There was no shortage of buyers when Huishan Dairy raised $1.3 billion in a 2013 listing in Hong Kong. The IPO was multiple times oversubscribed, in part due to a halo effect from Cheng Yu-tung, an existing shareholder and a Hong Kong property tycoon.
During the public offering marketing, its chairman Yang Kai vowed to build China’s most trusted dairy brand after a 2008 baby formula scandal in China raised public fears over the safety of dairy products.
But things soured for investors when Huishan Dairy’s Hong Kong-listed shares plunged 85% in an hour on March 24, before being suspended. On May 8, the Securities and Futures Commission ordered an indefinite extension in the trading halt.
The drop in Huishan Dairy’s shares came ahead of media reports that the company was meeting its major creditors for late payments in Liaoning, its home province. The liquidity problems at the company did not come before warning signs.
The company later confirmed it held a creditor meeting on the afternoon of March 23. It had failed to make interest payments on time, but said it was working on a new plan to ease the cash crunch. It also revealed it has lost contact with Ge Kun, an executive director in charge of treasury and cash operations, as well as handling the relationships with its almost two dozen bank lenders.
The company said Yang had received a letter from Ge, indicating that “the recent work stress had taken a toll on her health.” Ge also expressed the desire to take a leave of absence and did not want to be contacted.
It has since emerged that Yang was using his 70.76% holding of Huishan Dairy’s stock as collateral, borrowing money through his fully-owned vehicle Champ Harvest, including a HK$2.142 billion loan offered by Ping An Bank.
“I have never seen such rapid sell-off in the history of Hong Kong stock market,” said Ben Kwong, executive director of KGI Asia in Hong Kong told FinanceAsia. “The sharp share price movement could be related to margin calls from brokers, leading to a forced selling of shares at a discount price.”
According to filing with the Hong Kong Stock Exchange, Champ Harvest sold 250.9 million shares of Huishan at an average price of HK$0.394 each on March 24, when the Hong Kong-listed shares plunged from HK$2.81 to the trough of HK$0.25 a piece. The shares were down as much as 91% at one point.
The company said Ping An Bank was not the source of the sell-off on March 24, but did not provide additional information about whether there were other creditors that forced Yang to raise capital by selling his shares in the public market.
The cows come home
Last November, Huishan raised Rmb750 million after pledging 40,000 of its cows as collateral, which Yang called an innovative way to finance its business. The company said it collateralised about 20% of its herd for the loan at an interest rate of 6.2%, after it failed to complete the asset-backed loan in April of last year.
A group of mainland investors including China Financial Leasing and China Wood Group provided the credit to Huishan, a stock exchange disclosure shows. But less than a month later, US short seller Muddy Waters released a report on Huishan Dairy, saying the value of the company was “close to zero.” Huishan said at that time that the allegations in the report were groundless and contained misrepresentations. But the report only inflamed doubts among international investors — who often take a rather skeptical view of accounting standards in China.
“The size of the potential issues at troubled companies in China is like an elephant in the room as far as foreign investors are concerned,” said Brent Carlson, a Hong Kong-based director at AlixPartners, a global consultancy on debt restructuring, due diligence and internal investigations.
In the case of Huishan, mainland media reported that Huishan’s farmland was virtually an empty parcel of land, without any production facility or cattle farm. In 2013, the company said it would spend Rmb8.8 billion to build an integrated dairy facility in Shenyang, but the promise remained unfulfilled.
“You don’t know until you physically get in there, see how the operations are running and examine the original source documentation of records,” said Carlson. “In China, integrity of revenues is a high risk area as the company chops and paper trail can be fabricated, along with classic overstated assets and understated liabilities issues.”
According to Huishan’s 2013 listing document, the group reported Rmb 945.4 million in net profit in 2013, almost double the Rmb 449.7 million it made a year earlier.
“Sometimes the numbers may just look too good to be true especially those which go against industry trends and their peers,” said Carlson, who said it was important for investors to be aware of potential discrepancies — including those involving the so-called “three ledgers” adopted by some Chinese companies.
This is a system where some Chinese companies develop three different accounting ledgers to dodge tax bureau and public scrutiny, and keep the most accurate accounting book to themselves. These books are divided between one for external reporting, including statutory or tax reporting, one for management purposes, and one for the top inner circle.
It’s a practice with roots at least as far back as the Qing Dynasty, but recent regulatory enforcement actions and a corruption crack-down in China have gone some way to putting a dampener on the practice.
In early April, HSBC, one of Huishan Dairy’s creditors, filed a court order in Shanghai to freeze assets of the company and some of its subsidiaries, after the borrower defaulted on a $200 million dual-tranche loan facility.
The Hong Kong Monetary Authority, the city’s de facto central bank, investigated the $200 million loan made by some of the city’s lenders, asking banks to provide their due diligence and credit-checking process when the loan was approved in 2015.
Besides HSBC, Hang Seng Bank, China Merchants Bank and China Citic Bank were among the lenders that are cooperating with the regulator, according to a corporate loan banker familiar with the matter.
Three executive directors of Huishan and the company secretary have resigned since the stock collapse, leaving only Yang and Ge remaining on the board of directors. Ge remained unreachable as of late April, according to the company’s public statement.
Hong Kong Stock Exchange and the Securities and Futures Commission declined to comment. Neither a Huishan Dairy spokesperson nor chairman Yang responded to email and voicemail requests for comment.