Why Do Fraudulent Firms Favor Frost & Sullivan?
Li Jun
/SOURCE : Yicai
Why Do Fraudulent Firms Favor Frost & Sullivan?

(Yicai Global) July 31 -- The Hang Seng Index has exceeded 27,000 points, and blue chips such as Tencent Holdings Ltd. [HK:0700], HSBC Holdings PLC [LSE:HSBA] and AIA Group Ltd. [HK:1299] were among those leading the H-share market's rise.

Despite its prosperity, the H-share market has been unable to free itself of frequent financial fraud cases at small and medium-sized enterprises. In recent years, several listed small- and mid-sized companies have changed their earnings and provided inauthentic financial data, thus inflicting significant losses on investors.

Many companies that have undergone long-term trading suspensions from suspected financial fraud -- Boshiwa International Holding Ltd. [HK:01698], Fujian Nuoqi Co. [HK:01353] and China Huishan Dairy Holdings Co. [HK:06863] -- have left investors feeling helpless, as hopes are slim that their shares will resume trading any time soon. Since listing, the share price of Miko International Holdings Ltd. [HK:01247] has dropped 90 percent, while that of Asiaray Media Group Ltd. [HK:01993] has declined 60 percent, causing investors to sustain heavy losses.

These companies that are implicated in financial fraud all noted in their listing information that they hired Frost & Sullivan to provide a market position advisory report.

The market background report, which companies disclose in their prospectuses, is based on a series of assumptions and can be used for reference only, insiders said. The consulting firm may also prepare a consultancy report in accordance with the needs of the company to be listed, and thus it may lack sufficient independence, they said. Investors are cautioned to avoid investing in the initial public offerings of companies if their consultancy reports are unreliable.

Blaming the independent industry consultants for the business or financial problems that have occurred at some listed companies is inappropriate, the relevant head at Frost & Sullivan told Yicai Global.

When asked how the relevant data and statistics are collected and how the objectivity and impartiality of the market position reports can be ensured when the consulting firm charges hundreds of thousands of yuan or even about a million yuan, Frost & Sullivan's head did not reply.

How Independent Is the 'Independent Industry Consultant' in the End?

China Huishan Dairy 'bought' a report for USD192,800 (CNY1.3 million).

"Frost & Sullivan independently compiled the report we commissioned without our influence," China Huishan Dairy, whose share price fell 85 percent on March 24, 2017 because of a debt crisis, said in its prospectus. "We paid CNY1.3 million to Frost & Sullivan, and we believe this expense reflects the market rate."

"Huishan Dairy Group, China's largest commercial alfalfa producer by output, produced 113,000 tons of alfalfa in 2012, representing about 28.3 percent of the domestic alfalfa production market. As of 2012, Huishan Dairy Group had China's largest commercial alfalfa cultivation base, covering an area of 8,000 hectares."

With the H-share IPO market still booming, many companies preparing for listing need market consulting reports and hire Frost & Sullivan to concoct them.

China Reading Ltd., which is to be listed on the H-share market and has issued its prospectus, was recently involved in a plagiarism incident related to the popular television drama Princess Agents.

With Tencent holding more than 65 percent of its stock, China Reading hired Frost & Sullivan. "We commissioned the compilation of this report at a cost of CNY600,000, and we disclosed the report with the consent of Frost & Sullivan," China Reading said in its prospectus.

"In 2016, among all the Chinese entertainment products adapted from online literary works, most were based on works from our platform (China Reading Ltd.), which include 13 of the 20 highest-grossing movies, 15 of the 20 most-watched TV series, 14 of the 20 most-watched network dramas, 15 of the 20 most-downloaded online games, and 16 of the 20 most-watched cartoons," the report said.

Ireader Technology Co. said in its prospectus that its operating income last year was CNY1.197 billion, its net income was CNY77.21 million and its expenditures for copyrights and content was CNY300 million. China Reading Ltd.'s operating income last year was CNY2.557 billion, its net income was CNY30.40 million and its expenditures for content were CNY840 million.

Ireader Technology's operating income alone was nearly half that of China Reading. Is China Reading really dominating the field of adapting online literature for entertainment products, as the report insinuates?

A media industry analyst expressed doubts about the report. Whether China Reading is leading the industry in a position as advantageous as the one described remains an open question, he said. China Reading is just one of many online literature companies in China, with others including Ireader Technology, Ali Literature, Chinese All Digital Publishing Group Co. and Baidu Literature, he said. As each platform uses its own metrics, China Reading's apparent advantage may not be recognized industry-wide.

Frequent Fraud

Frost & Sullivan have provided market status data consulting services for many Hong Kong-listed firms, including Boshiwa International Holding and Fujian Nuoqi Co., who were later linked to financial fraud cases, which caused trading of some of their shares to be suspended for years. Investors lost access to money they invested in these listed companies. Nuoqi chairman Ding Hui has gone 'missing.'

When Miko International Holdings moved into the children's garment industry, it cited a Frost & Sullivan report on its market share. Data cited by Miko and Boshiwa in their prospectuses 'conflicted.' After Miko listed, its performance fell as did its stock price. Miko has now become a penny stock.

The outdoor advertising industry position of Asiaray Media Group [HK:1993] that Frost & Sullivan provided was quite different from that given by other consulting firms. Asiaray's share price has fallen repeatedly since it listed.  

Market background reports disclosed in prospectuses are based on a series of assumptions, and can only serve as a reference, said Partners Financial Holdings Ltd. Chief Executive Wen Tianna.

"Many companies that listed in Hong Kong would have not passed the brokerage audits if they had IPOs on the mainland," an investment banking executive from a brokerage in South China told Yicai Global. IPO-bound companies can obtain their desired reports by paying hundreds of thousands of yuan to consulting firms and these reports are often beneficial only to the IPO-bound companies.

Although the IPO filing system in Hong Kong has many advantages over that of the Chinese mainland, the requirements for information disclosure in Hong Kong are not as strict as in the mainland, which requires enterprises to compare their financial data with that of similar listed firms in their industry and include information on gross profit margins, asset-liability ratios, accounts receivable, and inventory turnover. Companies looking to float need to explain significant discrepancies from their peers. Hong Kong does not have such strict requirements, and this has opened the door to fraud.

Before Nuoqi listed in Hong Kong, China Securities Regulatory Commission (CSRC) had rejected its application for A-share listing 2011, but this did not cause Hong Kong's watchdogs to prick up their ears. Within half a year of Nuoqi's 2014 Hong Kong listing its chairman Ding Hui vanished, sending its stock price into freefall.

CSRC said in its statement of reasons for rejecting Nuoqi's A-share listing, "Your firm was founded in 2004, creating N&Q clothing brand and your product sales were mainly in Fujian province. During the reporting period, your company's brand promotion fees and research and development costs were lower than those of listed companies in the same industry. Your company's sales model changed from mainly direct sales into franchise sales, the sales model transitional period was not long, and new franchise stores' profit was lower than the previous franchise stores. Since the investment projects will be used mainly for building franchise stores, there is a risk of reduced sales for your company's future expansion of the terminal stores across the country. In your application materials and hearing, your company failed to make full and reasonable explanation of the above issues, so we cannot adjudge how these will impact your company profitability and whether the equity investment projects will have good market prospects and profitability."

Repeated 'conflicts' appeared between data in the consultation report.

Despite this, Frost & Sullivan still provided market consulting services for Nuoqi. Nuoqi's prospectus said that the company commissioned the consulting firm for China Men's Market Analysis, for which it paid CNY700,000.

Before Nuoqi listed in Hong Kong in January 2014, market data it disclosed came under suspicion of 'exaggerating.' Without clear indication of the risk of the current situation of its peers, Nuoqi still described the men's market as a "thriving" scene. Nuoqi quoted the report saying that the retail revenue in the Chinese menswear market increased from CNY262.6 billion in 2008 to CNY467.3 billion in 2012, a compound annual growth rate (CAGR) of 15.5 percent. China's menswear market is expected to maintain strong growth from 2012 to 2017, and will exceed CNY1 trillion next year, with a CAGR of 16.8 percent.

Its peers also operating in Fujian gave a poor performance in 2013 due to sluggish demand, weak consumption and weather disturbances. The operating profit and net profit of Fujian Septwolves Industry Co. [SHE:002029] 2013 3Q fell 11.18 percent and 7.35 percent, respectively. The first-half profit attributable to shareholders of Chinese Lilang Ltd. [HK:1234] for 2013 decreased by 12.8 percent, its semi-annual report showed. The data Frost & Sullivan provided apparently conflicted with the industry's.  

Both Boshiwa and Miko hired Frost & Sullivan as their consulting firm, with also an unreasonable discrepancy arising between the data sets. Boshiwa later received imposition of a long-term trading suspension, while Miko's stock has maintained a low performance.

Based on data provided by Frost & Sullivan, measured by 2012 retail revenue, Miko's Red Boy brand retail revenue reached CNY960 million, ranking second in the medium and high-end children's clothing market to claim a market share of 4.3 percent. The retail revenue of Balabala, which ranked first, was CNY3.5 billion, taking a market share of 15.7 percent. However, in Boshiwa's prospectus, the top 10 companies in China's high-end children's clothing market in 2009 in data Frost & Sullivan provided show Boshiwa's sales reaching CNY569 million, making up a high-end market share of 7.7 percent to rank first.

From Boshiwa's prospectus in 2009 to Miko's prospectus in 2012 (disclosing only the industry's top four), the market share of Annil Co. [SHE:002875] changed from a second-place 7.6 percent to the third-place 3.8 percent, with sales upped from CNY490 million to CNY846 million. Red Boy, however, did not appear in the top 10 in 2009, but the sales revenue of Beijing Topnew Group Co. which ranked 10th in 2009, reached CNY45 million. 

The resulting problem was, namely Red Boy's retail sales in 2009 were less than CNY45 million, so how could Boshiwa's retail sales climb up to CNY960 million in three years?   

Miko's shares have plummeted by more than 90 percent since its listing, while Boshiwa is still under trading suspension as its delisting proceeds.

Asiaray plunged by nearly 60 percent. Who is the leader in outdoor media advertising?

Asiaray, listed in early 2015, with the flotation price of HKD6, which once climbed to HKD7.46 (USD0.77) when Hong Kong stocks hit a seven-year high in April. Two years later, the current share price was only HKD2.68, a plunge of nearly 60 percent compared with the initial price upon listing. Investors suffered heavy losses. Asiaray is also a client of Frost & Sullivan.

Asiaray's prospectus shows that in the ranking list of exclusive operated airports of major private media companies in the airport advertising market in Greater China in terms of numbers and revenue in 2013, Asiaray had the most airports at 25, and its advertising revenue from its exclusively-operated airports reached CNY510 million, while 'Company B' had five airports, with a revenue of only CNY60 million. 'Company A' engaged in operations of four airports, with a revenue of CNY360 million, but the prospectus does not disclose the names of the two companies.

The Qianhai Industry Research Institute published the 2014-2018 Analysis Report on Typical Business Model and Innovation Strategy of China's Outdoor Advertising Industry which ranked Airmedia Group Inc. (NASDAQ:AMCN) third, but Asiaray does not appear in its top 10. Airmedia published data which greatly contradicts Asiaray's prospectus. 

Airmedia operates television screens in 37 airports across the country, far more than Asiaray's 25. In operating income, Airmedia's total revenue in 2013 was USD276.5 million, with revenues from the airport digital framework of USD152.3 million, revenue from the airport digital TV screens of USD14.1 million, and USD64.8 million from the airport's traditional media.

Airmedia's revenue in the airport outdoor advertising is evidently close to CNY1 billion, far more than Asiaray's CNY510 million. Asiaray said it ranked first in the "list of exclusive operated airports of major private media companies in the airport advertising market in Greater China in terms of numbers and revenue in 2013." What is wrong with this picture?

At present, in the field of outdoor advertising market distribution, the more authoritative investigative institutions are CCTV market research CTR, Analysys International and so on, but outdoor advertising is a relatively large category and there is a certain controversy in a variety of subdivisions among rankings and its basis and unity in sampling are not the same, an outdoor advertising company executive told Yicai Global.

The quality of small- and mid-sized enterprises listed in Hong Kong has been of concern to investors. "Although some low-quality listed companies had negatively affected the reputation of the Hong Kong market, they account for only a tiny fraction of the market in terms of quantity, market value and volume," said Li Xiaojia, chief executive of Hong Kong Exchanges and Clearing Ltd. (HKEX), on July 23.

However, among the "very small" fraction of companies that Li cited, "a large proportion" are important clients of Frost & Sullivan.

"From a business point of view, the quality of listed companies relates to the best interests of the HKEX, and only a growing number of good listed companies can attract more investors and bring more trading volume to the Exchange, and there is no reason for the HKEX to relax listing approval to cheapen the long-term interests of the Hong Kong market," Li said.

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Keywords: HKEX , Market Regulation , Stock Market , Flawed Financial Service