China Trading Stocks

[kindama]

Podcast: Accounting Abuse Among Listed Chinese Companies Still Widespread Link

Excerpt:

Q: Now let's talk about Keywise Capital. Give us a brief introduction of the firm?

A: We are a Hong Kong-based hedge fund with $1.4 billion under management. Our strategy is long-short equities. We typically buy high quality names at reasonable prices, and short those with broken business model or accounting fraud in the Greater China region.

Q: A short position Keywise engaged in was China Metal Recycling Holdings, which has been wound up because of accounting fraud. Do you still see many opportunities to short Chinese companies based on accounting fraud?

A: Based on my experience and observation, I think there is still widespread accounting abuse among listed (Chinese) companies, even some large ones.

There are no strong forces in Asia, in general, to go against those companies. Due to culture issues and regulatory framework, hedge funds here have not been aggressive in pursuing those opportunities.

Q: What type of accounting abuse is there?

A: For example, revenue recognition. We are seeing some companies booking revenue on a gross revenue basis, which will massively inflate their revenue.

A lot of companies also have unfair related party transactions, such as acquisitions. They may be paying inflated price to a small business, which is damaging to minority shareholders.

Also, there is no segregation of duties between the CEO and the chairman. Often, the CEO and the chairman might have already committed some violation, such as inter-party lending.

Q: If like you say, accounting fraud is widespread, your short position based on accounting abuse might take a long time to materialize, or may never materialize?

A: Shorting is very difficult. You need to have faith in your investment decision, and also have guts. You have to strongly believe that companies that utilized accounting frauds to maximize short-term profits, the issue will surface eventually.

But sometimes, you might just be too early. The key is to keep a pace on the investment. Maybe initially putting only a small position, and add on the cost gradually.

Q: What do you think should be done to help improve the situation?

A: The Hong Kong Stock Exchange is still quite relaxed on independent director rules. In the U.S., if you are listed on the mainboard, the majority of the directors need to be independent. But in Hong Kong, the requirement is only one-third.

There is also no regulation on class action lawsuit in Hong Kong. As a minority shareholder, you can still sue a company, but it's very difficult and costly.

But in the class action lawsuit in the U.S., the lawyers actually get involved. They get contingency payment if the lawsuit is successful. So the government needs to set up a better framework for minority shareholders to enforce changes.

Q: Aside from accounting fraud, what other short opportunities do you see?

A: We are seeing a lot of companies whose business models are becoming obsolete. For example, in the education sector, we are seeing the online business taking market share and profit from the offline business.

We also see that a lot of companies let the market think they are doing something, but in reality they are doing something else. The key is to read the small prints in their securities filings. Not a lot of investors are paying attention to this, so this could be very good short opportunities too.