Tuesday, July 12, 2005

Crash stock: CAO 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
There has been a series of stock scandals on the Singapore stock market over the last two years which has put one in serious doubt about the regulatory vigilance of the SGX. This is however another story for another day; I shall talk instead about the biggest scandal of them all, China Aviation Oil.

The dust over the CAO scandal has more or less settled, with blames being apportioned, independent inquests complete and creditors accepting the proposed schedule of payments. However, the figure US$550 million will forever be imprinted in the minds of unfortunate CAO shareholders.

This was the amount that CAO, in an announcement in Oct/Nov 2004, declared it had lost through derivatives trading (oil-related) over the past year. The stock had been suspended earlier in the day, and has not resumed trading since. What was the significance of this figure of US$550M? It was more than 3 times the net assets of the company, and about the total market capitalisation of the company before it was suspended (at 96.5 Singapore cents a share). With this announcement, a company which was seen as an emerging blue-chip by long-term investors was rendered insolvent (actually that is an understatement). This was a bolt out of the blue; over the next few days the CEO Chen Jiulin went missing (he returned to China, then came back), the papers had a field day, and China-linked stocks sank.

A post-mortem of this scandal must include a discussion of a few glaring issues. Firstly, why were the losses allowed to spiral upwards so uncontrollably? Apparently CAO had a vaunted risk management system but which appeared to have been circumvented by its CEO. Hedging instruments became speculative positions. Consequently, as oil prices continued their incredible spiral upwards through 2004, so did CAO's derivative losses as it made wrong bets on the price direction.

Secondly, it appeared that there were two versions of its 3Q04 results, one for internal consumption and the other for public announcement. The former, of course, captured the full losses due to the derivatives trading, while the latter took it off the balance sheet and P&L. The CFO, with his CEO's acquiescence, published the latter. If a past winner of the most transparent company award had such a practice, then the question begs: who else?!! Apparently, I heard from an auditor friend based in China that preparing several versions of financial statements for various contexts is a common practice for China companies.

Thirdly, in the frenzied trading in the stock over the month culminating to the CAO shocker, the holding company CAOHC placed out about S$100M worth of its CAO shares. Clearly this was a case of insider trading and indeed in later interviews they admitted as such. One might well have taken the insider placements as a danger sign to exit any positions and hence avoid the debacle that was to occur. The question leading from this issue is: will geographical technicalities and political sensitivities prevent action from being taken against the insider traders? Perhaps we will find out as the case for several of CAO's directors (and also concurrently CAOHC's) commences, in the near future.




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