More red flags for Carlyle's China portfolio

SINGAPORE: More Chinese companies in the Carlyle Group's Asia
portfolio have had questions raised about potential weaknesses in their
accounting practices or financial controls, bringing further scrutiny to
the private equity firm's investments across the country, Reuters
reported on Monday, July 25.
Carlyle, invested in more companies in China than any other private
equity firm, is not alone in having to sort out parts of its portfolio.
Several other major foreign players there have been caught up in various
accounting issues that surfaced in the last few months.
In Carlyle's case, though, it has already seized the headlines this
year after fraud allegations were levied at China Forestry and China
Agritech in high profile accounting-related cases, dealing a blow to the
Washington D.C.-based firm's image.
Now two other Carlyle companies in China have come under scrutiny in
the last few months. While questions raised at Carlyle's Concord Medical
Services and China Recycling Energy are less serious than the two high
profile cases, they have gained the attention of major auditors.
Last month, Ernst & Young said in the annual report of Carlyle
investment, Concord Medical Services that the China-based company has
not maintained effective internal controls over its financial reporting
due to a lack of staff with knowledge of U.S. accounting rules.
And in April this year, U.S-listed China Recycling Energy had to
refile its 2009 annual report after it failed to set out a full enough
assessment of its internal controls in line with SEC requirements.
A Reuters examination of China Recycling Energy's SEC filings show
auditor Deloitte raised a series of questions about the company's
accounting practices in 2009. Deloitte's contract as auditor was
terminated due to a misunderstanding after just three months.
ONGOING INVESTIGATIONS
Hong Kong-listed China Forestry shares have been suspended since
January following allegations of accounting irregularities. The company
is now in the process of trying to rebuild investor confidence and
offered earlier this month to buy back up to $120 million of bonds.
China Agritech was delisted from Nasdaq in May for failing to file
its annual report on time. An independent investigation is now looking
into allegations made by short-sellers that the company misled investors
about the size of its fertilizer business.
Carlyle remains an investor in the company, although its board representative, Anne Wang, resigned as a director in March.
Carlyle told Reuters that it is committed to helping all companies in its Chinese portfolio become international names.
"We are long-term investors in China and are committed to creating
value for all our portfolio companies," said Carlyle's Hong Kong-based
spokeswoman Dorothy Lee.
"It takes experience, patience and persuasion to guide portfolio companies on their path to internationalization."
Carlyle, with $107 billion under management, has been very active in
China and is currently invested in 31 Chinese companies across its Asia
Buyout and Asia Growth funds, a huge amount compared to other
competitors that have two or three to their name.
Carlyle's investment in China Pacific Insurance, could be one of its most successful of all time..
The firm has invested in companies such coffee and doughnut chain
Dunkin' Brands, rental car company Hertz and UK pharmacy chain Alliance
Boots. In Asia, Carlyle invests its buyout, growth capital and real
estate funds across the region.
In Greater China, it has offices in Hong Kong, Shanghai and Beijing.
DELOITTE'S SHORT STAY China Recycling Energy, which until 2007
was a mobile phone company called China Digital Wireless Inc, went
public on the over-the-counter bulletin board in the U.S. via a reverse
takeover in 2004. In March 2007 it changed business models, moving
into the energy saving and recycling industry. Eight months later it
said Carlyle was to invest, causing its share price to almost double
from $1.67 to $3.05. The company announced in May 2009 it was
changing auditor and bringing in Deloitte Touche Tohamatsu, one of the
world's "big four" accounting firms. "This also marks one of the
rare instances in which Deloitte has agreed to provide services to a
micro-cap Chinese company, demonstrating CREG's (China Recycling Energy
Group) ability and commitment to implement internal financial controls
that meet global standards," the company's CEO and Chairman Guohua Ku
said in a press release.
Three months later, Deloitte wrote to the company saying it
considered itself dismissed after China Recycling Energy announced its
previous auditor, California-based Goldman Parks Kurland Mohidin (GPKM),
was going to prepare its second quarter report.
Deloitte then flagged that during its brief stint as auditor it had
identified five different areas of "potential misstatements" for the
company's 2007 and 2008 results.
The issues raised by Deloitte were technical points, including how
the company accounted for revenue from the leasing of its energy
recycling systems.
Deloitte said it had discussed this and other issues with Carlyle's
nominee on China Recycling Energy's board, Nicholas Shao, yet did not
feel they were resolved at the time its contract ended.
China Recycling Energy did then restate its 2008 earnings, although
the company indicated that in some areas it and auditor GPKM disagreed
with some of Deloitte's points.
While the issues raised by Deloitte were highly technical, the
company's restated 2008 earnings meant it booked a loss for the year
instead of profit as originally reported.
"Net income of $1.8 million originally reported turned into a loss of
$2.2 million. That is a pretty significant change," said Paul Gillis,
visiting professor of accounting at Peking University and a former
partner at PricewaterhouseCoopers.
"There is no indication, however, that the company was trying to deceive anyone or that any kind of fraud was taking place."
Gillis added that it is common for a "big four" auditor such as
Deloitte to uncover these kind of issues that smaller accounting firms
might have missed.
China Recycling Energy subsequently transferred from the
over-the-counter market to the main Nasdaq global board although its
share price has fallen 64 percent since the move, last trading around
$1.98.
The company said in SEC filings that Deloitte has done some
consulting work for them since their audit contract ended, although
Deloitte's Hong Kong spokesman Wilfred Lee said they could not confirm
this due to client confidentiality.
STAFF SHORTAGE
Concord Medical Services, which Carlyle has been invested in since
2007, released its 2010 annual report on June 29, one day before the
final deadline for U.S.-listed stocks.
In the report auditor Ernst & Young, Hua Ming said the lack of
appropriate staff in its accounting unit with required knowledge of U.S.
accountancy standards meant the company "had not maintained effective
internal control over financial reporting as of December 31, 2010."
This is a fairly common problem for China-based companies listing in the U.S.
"China is really short of qualified accountants to begin with, and
there are not nearly enough with U.S. GAAP (generally accepted
accounting principles) expertise for all of the Chinese companies listed
in the U.S," said Peking University's Gillis.
The company, which operates radiotherapy and diagnostic imaging
centres in China, has flagged this as an internal weakness ever since it
went public in December 2009 and repeatedly said it is trying to remedy
it.
Its shares have also struggled. Having priced its IPO at $11.00 a
share, its shares hit an all-time low last week of $3.43. - Reuters