Published December 12, 2008

More clarity needed at Zhonghui

By LYNETTE KHOO

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ZHONGHUI Holdings investors are on tenterhooks - and for good reasons. First was news last week that United Overseas Bank (UOB) has demanded repayment of two outstanding loans totalling about $19.6 million. And second, there is worry over whether the company's proposed solution to meet the debt repayment will work.

The deadline for Zhonghui to repay UOB two outstanding sums - S$1.02 million and US$12.5 million (S$18.6 million) - is over and, to help address investors' concerns, the company needs to give an urgent update on its negotiations with the bank. In its letter of demand last week, which sought repayment within seven days, UOB said it is also seeking payment of interest accrued.

Zhonghui appears to have a solution at hand - which is to partially divest its 42.06 per cent stake in associate Baoji ZhongCheng Machine Tooling Co to repay the debt. But as shareholders are also clueless about the progress of this divestment, they will appreciate an equally urgent update on this issue. When contacted by BT, a Zhonghui executive declined to comment. The consolation is that the executive said an announcement would be made next week.

Shareholders are keeping their fingers crossed pending answers to this debt repayment issue and, hopefully, the company would also shed some light on the impact of the partial divestment on Zhonghui's profitability as well.

For fiscal 2007 and the first nine months of this year, Zhonghui would have been in the red had it not recognised profits from its stake in Baoji, due to a lack of secured contracts for its core business in solid waste treatment.

Paring down its stake in Baoji would translate to a smaller share of its profits, possibly hurting its profitability.

Zhonghui had said in April that it planned to divest a stake of up to 20 per cent in Baoji. But based on Q3 results, its investment in Baoji was 252.11 million yuan (S$54.7 million) as at Sept 30, so divesting a 20 per cent stake may not be sufficient to fully pay off the debt. And given current market conditions, it is unclear if Zhonghui could derive a fair value from the stake sale. The group may have to dispose of a larger stake.

Understandably, this divestment may be necessary for Zhonghui to stay afloat, but some disclosure on its impact is still warranted.

At this point, Zhonghui's share of profits from Baoji and its investment value have not been audited under IFRS accounting standards (prompting an audit qualification on Zhonghui's share of Baoji's results), which may complicate the pricing of its stake. Neither has the ownership of the shares been transferred from the vendor to Zhonghui yet, based on a filing with the Singapore Exchange (SGX) in April, so its entitlement to rights and benefits in Baoji shares appears to come under Chinese laws.

One wonders whether a Singapore-incorporated firm should be subject to Chinese laws when it comes to equity accounting. And given the significance of Baoji in Zhonghui's profitability, Zhonghui's auditors should perhaps carry out an audit on Baoji to verify if its numbers reflect a true and fair view.

Prompted by a query from SGX in April, Zhonghui explained that the request by its auditors to carry out an audit on Baoji was turned down because of 'confidentiality issues' as Baoji was in the process of preparing for its initial public offering. Baoji was slated to be listed this quarter or the first quarter of 2009, but there is still no news of it.

Coupled with this lack of clarity, the recent spate of sudden departures by Zhonghui's senior officers and external auditors also cast a pall over the group.

The group financial controller, Emily Ang, and two independent directors resigned in May. External auditors Horwath First Trust also notified the company in July of their wish to resign as auditors of the company.

Shortly after joining the board in May, new lead independent director Lim Lian Soon stepped down in October, citing unsatisfactory information flow from the executive directors, which makes it difficult for him to properly discharge his duties.

He said then that the audit committee could not obtain the support of the CEO to appoint a special accountant to help resolve certain issues, which included the default in paying the UOB loan, the issue of profit sharing in Baoji and the search for a buyer for the partial divestment in Baoji.

Such comments certainly raised eyebrows over a perceived lack of disclosure and urgency of management to resolve those issues.

Zhonghui has since appointed PricewaterhouseCoopers (PwC) as special accountants to conduct a limited review on its financial position and other issues in question. Hopefully, the PwC findings will soon shed light on these matters.

At this juncture, silence from the management now would do little to assure shareholders of its continued diligence in making sure the company can continue as a going concern.

While these uncertainties persist, shares of Zhonghui remain traded and investors have little information to rely on. Hopefully, it would not have to take another query from SGX to trigger a disclosure.