19 April 2019
Dairy farm operator Huishan saw about US$4 bln wiped off its market value amid reports of liquidity problems and dodgy accounts. Photo: Huishan Dairy
Dairy farm operator Huishan saw about US$4 bln wiped off its market value amid reports of liquidity problems and dodgy accounts. Photo: Huishan Dairy

The straw that broke Huishan Dairy’s back

China Huishan Dairy Holdings (06863.HK) set a dubious record on the Hong Kong bourse last Friday as its shares plunged nearly 90 percent in the space of just over an hour.

The chill has been felt by a number of the Chinese firm’s creditors, such as Ping An Insurance Group Co. of China (02318.HK) and Far East Horizon (03360.HK).

Jilin Jiutai Rural Commercial Bank Corp. (06212.HK) saw its stock dive 8.7 percent on Monday. The small bank, it turns out, is the second largest creditor of Huishan, having extended more than 2 billion yuan in loans.

Huishan Dairy remains suspended from trade following last week’s tumble.

The dairy farm operator’s crash, from a certain perspective, was triggered by a report released by short-seller Muddy Waters Research Group, but in an indirect and unusual way.

Muddy Waters had in December published a negative report on Huishan, accusing the firm of faking a rare business model—self production of cow feed to achieve a higher profit margin — and suggesting that Huishan shares are almost worthless.

Based in the northeastern city of Shenyang, Huishan has claimed that it is self-sufficient in alfalfa (used to feed cows) by growing it in-house.

It’s widely known that alfalfa represents 60 percent of costs for dairy firms. Alfalfa self sufficiency hence would enable a company to boost the gross profit margin nearly 10 percentage points more than the peers.

The alfalfa self production niche was one of Huishan’s selling points when it launched its initial public offering in 2013.

Growing alfalfa requires a massive amount of land, the right climate and a lot of know-how. Currently, no other big dairy company has been able to do that.

Some people harbored doubts about Huishan’s claim but couldn’t get any real proof.

To find out the truth, Muddy Waters sent investigators to visit 35 farms, five production facilities and two production sites of Huishan.

The on-site visits showed that Huishan had stockpiled a large quantity of alfalfa imported from American company Anderson Hay in its warehouse. So Muddy Waters came to the conclusion that Huishan was lying and that it has been overstating its profits.

Still, Huishan’s shares had held steady after the report, until last Friday when the meltdown happened.

The immediate trigger for Huishan’s collapse was actually a news report that the Liaoning government convened a conference last Thursday with 23 creditor banks to discuss Huishan Dairy’s debt.

It’s rumored that its bankers had conducted an audit of the firm and found a large number of forged invoices and that the firm’s controlling shareholder had misappropriated up to 3 billion yuan to invest in Shenyang real estate market.

Shenyang property market happened to be the exception amid China’s real estate boom, as the city had a high level of inventory. Huishan was said to have suffered terribly from its property investments.

The company confirmed on Tuesday that it had missed some loan repayments and that it is having grave difficulties in raising enough cash. But it denied the fund misappropriation allegation.

Apparently, although the market didn’t take Muddy Waters’ report seriously earlier, the fresh news report drew the attention of Huishan’s lenders.

As they conducted auditing exercises to make sure things are okay, some of them accidentally discovered some irregularity in the firm’s finances, which eventually led to the share price crash.

Carson Block, founder of Muddy Waters Capital, said he was surprised by the share price plunge.

“It’s definitely not what I expected to happen. I haven’t ever been involved with a stock that holds this steady pattern for a few months after our initial report, and then just crashes with no advance warning — that’s the first time for me,” Block said.

This article appeared in the Hong Kong Economic Journal on March 28

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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