize reported loss on the receivables arising from defaults. Herein lies the critical announcement on 14 Nov 2011, essentially an agreement of potential accounting tunneling fraud. The Company enters into a Equipment Purchase Agreement with a subsidiary of Sany Group. There is a follow-on announcement in December 2014 in which the Company entered into a Master Purchase Agreement with Sany Group to purchase second-hand machinery equipment from Sany Group. Minority investors of the HK-listed entity lose out when the company overpays on the second-hand machine acquisition from other related entities who can avoid recognizing losses. These assets end up sitting on the balance sheet of the buying company with no recourse as they are essentially valueless in the market. The minority shareholders of Sany Heavy Equipment are clearly at the losing end when controlling shareholders of Sany Group tunnel money out of the HK listco through inflating PPE purchase prices.
Sany3
Sany Group is where all the wealth and IPO proceeds from the Company’s HK listing is being tunneling to and stored. Sany Heavy Equipment seems to be a vehicle concocted to raise funds to support the operations and financial performance of Sany Group. When sales are weaker in Sany Group and its subsidiaries, the HK listco would increase “purchases” from these entities. The controlling shareholders are less concerned about the performance of Sany Heavy Equipment, with their primary interest in Sany Group and the A-share listed flagship vehicle Sany Heavy Industry.
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In the Table of selected HK-listed and US-listed Chinese companies in this compiled Special Case Report with deceptively attractive statistics and some of the corresponding measures to detect accounting tunneling fraud, we are able to see the accounting echolocation measures have been sensitive enough as a systematic analytical framework and tool to detect accounting fraud in Asia.
We have highlighted three cases out of the 19 – SGX-listed Silverlake Axis (SILV SP), HK-listed Fu Shou Yuan (1448 HK) and Sany Heavy Equipment (631 HK) to give the reader a flavor of the richness of this Special Case Report compilation “The Daredevil’s Case Guide to Detect Accounting Fraud in Asia”. They are not the disguised case studies describing events unfolding in chronological events based on short-seller reports and news articles; they are analytical cases that seek to go beyond a list of red flags with a underlying story about the deeper accounting fraud issues that serve to inform and educate the readers in a deeper way to enable the adaptation of the lessons and tools of each case in different Asian contextual situations.
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The Daredevil does not ask: What do I want from life? The Daredevil asks a different set of questions: What does life want from me? What are my circumstances calling me to do? The Daredevil does not create her life; she is summoned by life.
The Daredevil’s perspective begins with an awareness that the problem of accounting fraud in the Asian capital jungle is not only prevalent but also distinctive from the usual western-based cases primarily because the fraud perpetuators are the controlling insiders themselves (the principal-principal governance problem) as opposed to managers (the principal-agent problem).
Lurking beneath the deceptively attractive financial ratios and valuation metrics from the western-based financial statement analysis, wildness lie in wait in the complex related-party transactions manifested in artful accounting tunneling fraud using “roll-away sins”, “grand capex fraud”, “deals potion fraud” and “all-in-the-family asset/liability shift” to expropriate corporate wealth at the expense of the abused minority shareholders.
After a decade-plus journey in the Asian capital jungles, it has been somewhat disheartening as we observe many fraud perpetrators go away scot-free and live a life of super luxury on minority investors’ hard-earned money. And these perpetrators make tempting offers to various parties in the financial community to go along with their schemes. When investors have knowledge in their hands, we have a choice to stay away from these people and away from temptations and do the things that we think are right. With knowledge, we have a choice to invest in the hardworking Asian entrepreneurs and capital allocators who are serious in building a wide-moat business.
Thus, the Daredevil’s job is to figure certain things out: What does this environment need in order to be made whole? What is it that needs repair? What tasks are lying around waiting to be performed? Thus, to become a Daredevil is to become an instrument for the performance of the job that has been put before her. She molds herself to the task at hand. While serving as an instrument in the fight against Soviet tyranny, Alexander Solzhenitsyn put it this way:
“It makes me happier, more secure, to think that I do not have to plan and manage everything for myself, that I am only a sword to cleave and disperse them. Grant, O Lord, that I may not break as I strike! Let me not fall from Thy hand!”
We hope this “Daredevil’s Case Guide to Detect Accounting Fraud in Asia” will serve as an introductory guide for value investors caught in a web of deception and evil to navigate through the struggle of these powerful forces and to experience the deep satisfaction of generating sustainable investment performance with true craftsmanship and values.
PS: The Daredevil’s Case Guide to Detect Accounting Fraud in Asia is exclusively only for our Moat Report Asia subscribers.
Content
Case 1: Silverlake Axis: The Next Satyam?
Case 2: Fu Shou Yuan: A Funeral Service Company with Skeletons in the Closet?
Case 3: Sany Heavy Equipment: Off-Balance Sheet Receivables Accounting Fraud?
Case 4: China Taifeng Beddings: Accounting Tunneling Fraud with Prepayment to Suppliers, Loan Agreements and Finance Lease Agreements
Case 5: Muda Holdings Berhad: Potential Accounting Fraud at Paper Mill?
Case 6: Zhongmin Baihui: Overvalued S-Chip Retailer with Potentially Cornered Stock, Weak Performance and Questionable Related-Party Transactions
Case 7 and 8: Opaque and Complex Water Stocks – Beijing Enterprise Water Group and SIIC Environment
Case 9: Rongsheng Heavy Industry: A Story about the 21st Century Titanic
Case 10: Rexlot: Breakdown of Deal Machine with Impairment and Write-Downs
Case 11: Bracell: Accounting Tunneling Vehicle to Fund Tycoon’s Private Business Empire
Case 12: China XD Plastic: Potential Accounting Fraud at Automotive Plastics Trader
Case 13: Pingtan Marine: Something Smells Fishy in Here
Case 14: Nature Home: Be Wary of Unstable Flooring – Unrealistic Revenue from Trademark and Distribution Network Usage Fees
Case 15: Cordlife: Suspected Accounting Irregularities and Accounting Tunneling Activities
Case 16: Celltrion Inc: Case Study of Price- and Action-based Manipulation
Case 17: Transmile Holdings: Case Study of a Stock Darling Turned Bad
Case 18: China Eratat Sports: Case Study of Accounting Tunneling Fraud with Opaque Distribution Network
Case 19: Dukang Distillers: Intoxicated by Capex- and M&A-Fraud Catalyzed by Toxic ** Issuance
Warm regards,
KB
The Moat Report Asia
www.moatreport.com
www.asianextractor.com
http://accountancy.smu.edu.sg/faculty/profile/108141/KEE-Koon-Boon
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Kerry Logistics Network (636 HK) and China’s Transportation & Logistics Industry, by JIANG Lingjun
PT Bank Tabungan (BTPN IJ): BTPN’s Successful Business Model, by Daniel IGOR
PT Sumber Alfaria Trijaya Tbk (Alfamart) (AMRT IJ): Maintaining Its Stranglehold as Competition Heats Up in Indonesia’s Modern Grocery Retail Industry, by Kelly GOH Wan Jun
Mitra Adi Perkasa Tbk PT (MAPI IJ): Still Fashionable in the Fashion Apparel Retail Industry? by Lucas LIM
Alibaba: Embracing Its Challenges + China Online Market: Growing with Challenges, by JIANG Lingjun
Ulmart: Russia’s Own Amazon, by Christina LIM
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