For Zhongwang Holdings, It's Transparency or Bust

He isn’t talking, so we don’t really know what’s going on in his head, but CFOs can surely feel a twinge of sympathy for the finance chief of China Zhongwang Holdings.

The major mainland aluminium producer had listed with much funfare in Hong Kong last April and was among the hottest IPOs in 2009. But it has been the subject of much scrutiny since September, when allegations arose that its IPO prospectus contained falsified information.
Vowing transparency, Zhongwang hired accounting heavyweight Ernst & Young to conduct an independent investigation to prove that the sales transaction data and tax documentation disclosed in its prospectus are accurate. On January 5, Zhongwang filed a two-page announcement with the Hong Kong Stock Exchanges and Clearing that, in effect, confirms its version of events.
“Ernst & Young has submitted the independent review report to the Audit Committee [of Zhongwang],” said the announcement. “The Audit Committee has reviewed the independent review report and the Audit Committee is in the opinion and confirms that (i) there were no any deficiencies in the Group’s sales transactions with the major 10 customers during the period from 1 January 2008 to 30 June 2009 in any material respect; and (ii) there were no any deficiencies in annual corporate income tax filing documentation and the corporate income tax payment records for the financial year ended 31 December 2008 in any material respect.”
But if Zhongwang expected these bald statements to end the controversy, it was wrong. Two days after the January 5 announcement, trading in the company’s shares was suddenly suspended. After trading resumed on February 8, the stock price plunged nearly 30% to HK$5.87. Today, it continues to languish at the HK$6 level, down 45% from its high of HK$10.88 last July and 12% lower than its IPO price of HK$7 per share.
What Went Right
An examination of the events and Zhongwang’s responses to them suggests that the company had done some things right – but failed to handled other issues with finesse and transparency. Unfortunately, in this post-crisis environment, investors and the media tend to focus on the negative and the stock gets punished accordingly.
To his credit, Zhongwang’s finance director, Vincent Cheung Lap-kei, had been front and centre when the controversy initially broke. He staunchly declared, for example, that “Zhongwang confirms the accuracy of its operational and financial information.”
Cheung’s fighting words were backed by an impressive series of initiatives. After strongly refuting the article by mainland newspaper Economic Observer that started it all, Zhongwang won a retraction and an apology from the daily. The Observer admitted that its story was written “without first verifying the relevant facts with the Company, without first evaluating all the relevant materials and based on interviews with persons who have limited knowledge of the facts.”
Then in a video press conference in September, representatives from four major Zhongwang customers confirmed the accuracy of the transactions and their company’s business relationship with Zhongwang as disclosed in the IPO prospectus. The company later said that its audit committee, composed of independent non-executive directors Wong Chun Wa, Wen Xianjun and Shi Ketong, will oversee an independent review of the information set forth in the prospectus.
The media reported that Ernst & Young had been hired to undertake the independent review. In a November conference call, Zhongwang executives indicated that the review would take five weeks, setting up expectations that the results would be announced by December 15.
Zhongwang’s actions bought it some time. Its stock price stabilised as investors appeared willing to give it the benefit of the doubt while awaiting the results of the independent review.

What Went Wrong

But Zhongwang then committed what, in hindsight, looks like a series of errors. Ernst & Young’s report did not materialise by December 15. The stock fell more than 20% within the week, scraping bottom at an all-time low of HK$5.51 on 18 December.
According to Hong Kong daily South China Morning Post, Zhongwang executives told analysts that Ernst & Young would not be able to complete the audit for another two or three weeks — but no reason was stated for the delay, thus stoking further media speculation.
Anticipation built up again in 2010 as those “two to three weeks” neared. Zhongwang’s stock price rose 39% to HK$7 in the first week of January. The company did release information about Ernst & Young’s findings on January 5 – but only in that sparse two-page announcement.
Two days later, on January 7, Zhongwang requested that trading in its shares be suspended. It did not explain at that time why, but when trading in the stock resumed one month later, the company indicated in a statement that it took action because certain press articles “contained statements which the Company considers not to be an accurate reflection of the statements set out in the 5 January Announcement.”  
Unfortunately, that February 8 announcement raised more questions than it answered. It appears that Ernst & Young had told Zhongwang that it had encountered “external limitations” in its verification procedures, which required specific information from independent third parties. The accounting firm outlined what steps could be taken to address the limitations.
But the committee decided not to take those steps, concluding that “such limitations would not affect [Ernst & Young’s] conclusion in respect to the independent review under PRC laws and regulations.” The decision was based on the committee’s assessment of the “samples selected during the independent review” that included “relevant contracts, sales orders, sales invoices, stock out notes, customs declarations (in respect of export sales), bank deposits records and banks statements related to bank subsequent receipts of the sales transactions.”
Trust Our Judgement
In other words, after one month of deliberation in which trading in its stock was suspended, Zhongwang has decided to tell the world: Enough of the investigations. You’ve got to trust our judgement. Asking Ernst & Young to do more work will simply further confirm its conclusion that was set forth in the January 5 announcement.
That’s not exactly the kind of message any company wants to send to the market, particularly at a time of economic uncertainty and when the company involved operates in China, whose economic and business environment is not exactly seen as mature. “Everyone’s dumping the stock,” Castor Pang, an analyst at Cinda International Holdings in Hong Kong, told Bloomberg. “Ernst & Young is saying that apart from sales and taxes there are parts of the internal information they can’t touch, limiting their investigation.”
That assessment may or may not be exaggerated, but Ernst & Young has not issued any statement, beyond saying that it had signed off on Zhongwang’s February 8 announcement. The company itself has not said anything after filing the announcement. There has been no word as well from any of the other parties involved in the IPO, including joint sponsors UBS and Citic Securities International.
But the media has not been silent. It is easy enough to spot what looks like inconsistencies. For example, Zhongwang stated in its prospectus that its sales to Xian Yingqiang Power Engineering Material in 2008 is equal to 3.6% of its revenues that year – or RMB497 million (HK$564.45 million). Yet according to its registry filing, Xian Yingqiang reported sales of only RMB23 million in 2008. How can such a tiny company afford to buy aluminium products worth more than 22 times its annual revenues?

Lessons for the CFO

And herein lies the first lesson for CFOs. Assuming that Zhongwang’s sales figures are accurate and those of its customers could possibly be underreported, the chances are that the discrepancy will surface sooner or later. The Internet, mobile communications and other technological innovations will see to that. These days, it does not take much for an enterprising reporter or business newspaper eager to make a name to find things out.
Zhongwang perhaps should not have attempted to be so transparent at the granular level by identifying its major clients and specifying how much they bought of its products. Granted, quoting precise figures may have helped assure potential investors about the company’s prospects. But given the possibility that unlisted and private enterprises in China may be fudging their numbers for tax reasons, for example, disclosing aggregate sales is probably the better part of valour.
The Zhongwang saga also highlights the importance of managing expectations. When a company says a report will be completed in five weeks, make sure it happens. Investors, analysts and the media will hold you to it. And it’s not just the deadline. When you pledge to be transparent, everyone will hold you to that promise, too. Thus the stunned reaction when Zhongwang delivered the two-page statement on January 5, which was not only late, but simply told people to trust its audit committee’s judgement.
One can argue that the company did not, in fact, manage expectations. What it did was puff them up to the point that some observers probably expected the full Ernst & Young report to be made public.
Should Zhongwang release the full report so people can make up their own mind? The company has asked stakeholders and the media to accept its audit committee’s judgement that the same results will be gained even if Ernst & Young continues with its independent review. They are not buying it, if the stock market’s reaction is any gauge. Letting them see the report may help make them see where Zhongwang is coming from.
Or Zhongwang can simply hunker down now and wait for the brouhaha to blow over. That can happen, provided regulatory authorities in Hong Kong and China do not see the need to launch their own probes, as they have apparently decided is the case thus far. It may be that, in the eyes of its executives, the company has already played all of its cards and must now let the financial results do the talking.  
Other things are happening at Zhongwang. Overshadowed by the controversy was a February 9 announcement that a company subsidiary is close to buying an unnamed manufacturer boasting annual capacity of 120,000 tons of high precision hard aluminium alloys. Zhongwang aims to expand production capacity to 800,000 tons by 2011, but with this acquisition, its target may be achieved a year early.
As always, the best way to regain the market’s trust is to deliver sales and earnings growth and enhance shareholder value consistently year after year. But will stakeholders and regulators allow Zhongwang to move on?
About the Author
Angie Mak is online editor at CFO Innovation.  



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