Chaoda Modern Agriculture (ticker: 682 HK)

This is an embarrassment to the Hong Kong stock market.  Chaoda Modern Agriculture and China Green (ticker: 904 HK) are two of the largest listed vegetable farming and distribution companies in Hong Kong.  They are also two widely publicized and commonly acknowledged frauds in Hong Kong, yet it is still listed with a market cap of HK$11.1bn and HK$4.5bn respectively.

I won't spend much time writing this up as it is well publicized and understood.  In the case of Chaoda -

Margins.  In an industry known to be notoriously cyclical and low margin, this company has an EBITDA margins of 60% and has consistently grown at 20-30% p.a. since listing without missing a beat.  It appears be never subject to price or cost fluctuations.  If farming was that lucrative, why would farmers migrate to the cities in China?  Urbanization should be "ruralization".

Auditors. The number of changes in auditors ought to raise some serious questions.  The company was jointly audited by PWC and CCIF when it first came to the market in 2000.  PWC dropped off, with CCIF as sole for the 2002/3 audit. They added Baker Tilly for the 2004/5 audit, but dropped both Baker Tilly and CCIF for their 2006/7 audit.  They are currently audited by Grant Thornton.  The turnover of auditors should ring some alarm bells.  Any listed business that want to be taken seriously should stick to using a Big Four auditor ...unless they can't (to be clear, using a Big Four doesn't eliminate accounting fraud risk, but that is a story for another time).

Asset Size/Quality.  There have been many reports on Chaoda vastly overstating their asset size.  According to this Next Media report (source, in Chinese), a site visit of a 5,000 mu farmland in Beijing revealed it was actually only 1,000 mu.  There are other allegations in the report which you may read for yourself (in Chinese though).

Balance Sheet.  As a former high yield/distressed investor, I find it interesting that Chaoda has tapped the high yield/convertible bond market several times in the past, despite having a ton of cash on its balance sheet.  It recently raised US$150mm in convertible bond, despite having over US$300mm (RMB2,044mm based on its 2009/10 annual report) of cash on its balance sheet.  Does that make sense? Unless the cash... (reminds me of Sino-Forest, Longtop, China Mediaexpress...)

Long list of other red flags, but I will stop here.

One thing I've noticed is if one of the leaders in a sector (particularly the first company to list) is fraudulent, it is very likely the whole sector is fraudulent .  This seems to be the case in the agriculture sector (Chaoda leading, followed by China Green), forestry sector (Sino Forest, followed by several smaller guys), milk/infant formula and aluminum extrusion sectors (I'll write it up some other time) .  My guess is it is harder to be fraudulent in an established sector if the incumbent produces honest/accurate figures (people will always benchmark to the leader and ask questions).  Put differently, it is easier to produce fraudulent accounts if the company is first to come to the market in the sector (no established benchmarks to compare to) or if listed incumbents are already committing accounting fraud.

China Modern Agriculture has been listed for over 11 years (China Green for 7 years) and has been a known fraud for many years now.  Please do something about this, Mr. Charles Li...