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CoStone Capital Zhang Wei: What Happened Last Week Was An Embarrassment to China’s Capital Market

2019.02.02 Zhang Wei Views:


In a recent week, many listed companies had disclosed massive losses in quite a ridiculous way. Seriously speaking, that was a real embarrassment to China’s capital market.

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In a recent week, many listed companies had disclosed massive losses in quite a ridiculous way. Seriously speaking, that was a real embarrassment to China’s capital market.

Over 380 companies on A-share market have disclosed their earnings forecasts, claiming a total loss of ¥282.388B for which goodwill impairment accounts a substantial part. Zeus Entertainment (002354) lost ¥7.3B to ¥7.8B. PD Group (601258), ¥6B to ¥6.5B. And Kaidi (000939), ¥5B to ¥6B. What’s worse, 9 companies including Homyear Capital (600240), Liyuan Precision Manufacturing (002501), Feilo Acoustics (600651), Tianshan Animal Husbandry Bio-engineering (300313) and Chinasun Pharmaceutical Machinery (300216) lost more than their market value. What an embarrassing week for A-share market!

Zhang Wei: 2019 will be a Big Bath year for China’s capital market.


Last year, I predicted that 2019 would be a Big Bath year and sadly, it seems I was right about that. Behind the embarrassment lies a disrupted pricing system of China’s capital market and regulators being too lenient with the evil-doers.


Goodwill has formed an artificial “quake lake” in stock market.

Zeus Entertainment (002354), for example, reported ¥1.8B revenue 2018 Q1-Q3, with net profit worth of ¥250M. And then a net loss of ¥7.3B to ¥7.8B was posted in a revised annual financial statement, with goodwill impairment charge of ¥4.9B. Similarly, companies acquired by Dongfang Precision Science and Technology (002611) suffered goodwill impairments charge of ¥3.06B to ¥4.142B. In the case of Kangni Mechanical & Electrical (9603111), the impairment was ¥2B to ¥2.271B.


Such a significant amount of goodwill results from acquisition premiums in a large scale in recent years. Especially in 2015, many companies pumped up their stock prices and market value by M&A and the target companies were overvalued when they were acquired, which led to huge amounts of goodwill. Statistics show that goodwill on A-share market had reached ¥1.4T by the end of 2018, which had formed a large “quake lake”.


Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process.


Article 4 of Accounting Standards for Enterprises No. 8 – Asset Impairment states that an enterprise shall, on the day of balance sheet, make a judgment on whether there is any sign of possible assets impairment. No matter whether there is any sign of possible assets impairment, the business reputation formed by the merger of enterprises and intangible assets with uncertain service lives shall be subject to impairment test every year.


Under Article 23, the business reputation formed by merger of enterprises shall be subject to an impairment test at least at the end of each year. The business reputation shall, together with the related asset group or combination of asset group, be subject to the impairment test. That is to say, a company needs to check its goodwill for impairment yearly.


The listed companies dare not to take a chance because they would be delisted if their income hasn’t been covering their goodwill impairment expense for 3 consecutive years. They’d be better off to take a Big Bath in a pre-emptive strike.


The approval-based IPO system is to blame for a disrupted pricing system.

The huge amount of goodwill has severely disrupted the financial environment of A-share market, which highlights a complete disorder in the pricing system of China’s capital market under the approval-based IPO system. Moreover, shell resource value has distorted issuing and pricing system and zombie firms that have been dormant are brought back to life repeatedly.


Since it’s tough to get listed on domestic stock market, companies that have the chance to go public are willing to do whatever it takes including M&A, private placement and share pledge to pump up the stock prices in order to dump their own shares at the inflated price. Meanwhile, the high barriers to entry bock many companies’ way of flotation. During the period of IPO “quake lake”, the number of queuing companies peaked at over 800. And there are thousands of small and medium-sized companies which do not get a chance to enter capital market.


While in the secondary market, individual investors predominate in A-share market. When the market is showing good momentum, stock prices will likely go up around the time of the M&A announcement. It’s the exact opposite in overseas markets. The findings of an American study suggest positive returns for a considerable proportion (15-30%) of target firms but negative returns for the acquirers in an acquisition.


The perpetrators should be treated with harsh punishments.

The massive goodwill impairment of listed companies this time has underlined a lack of harsh penalties and delisting system. 


Public firms announced their financial disclosures with little seriousness and legal force. Homa Appliances(002668) saw a downward forecast revision of earnings forecast to a loss ¥1.242T-1.578B from a profit of ¥305M-343M. Feima International (003310), a loss of ¥1.75B-1.95B from a profit of ¥15.29M-138M. Broad-Ocean Motor (002249), a loss of ¥2.1B-2.3B from a profit of ¥230M-439M


Most market participants can neither understand nor accept such dramatic downward turns. Public firms reporting profit for first three quarters but massive loss for the fourth quarter are committing accounting fraud. But the current capital market is too lenient with those listed companies and acknowledges no responsibility to investors.


The “low-cost fraud” has long been the scourge of A-share market. Previous regulations focused enforcement resources on intermediary institutions and stock prices manipulation rather than the public companies and their actual controllers.


What kind of STAR Market do we need?

Without reforming the system, the Sci-tech Innovation Board, or STAR Market, will only end up a minor technical advance rather than a milestone success.


For the STAR Market to succeed, a registration-based IPO system should be implemented with corresponding delisting mechanism. Rules and regulations should be put into place to punish listed companies and their major shareholders for fraudulent practices, false promises, insider trading and market manipulation. That is the way to restore integrity and promote fairness, equality and transparency in China’s capital market and protect investors with best efforts.



This editorial written by Zhang Wei was originally published on Securities Times, to read the full article in Chinese please check

Rewritten by a Lu Ying, Edited by Li Yunzhen

The year 2019 marks the fortieth anniversary of China’s Reform &Opening-Up, once again, we meet at the turning point of history. What’s the next step for the game, is there any clear guidance? The answer is affirmative.

Our country is enjoying a good momentum of development, which does not come from the Washington Consensus nor the Beijing Consensus. China’s experience has proved that both the visible hand and the invisible hand are crucial: the visible hand, stands for the government-led reform, and would yield benefits for reform and opening up; the invisible hand, stands for the Marginal Power represented by the private sector, and would improve economic efficiency and tax collection, create jobs and employment opportunities.

Provided that we want to protect and expand the benefits form reform, three simple but mandatory agreements are to be made and followed: No.1 Private ownership must be recognized, protected and treated equally with public ownership constitutionally, both ownerships are scared and inviolable;No.2 Make further clarification of the principal position of market economy, “deepen economic system reform by centering on the decisive role of the market in allocating resources”, as President Xi addressed in the third Plenary Session of the 18th CPC Central Committee;No.3 Implement the guiding principles of “comprehensively promoting law-based governance” of the fourth plenum. The rule of law is essential for economic growth, irreplaceable to protect private ownership, and necessary to encourage innovation and entrepreneurship.

Above are three rules for us to avoid falling into the Middle-income Trap. Assuming that we are breaking systematic barriers to private enterprises’ participation in market economy, and boosting innovation and entrepreneurship of our society, then we are heading towards a promoting direction. We are marching in the path of light, regardless of the ups and downs of Sino-US relationship, the drop in GDP growth rate, or the monetary policy.

These principals also apply on knowing how better to run a business: don’t be hedged by rules and regulations at the beginning, pay more attention to your survival, and you’ll learn more when you start your second business.

For many years, Huawei has been the only Chinese company on the list of the Top 50 R&D Spenders. Regardless of the economy and its income, what Huawei has been doing is investing in its future, dedicated to R&D, continuously and resolutely. This provisional work underscores Huawei’s accomplishments, making Huawei anindustry leader.

So, there are standard answers on how to run a company,which could be summarized as concentration and professional dedication, continuous investment on innovation and trying harder in R&D. Entrepreneurship is also important, every single company needs entrepreneurs to push aside all obstacles and difficulties, to implement strategies and ideas. We, as investors, are destined to look for such outstanding entrepreneurs and their companies, invest in them and partner with them.

At this key point of history, a country, a company, or asingle individual, will all need to find the right path. Four decades after the Reform and Opening-up, it’s time to learn from our experience and stop “wadding across


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