Caterpillar writes off most of China deal after fraud
Caterpillar Inc uncovered "deliberate, multi-year, coordinated accounting misconduct" at a subsidiary of a Chinese company it acquired last summer, leading it to write off most of the value of the deal and wiping out more than half its expected earnings for the fourth quarter of 2012.
Shares of Caterpillar fell 1.5 percent in afterhours trading following news of the fraud, which was discovered after problems were found with the Chinese company's inventory. Caterpillar, the world's largest maker of tractors and excavators, said it would take a non-cash goodwill impairment charge of $580 million, or 87 cents per share, in the quarter.
Analysts had expected the company to report $1.70 per share when it reports its results. Caterpillar closed the purchase of ERA Mining Machinery Ltd and its subsidiary Siwei, China's fourth-largest maker of hydraulic roof supports, last June, paying HK$5.06 billion, or $653.4 million. ERA had been publicly traded in Hong Kong, doing business through Siwei, which is known for making equipment to support roofs in mines. A member of the Caterpillar board during the course of the Siwei deal said the board was distracted at the time by a larger transaction and paid relatively little attention to the Siwei acquisition.
"It came as a complete surprise to us," the former board member said of the fraud, speaking on condition of anonymity because of the sensitivity of the situation. "It was presented to us as a pretty straightforward transaction. It's a shame. It should have been investigated further." The source said the driving force behind the deal was Ed Rapp, the former Caterpillar chief financial officer who now serves as a group president with responsibility for China, among other operations. The source said it was Rapp who presented the deal to the board and pushed for its completion.
A Caterpillar spokesman declined to comment on Rapp's role in the deal. Rapp could not be immediately located for comment. At the time of the Caterpillar purchase, ERA Mining was listed in the Growth Enterprise Market (GEM) of the Hong Kong stock exchange, which is "designed to accommodate companies to which a higher investment risk may be attached," according to the offering circular filed by Caterpillar last year in Hong Kong.
The company was previously known as ERA Holdings Global Ltd. and provided "corporate secretarial services" before being acquired by Siwei in September 2010 through a reverse takeover. Caterpillar's write-off could revive concerns over accounting scandals and corporate governance issues of Chinese companies voiced by investors including Muddy Waters founder Carson Block. Reverse takeovers have been of particular concern, since most of the recent account- ing scandals in the United States have come from small Chinese companies who went public via a reverse takeover, including China MediaExpress Holdings Inc. A Hong Kong arbitration panel ruled China MediaExpress was a "fraudulent enterprise."
In a statement, Caterpillar said an ongoing investigation launched after the deal closed "determined several Siwei senior managers engaged in deliberate misconduct beginning several years prior to Caterpillar's acquisition of Siwei." According to a question-and-answer dialog Caterpillar included in its statement, the company found discrepancies in November between the inventory in Siwei's books and its actual physical inventory, triggering the probe.