A Red Star comes crashing down

When aluminium giant China Zhongwang Holdings went public in May last year with a $1.3 billion IPO — the world’s largest in months — it was celebrated as a coming-out party for a Red Star, a success story wholly made in China.

The timing of the offering, when the IPO market was down and out amidst gloom-and-doom scenarios for the global economy, was seen as a sign of the supreme confidence — even audacity — of Asia’s largest manufacturer of aluminium extrusion products.

But barely months later, the Red Star has come crashing down to earth, its reputation in tatters, with a galaxy of unanswered questions about its financial probity, and with private investigators snooping around for evidence of crime.

Symbolising Zhongwang’s fall from grace, the company’s shares slumped 27% on the Hong Kong stock exchange on Tuesday, when they resumed trading after a suspension of more than a month. By the day’s end, they were quoted at HK$5.87, down 16% from the IPO price of HK$7.

Investors dumped Zhongwang’s shares, unconvinced by the company’s reiteration late on Monday that a review of its accounts by consultancy firm Ernst & Young had found “no deficiencies” in its pre-IPO financial statements.

“Zhongwang’s case is symptomatic of the problems that Chinese companies face when they step out of a bubble into the real world —- and feel the harsh light of transparency of the sort they’re not used to,” an analyst in a leading investment bank told DNA Money.

Zhongwang’s troubles began in September when a Chinese newspaper carried a sensational expose claiming the company had, in its IPO prospectus, made false claims in respect of its customers. The 10 biggest ‘customers’ named in the document had in fact not bought from the company in 2008, the report claimed.

Zhongwang officials denied the claims and extracted an apology from the newspaper. A statement issued at that time noted that “the allegations” in the article were “false”.

The company and its directors “reaffirm that they accept full
responsibility for the accuracy of the information contained in the prospectus,” it added.

It also went on a public relations offensive, marshalling management representative of four of its biggest customers at a press conference to validate its claims about their business relationship. Yet, investors’ concerns lingered.    

Investors, including hedge funds, even hired securities firms and private investigators to confirm Zhongwang’s claims in respect of its customers. The evidence they unearthed in some cases conflicted with the company’s claims in its IPO prospectus.

Zhongwang’s shares fell as investor confidence retreated again.
In November, Zhongwang announced it had hired Ernst & Young as an external auditor to conduct an independent review of its sales transactions with its 10 major customers during 2008 and 2009, but the effort —- intended to restore investor confidence —- backfired. Zhongwang trumpeted E&Y’s certification that it had found “no material deficiencies” in the IPO prospectus.

However, the authenticity of that clean-chit was sullied by the auditing firm’s observation that it found some “external limitations in its verification procedures which require certain information of independent third parties.”

Zhongwang stuck to its guns, noting that its audit committee had considered E&Y’s views and concluded that “such limitations would not affect their conclusion in relation to the independent review” under Chinese laws. It further claimed that there were “sufficient documents and evidences” to support its statements in the IPO prospectus.

Trading on the company’s shares were suspended early in January, but the month-long hiatus has done nothing to ease investors’ worries —- as the stock’s performance on Tuesday revealed.

“Investors are desperately hoping that Zhongwang will ‘say it ain’t so’,” the analyst told DNA Money. “But the company appears to be looking to brazen it out.” It was, he said, a ‘clash of cultures’ —- one that will be played out many more times as Chinese Red Stars step out into the world.