Published September 12, 2008

Closure to China Energy saga may be premature

By LYNETTE KHOO
Email this article
Print article
Feedback

THE update by China Energy on the measures taken to strengthen internal controls and corporate governance is the right way forward, keeping shareholders in the know of where the company is heading.

While this sets the tone for closure to a chapter marred by unapproved and undisclosed payments, it has not fully addressed several related concerns.

It all started with the discovery of an additional payment of 191 million yuan (S$40.3 million) by China Energy in its acquisition of Jiutai Guangzhou - which was paid without approval or knowledge of its audit committee (AC) and unaccounted for in its financials. The AC engaged PwC in March to probe into this.

In its review, PwC said that the bulk of these payments went to a key contractor for the construction of Jiutai Guangzhou's dimethyl ether (DME) Phase 1 plant. This contractor is 60 per cent owned by the brother-in-law of China Energy chief executive officer Cui Lianguo.

PwC found no irregularity in the payments, but it stressed that certain approval processes in the group could be improved and advised that the board of directors take measures to enhance or strengthen such processes.

While investors should be pleased with the efforts made by the group to implement those recommendations, they should not hastily close this chapter yet as some questions are still up in the air.

For one, the acquisition of Jiutai Guangzhou was funded by IPO proceeds and the payment went far and beyond the amount set aside for it. Although China Energy had agreed to pay 197.8 million yuan in November 2006, an additional 191 million yuan was coughed out from the IPO coffers - possibly being channelled from some other uses.

This begs the question why the use of IPO proceeds could differ from what was presented in the IPO prospectus.

Since shareholders have bought into the IPO based on information in the IPO prospectus, it is only fair that their approval is sought or a timely update be given on a change in the use of funds. Otherwise, what protection is there for those who buy into an IPO and how much can they take the prospectus at its word?

And on the face of it, some conditions of this acquisition might not have been met. According to the IPO prospectus, the acquisition was conditional upon the eventual payment not exceeding 220 million yuan (110 per cent of the estimated sum) or it would require the approval of the AC and shareholders. The company also said that it did not expect any material difference in price save for any land revaluation difference and an additional capital injection of 51.7 million yuan, which was effected in September 2006.

But the total payment turned out to exceed the cap and the price difference was due mainly to debts owed by the target company for its plant construction. The fact that this acquisition still went through despite some unmet conditions is something that regulators should be mindful of.

It is unclear if SGX has taken up this matter privately with China Energy, since it does not usually disclose its dealings with individual companies. But if private sessions touched on these issues, then information should not be kept behind closed doors. This is so since it concerns shareholders' entitlement to the terms set out in an IPO prospectus.

More disclosure at the public level will also help reassure investors over Chinese listcos, given that Chinese IPOs form the bulk of foreign listings here.

And if the PwC executive summary - the only part of the review that is disclosed - cannot provide all the answers, then making the full PwC report accessible to the investing public may be necessary to provide a fuller picture.

It is also worth noting that since the PwC review was released, subsequent filings pertaining to this matter have been issued by group CEO Mr Cui, instead of the audit committee that engaged PwC. SGX should consider if it is best for a management executive to be the one driving announcements on a review on the use of funds by the management itself.

Surely, this gives rise to the appearance of a conflict of interest. Adding to this view is the fact that the acquisition of Jiutai Guangzhou is an interested person transaction involving Mr Cui, who owns controlling stakes in China Energy and the former vendors of Jiutai Guangzhou.

If these concerns are not adequately looked into, a closure to this episode could be premature. More transparency and disclosure is necessary to provide that clarity.

Strengthening internal controls and corporate governance is certainly a good thing, but resolving persisting issues surrounding these efforts is just as crucial.