Kangmei Pharmaceutical Co. (600518.CN) dropped a bomb on its investors last week, announcing that it had massively overestimated its cash holdings by over 30 billion yuan (US$4.44 billion).
In a letter to shareholders, the company said that an accounting “error” led to an overstatement of its 2017 cash position to 34.15 billion yuan, but the actual cash position was only 4.2 billion yuan.
Involving one of China’s top drupmakers, this could be one of the biggest scandals in China’s domestic equity market.
Kangmei was founded by Ma Xingtian in 1997. The private sector drugmaker has long been labeled one of the nation’s most successful.
The company was listed in Shanghai in 2001, with a market cap of 890 million yuan. Following its successful launch of several new drugs, Kangmei’s market cap zoomed beyond the 100 billion yuan mark in 2015, making it China’s most valuable listed drugmaker. Its market cap further surged to 140 billion yuan last May.
As the company becomes increasingly popular with investors, its financial reports are also getting more closely scrutinized.
In fact, there had been a few suspicious points before the latest bad news broke.
For example, the company had an outstanding loan of 22.2 billion yuan by the end of 2017, while it claimed a cash position of 34.15 billion yuan, begging the question why the company did not use part of its massive cash position to reduce the large debt pile.
Kangmei’s interest income was only 270 million yuan in the period, which is less than 0.8 percent, much smaller than the benchmark deposit rate of 1.35 percent.
The company also disclosed a large amount of connected transactions. All these are typical warning signs.
Kangmei finally caught the attention of the China Securities Regulatory Commission. In January, the watchdog formally asked the company to explain.
Market participants soon became aware of the problem but still thought it would not be that serious. After all, we are talking about one of the country’s champion drugmakers.
It might just be some sort of warning from the authorities, some thought.
Suddenly, company chairman Ma revealed in a letter to shareholders on May 1 that it had overstated the revenue by 7.66 billion yuan and cash position by almost 30 billion yuan in its 2017 report, due to “previous accounting error”.
This jumbo-sized fraud must have involved major shareholders, company management, auditors, or even regulators.
Ma did not elaborate on what had led to such a huge “accounting error”, except to explain vaguely that “rapid expansion has led to loopholes in internal control and financial management”.
Industry insiders noted that drug making is a capital-intensive sector, and pharmaceutical firms need to spend heavily on new drug R&D and testing. It takes years to get a return on investment, if the drugmaker is lucky enough to get approval.
Kangmei might have problems with keeping a steady flow of new drugs in its pipeline and chose to cover the bad news by cooking its books.
In fact, such fraud is nothing new in the industry. Theranos, the blood-testing company founded by Elizabeth Holmes, was charged with flaws and inaccuracies in its technology.
The blood-testing startup had once racked up a US$10 billion valuation but ended up in bankruptcy.
This article appeared in the Hong Kong Economic Journal on May 3
Translation by Julie Zhu
[Chinese version 中文版]
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