Illustration: Luo Xuan/GT
On March 24, shares of China Huishan Dairy Holdings Co slumped more than 80 percent on the Hong Kong Stock Exchange before the company suspended trading. The sudden plunge, which wiped out about HK$32 billion ($4.1 billion) of the firm's market value, came three months after US investment research company Muddy Waters released a report accusing Huishan of financial fraud. The question then is why Huishan's shares didn't crash until now.
When Muddy Waters said in mid-December that it was shorting Huishan's stock, it alleged the company had engaged in financial fraud and inflating profits given its flawlessness in business operation. Meanwhile, Huishan's products have a good reputation in terms of quality among the dairy industry, indicating that flawed products or market operations did not offer motivation for financial overstatement.
Then what was the purpose of Huishan's falsified financial statement? Looking back at the beginning of Huishan's listing, many high-profile investors in Hong Kong bought shares but all sold their stakes after the lock-up period. Meanwhile, Yang Kai, founder and controlling shareholder of Huishan, increased his holding from 50 percent to nearly 75 percent. According to Main Board listings rules in Hong Kong, "at least 25 percent of the issuer's total number of issued shares must at all times be held by the public." Yang bought up almost all the shares subscribed by its cornerstone investors in the Hong Kong listing, and he had to, because if those major shareholders didn't do anything, Huishan's share price would have slumped substantially. Considering that the capital Yang used to buy those shares could be financed by using his company shares as collateral or guarantee for bank credit, it was necessary to keep the share price of Huishan at a relatively high level.
According to Huishan's balance sheet and cash flow statement, the company's debt structure is imbalanced with its proportion of short-term borrowings much higher than that of long-term borrowings. It shows that the agriculture and husbandry company, despite being listed, still doesn't have much collateral qualified for obtaining long-term borrowings from domestic financial institutions. Meanwhile, Huishan's investment in dairy cattle raising and milk processing are long-term inputs, which forced Huishan to use short-term borrowings to support its long-term investment, posing high risks and pressure on the company's cash flow and capital chain.
It was in 2016 that Huishan's cash flow statement showed that new loans and loan repayments surged sharply, representing tension on its capital chain.
Huishan's experience reflects a common phenomenon currently faced by China's private enterprises. On the one hand, they don't have much choice in regards to financing channels. In addition to bank credit, private firms can only rely on high-cost financing from non-bank financial institutions, further eroding their already meager profit margins and suppressing them from becoming bigger and stronger. On the other hand, although private enterprises have recognized that public listing is a good way to obtain financing, they cannot make full use of their status as listing companies due to the lack of necessary experience and management flexibility in the capital market, apart from issuing stocks and raising debts. The recent case of Huishan has not only put forward new requirements on bank and other traditional financial institutions on how to more effectively support the transformation and upgrading of the real economy, but has also raised the standards on private firms' own business operations and the capital market development.
While triggered by the Muddy Waters report, the sudden crash in shares of Huishan is rooted in the lousy financial conditions for China's private enterprises from the real economy, as they have to worry about their capital chain and sometimes even make dangerous moves. Even though the State Council, China's cabinet, has repeatedly urged financial institutions to support the real economy, financial institutions are still inclined to choose to lend big loans to enterprises with implicit government guarantees for the purpose of their own asset safety. If these financial institutions could strive to offer support to the real economy, especially private enterprises, the prospects of the Chinese economy will be brighter.
The author is director of Chanson&Co, a boutique investment bank in Beijing. firstname.lastname@example.org