Overdue diligence in China
Analysts can sometimes find it hard to do due diligence on Chinese companies. The language barrier, local regulations and differences in accounting standards all need to be dealt with. They also need to consider the distinct possibility they are being fed a large helping of absolute piffle.
Stories I’ve been hearing of late from a private equity friend who does due diligence on businesses in China underline the problems they can face.
For instance, my friend had to check on the supplies of one manufacturer. The company representatives took him to one of their warehouses in a Chinese city, showing him the boxes upon boxes of goods they had available. It was an impressive first stop, the chap thought. The next day the company took him to visit another warehouse in a nearby city and he found a similar situation.
But the following day, at a third warehouse, my friend smelled something fishy. The constant scrambling of employees in the back of the warehouse seemed strange, forcing him to dig deeper. By the end of the day, he had figured it out. The company did not actually have multiple warehouses piled high with goods, but instead had just enough to fill one warehouse, which it quickly sent via truck at night to fill the next warehouse before the chap arrived.
In a similar fashion, he visited the fleet of a shipping company that claimed to have a number of boats at its disposal. A quick glance at the dock made that appear so. But on closer inspection, some of the company logos on the side of the ships seemed too fresh. A quick chat with one sailor confirmed my friend’s suspicions. The company had paid off ship captains in the area to sport its logo temporarily.
The fact that these companies remain a going concern is the most alarming thing about all this. Due diligence? It’s long past its due date for some.