Crash Stock: New Lakeside 2 comments

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In the context of today's euphoric China stocks theme on the SGX, it may be pertinent to have some kind of reality check once in a while by looking back at the gloom and doom surrounding this very theme just one to two years back. Another theme that is hot now and cold then is IPOs. The CAO scandal had led to a crisis of confidence in China stocks, and a string of IPOs reporting poor results immediately post-IPO had led to a similar loss of confidence in IPOs.

New Lakeside was a new China IPO in March 2004, a confluence of the above two themes, and its subsequent performance (or lack of it) was arguably a strong factor in causing the abovementioned confidence leakage in China IPOs. The company's core business was in the production and apple juice concentrate and production of animal feed using apple pomace, with clients being big US companies which used the concentrate in their various F&B products. The company IPOed at the price of $0.34, on the back of a dramatic threefold surge in FY03 revenue and profits (RMB200M and RMB30M respectively). NTUC was one of its substantial shareholders which helped shore up retail interest in the stock.

Later it emerged that the company had increased revenue so much in FY03 because it had deferred a substantial amount of sales orders fulfilment from 2002 into 2003, the reason being to "take advantage of the zero-rated anti-dumping duty for exports to the US". This was stated in the IPO prospectus and investors should learn to read such documents, which are actually legal documents (the company can be sued if it gets the facts wrong inside), and not just concentrate on the colour pages at the front offering rose-tinted views of the company.

But the worst shock New Lakeside investors received was in the interim 1H04 results several months after its IPO, which showed an unexpected loss of RMB9M (as opposed to a RMB6M profit in FY03). This included trade debtor provisions amounting to RMB8m, higher distribution costs and finance costs.

This shock set of interim results brought several issues into focus, most of them corporate governance-related, which would later form the background of fear that would overshadow the rest of the year (and brought to a crescendo by the CAO scandal). Firstly, SGX pointedly asked why the company had continued giving indications as late as end August 2004 (the 1H04 results were released in mid-September) that "there was no information that would have a material bearing on investors' decision which had yet to be announced by the Company" when such heavy provisions were eventually made; the company's reply that its auditors had only pointed out the need for such provisions very near the results announcement date, to me, was unconvincing to the neutral observer. Indeed, the market seemed to have already anticipated the poor results, dropping to <20 cents by end-July at an apparently irresistable 5X trailing PE (that was before the shocker set of 1H04 results). Secondly, the issue of companies giving timely profit warnings as early guidance and a form of transparency was also highlighted, something which New Lakeside's board had failed entirely to do, while its IPO brokers GK Goh churned out rosy reports on the company and slapping a now-ludicruous 48-cent price target on it. Thirdly, the fact that the provisions had to be made at the last minute on the advice of external auditors (Moore Stephens) showed up the laxity in Chinese accounting standards. Accounts of New Lakeside's subsidiaries were kept according to Chinese accounting standards and had to be consolidated and adjusted to meet Singapore standards; it was through the consolidation process that Moore Stephens decided that the RMB8m debt provisions had to be made due to the long-standing nature of the debts. This meant that unaudited statements from Chinese subsidiaries might not be adequate for measurement of company performance, due to significant divergence from the Singapore FRS accounting standards. Fourthly, the responsibility on IPO managers to ensure the quality of their listings was highlighted.

The onus on independent directors to force management changes when necessary was the only plus point illustrated in this whole episode, as the managing director and CFO were forced to resign in an EGM by the largely Singaporean independent directors for the poor financial management at the company's China subsidiaries (the former was later reinstated).

New Lakeside has never recovered from that debacle. It went on to make full-year losses in FY04 and FY05; for the latter it lost close to RMB100M, including another set of writeoffs amounting to ~RMB30M. Those holding the stock are effectively "stuckees", both in price and trading liquidity; the stock is at 5 cents and zero volume on most days, hence offering no means of exit for holders. An example of a company where things just get from bad to worse, it also offers the classic warning tale of putting one's money into a China stock with no post-listing track record.

References:
(1) Business Times articles Sep till Nov 2004, covering New Lakeside