Wednesday, December 08, 2004

The CAO scandal is interesting, but I think it really isn't a big deal. First of all, if their business is oil, they are most likely profitable in their real business. True, they lost half a billion dollars, but the government can certainly handle it. Below is a hypothetical scene in the State Council:

CEO of CAO: Eh, we lost like 4 billion RMB due a "small minority of people" making a mistake.
Wen: This is very bad. We must maintain international confidence in China by paying off this amount immediately. Xiao Zhou, please take care of it.
Zhou Xiaochuan: Okay, the PBOC will increase relending to Bank of China, and it can make an emergency loan based on the relending to CAO. We will charge the BOC 2.25% in interest, and BOC can charge CAO up to 4% in interest.
Li Lihui (CEO of BOC): Okay, meanwhile, we will roll over any loan CAO had with us so that it does not become non-performing.

Duration: 2 minutes and 30 seconds

Commentary: Is China on the verge of its own Enron scandal?By William Pesek Jr. Bloomberg NewsThursday, December 9, 2004 http://www.iht.com/bin/print_ipub.php?file=/articles/2004/12/08/bloomberg/sxpesek.html
In 2002, China Aviation Oil (Singapore) was named Singapore's most transparent company by the island's Securities Investors Association. No doubt the group is regretting that decision.
The Singapore-based company is being investigated for losses from speculative oil trading that it hid from investors. The $550 million derivatives-trading loss is Singapore's biggest since the trader Nick Leeson brought down Barings in 1995 with more than $1.4 billion in losses. Former Prime Minister Goh Chok Tong says the city's reputation as a financial center will rest on how it handles the inquiry.
Yet China Aviation Oil's story may say less about Singapore than about the risks of investing in the Chinese economy. Could the affair turn out to be the Chinese equivalent of the Enron debacle?
While allegations have yet to be proven in court, the scandal could prompt reassessment of an entire economy and its companies, just as Enron's collapse did in the United States.
China Aviation Oil's woes show how challenges in the Chinese economy can undermine other markets. Hundreds of state-owned Chinese companies have sold shares in Hong Kong, New York and Singapore. China Aviation Oil - a foreign unit of a Beijing company - is a reminder that transparency and corporate governance at such enterprises can be inadequate.
"Complex corporate structures and unreliable accounting practices make it difficult to perform substantive analysis on some China-related companies," Standard & Poor's said last week. "On the accounting side, the problem of limited disclosure is compounded with problems of compliance."
That's not the image many investors have of the world's most dynamic economy. Its 9 percent growth rate and rapidly growing influence in global affairs have convinced the worldliest of executives and investors that China is a risk they can't afford to bypass.
China is the national equivalent of Internet companies during the late 1990s. Investors and corporate executives seem to have little time for a discussion of the risks. 'China.com' is Asia's New Economy and anyone who doesn't see that is a fool.
The Chinese boom may be prompting a sequel to the "Jeff Vinik Effect" that pervaded stock markets in the 1990s. Vinik used to manage Fidelity Investments' flagship Magellan Fund. He grew bearish on technology stocks in 1995 and loaded up on bonds.
The bond market soured, technology shares boomed and Vinik resigned in May 1996 as Magellan's performance plummeted.
The episode became all too common during the Internet boom. At the time, even Warren Buffett was being dismissed as a dinosaur for saying he didn't understand dot-coms and their creative accounting. Skeptical fund managers held their noses and bought shares in dodgy companies.
It's hard to ignore China's potential. That is why everyone from executives at Wal-Mart Stores to the smallest venture capital firm in Silicon Valley is spending more time in there nowadays.
Yet, its equity markets are a work in progress. Its bourses are fragmented, at times illiquid and vulnerable to speculative mania. There's also little correlation with China's growth rates and the performance of equity markets. And corporate governance can be a contradiction in terms.
Hence, many people invest in Chinese companies through the markets of third countries. Institutional investors are now painfully aware that the strategy doesn't always work. China Aviation Oil disclosed its trading losses a month after its state-owned parent - China Aviation Oil Holding - sold 196 million Singapore dollars, or $119 million, shares to investors. Buyers included Temasek Holdings, Singapore's state-owned investment company.
Judging from China Aviation Oil's stock, investors had few questions with management. Shares more that tripled between December 2001 and late November when it announced its trading losses. Company officials knew of their losses last month when predicting that profit this year would outpace last year's results, the Financial Times reported. All of this surely sounds Enron-esque.

Temasek and China Aviation Oil's parent company are now being asked for a $50 million handout. If Temasek does contribute, that may have more to do with improving ties with China than with economics. Temasek, after all, could lose even more if the company fails. And Singapore has much riding on its relationship with China; trade between the countries grew more than 30 percent in 2003.
The last thing China wants to see is a globally-known company that supplies a third of its jet fuel and that is listed overseas, go bust.
Whatever the company's fate, though, the China Aviation Oil scandal is a wake-up call for those who think Chinese growth is risk-free, and for those who thought investing in other countries' markets would shield them from ugly surprises. If more abuses are unearthed, investors could be in for a rude awakening.

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