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Firm's Woes Put Spotlight on Wall Street -- WSJ

1 Apr 2017 6:32 am

Chinese dairy firm has struggled following its listing in Hong Kong, led by Western banks
By Julie Steinberg 

HONG KONG -- The strange case of a Chinese dairy company whose stock collapsed last week is raising fresh questions about how thoroughly Western banks are vetting the Chinese firms they bring to market.

This week, China Huishan Dairy Holdings Co. said it lost contact with a top executive and was in talks with its creditors, following an 85% plunge in its Hong Kong-listed shares on March 24, which knocked $4.1 billion off its value. The drama comes just four years after the company's $1.5 billion initial public offering, which was led by Deutsche Bank AG, Goldman Sachs Group Inc., HSBC Holdings PLC and UBS Group AG.

It isn't known if regulators are looking at Huishan or the banks with regard to the IPO and the banks haven't been accused of wrongdoing; they declined to comment on the matter. Spokesmen for the Hong Kong stock exchange and its regulator, the Securities and Futures Commission, also declined to comment. A Huishan representative didn't return requests for comment.

Still, Huishan's troubles come after the regulator said in November that it would crack down on shoddy work by IPO sponsors -- a role that involves scrutinizing the financial health of companies planning to list.

"Some sponsors are not doing what they need to do to find out the truth behind apparent facts," when doing due diligence, said Syren Johnstone, a securities regulation expert at the University of Hong Kong. "The problems may surface soon after a listing or may take some years. In either case, the market and investors suffer."

The securities regulator in Hong Kong has been examining Morgan Stanley, UBS and Bank of America Corp. in connection with Chinese chemicals company Tianhe Chemicals Group Ltd., which they helped go public in the city in 2014 with a $748 million IPO, according to people familiar with the matter.

In January, the Hong Kong regulator sued UBS, Standard Chartered PLC and KPMG over alleged misconduct related to the 2009 initial public offering of China Forestry Holdings Co., which is being liquidated after its auditor found accounting irregularities.

The regulator is also looking at the 2009 IPO of China Metal Recycling (Holdings) Ltd., for which UBS was one of the sponsors, The Wall Street Journal has reported. The two companies raised more than $400 million combined.

UBS and Standard Chartered have said they are facing regulatory investigations for unnamed IPOs and there could be financial consequences. UBS has also said it may temporarily lose its ability to advise on corporate finance in the city. KPMG declined to comment on China Forestry.

Arranging IPOs has been the bread and butter of Western banks in Asia for years, although Hong Kong listings aren't especially lucrative. Fees average around 2.5% of the funds raised, bankers say, where the cut for typical New York IPOs is 6% to 7%.

Asia-based IPO bankers and lawyers say due diligence on Chinese companies -- especially verifying physical assets -- is often difficult. They say there isn't much they can do if companies present false information or deliberately mislead them.

Bankers say they have walked away from deals that weren't worth the risk in recent years, especially in light of 2013 rules that hold investment banks and bankers liable for false information in IPO prospectuses.

Chinese banks have also been scrutinized by the Hong Kong regulator. Earlier this month, the Securities and Futures Commission fined a unit of Bank of Communications Co. for incomplete due diligence on a prospective listing, which was rejected. The bank didn't respond to a request for comment.

Huishan, the battered Chinese dairy company, gained notice in December when short seller Muddy Waters Research said it overstated its profit and falsely implied in its IPO prospectus and elsewhere that it was self-sufficient in producing alfalfa, which is used as cattle feed. Huishan disputed the Muddy Waters report by saying it produces at least 90% of its own alfalfa and that its financial statements are accurate.

Tianhe -- a chemicals company that makes water and oil repellent used on smartphone screens -- was wooed by global banks eager to handle its flotation. But its shares were suspended from trading for more than a month soon after its IPO. In September 2014, an anonymous stock-research group alleged that the company kept two sets of books -- one for investors and one for Chinese authorities -- and overstated sales.

Tianhe denied the accusations, but trading was halted again at the company's request in March 2015 when it said it wouldn't be able to file its 2014 earnings on time. On Thursday, the company released part of its 2016 financials and said it was working to resume trading.

The Hong Kong regulator has asked Tianhe's sponsors, Morgan Stanley, UBS and Bank of America, about their due diligence ahead of the IPO, according to people familiar with the matter. One of the regulator's requests focused on the due diligence conducted by the banks on two sets of tax records provided by the company, one of the people said.

Separately, the U.S. Securities and Exchange Commission has looked into correspondence between Morgan Stanley's Asia private-equity fund and investors regarding Tianhe, in which the fund and its co-investors have a 8.9% stake, according to people familiar with the matter.

It isn't clear if the Hong Kong and U.S. probes into Tianhe will lead to disciplinary action and the banks haven't been accused of wrongdoing.

Morgan Stanley's private-equity arm, which invested in Tianhe in 2012, now values its stake at about $188 million, or about 60% of its original investment, according to a document from February viewed by The Wall Street Journal. In private off-market transactions, Tianhe shares are trading at between five and eight Hong Kong cents (US$0.006 to US$0.01) a share, according to a person familiar with the matter, or around 3% of the IPO price.

--Kane Wu and Wayne Ma contributed to this article.

Write to Julie Steinberg at julie.steinberg@wsj.com

(END) Dow Jones Newswires

April 01, 2017 02:32 ET (06:32 GMT)

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