China Zhongwang (tkr: 1333 HK) - More Corporate Governance Issues

Apparently I missed this little account on Zhongwang in my earlier post (read here).  Zhongwang disclosed in the footnotes of its 2009 annual announcement (read here) it borrowed RMB2.3billion from two Liaoning banks and gave it to a local government construction entity.  The company claims it is not on the hook to repay the debt (read here).

This is another example of poor corporate governance in China.  As local governments are prohibited from borrowing debt, this is also an example of how local governments get around this policy restriction.  Perhaps more importantly, as this article points out (read here), how will this continue as central government clamps down on various 'shadow lending' schemes?

Chinese Banks - "These Things Aren't Banks"

An oldie but a goodie.  Interview with Victor Shih and Carl Walter (watch here) on the distorted banking system and incentives of China and how it may unravel.

Here is a partial picture (in very simplistic terms) of how I see it:

1. China has gone through years of economic growth (productivity improvement) through introducing capital equipments to China's cheap labor force.  This process has slowed in the last few years with growth driven by fixed asset investment (ie. infrastructure and real estate).
2. Fixed asset investments have been productive in the early years.  Urbanization has driven the need for real estate.  Better ports, roads, transport systems, etc. is important to furthering productivity.
3. Local government, SOEs and government ministries (with distorted incentive system and corruption) found that it was easy to drive GDP growth through fixed asset investment.  Land sales were easy as real estate prices kept going up and real estate developers were able to get relatively cheap borrowing from the banks.  Infrastructure construction was a function of borrowing from the banks and throwing money at the projects.  Everyone was making money!
4. How is this possible?  The key is that banking system in China is not structured to make commercially viable loans (ie. allocate capital wisely).  Loans are made primarily through relationships (fueled by corruption) and directed towards SOEs and local governments (indirectly, as local governments are generally prohibited from borrowing).
5. As productivity of various fixed asset investments decline, the massive credit binge (bank lending) is leading to rampant inflation throughout the system.
6. The central government is attempting to contain the issue through imposing various restrictions and mechanisms on banks (eg. changing capital requirements, reserve requirements, limiting total loans made available, etc.).  Problem is these policy 'tweaks' don't fixed the underlying problem - *distorted incentives* throughout the system!
7. Local governments and banks have found ways around the central government policy restrictions by setting up various trust vehicles to obtain funding directly/indirectly from banks (read here).
8. As the central government starts to close in on these trust vehicles, we see a sudden surge in local financing companies and credit guarantee companies prop up around the country that charge exorbitant interest rates (well north of 20-30%+).  Many of these local financing companies are setup by SOEs (like China Mobile, read here) which can still borrow cheaply from the banks, but able to lend out at exorbitant rates (what a great scheme!).
9. Bad loans are on the rise (read here), but banks are more than willing to roll them over and not take a loss.  Now the central government is asking banks to *not* roll over the debt (read here).
10. This is like plugging a leaking dam.  We shall see how it unfolds.

This is obviously an oversimplification of the current situation.  I can write a book on this.  But hopefully this suffices to describe things in broad strokes.

Angang Steel (tkr: 347 HK) - Useful Life of Fixed Assets

What do you do when you can't hit your target earnings?

In the case of Angang Steel (tkr: 347 HK), just change the depreciation schedule (read here and here for corporate announcement)!

Estimated Useful Life (years)

Category of fixed assets   Before revision    After revision

Buildings                  20                 30

Structures                 20                 30

Conductor facilities       15                 15

Machinery                  10                 15

Power equipment            11                 10

Reason for the change as follows:

"The Company has been endeavouring to enhance the value of its fixed assets in recent years by carrying out continuous renovation and upgrading and regular examination and maintenance of its production facilities. As a result, the actual useful life of certain fixed assets of the Company, in particular, the buildings, structures, machinery and equipment used in production, has been prolonged."

As mentioned with Nine Dragons (tkr: 2689 HK) here, having low (under) depreciation seems to be pretty common with capital intensive industries in China.  It is a quick and dirty way of increasing earnings and margins.  The need for maintenance capex exceeding depreciation is evident, but masked by what many companies claim to be 'growth capex'.

A quick tour of a steel mill (or paper mill) in China will convince anyone there is little chance any fixed asset gets its useful life 'prolonged' in China.

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ps. I have no idea why useful life of power equipment is shortened by one year.  Seems awfully precise.

Chaoda (tkr: 682 HK) - Last Breath?

As mentioned before in the blog - is this finally the end of Chaoda Modern Agriculture as it goes to Hong Kong's Market Misconduct Tribunal (read here) and exposed as a fraud (for the 'x'th time), this time by Anonymous Analytics (read here)?

Anonymous Analytics mentions sibling / affiliates, Asian Citrus (tkr: 73 HK) and Le Gaga (tkr: GAGA).  I would keep a close eye on and stay away from them.

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ps. sry about the slow postings, it has been a very hectic few weeks.