Cash confirmation plays | China Accounting Blog | Paul Gillis

Cash confirmation plays

These are sure exciting times to be an auditor in China.  While the signing of a clean audit opinion is always an important milestone in a company’s annual reporting cycle, I have never seen it take on the importance that it has in China. Lately, the life or death of many U.S. listed Chinese companies has come down to whether the auditors are going to sign off, and that decision is often resting on whether they can confirm the bank balances to their satisfaction.  If the auditors sign off, the price should increase significantly, but if they don’t, the stock is likely to be delisted before it trades again.  We seem to have a new type of investment strategy - the cash confirmation play, where you wager whether the auditors successfully confirm cash. 

China Media Express Holdings (NASDAQ: CCME) lost its auditor and its NASDAQ listing when the auditors were unable to confirm cash to their satisfaction.  In their most recent financial statements, CCME reported cash of $170 million, or 76% of its total assets.  That amounted to $4.82 of cash per share, and the company last traded at $11.88 before it was delisted upon the resignation of its auditor, Deloitte.  As I discussed in an earlier post, there were several other similar situations as the U.S. listed Chinese companies with calendar year ends prepared to file their annual report on Form 10K in March. 

There was a different story at China Education Alliance (NYSE: CEU).  CEU was under withering attack from short sellers alleging fraud.  Its auditor, Sherb & Co. signed off on its accounts showing $71 million of cash, 76% of its balance sheet. That amounts to $2.30 of cash per share.  The stock jumped 46% after the auditors signed off, but rapidly fell back as investors may have begun to wonder about the small, U.S. based auditor.  The stock now trades at $1.26, significantly below the stated cash per share. 

There are two more cash confirmation plays in the works right now.  China Biotics (NASDAQ: CHBT) has been attacked by short sellers (including Citron Research, which targeted CCME and is also after LFT) for many months.  It is time now for it to file its first audited report since the allegations were made, a Form 10K reporting its fiscal year ended March 31, 2011 results.   In its last quarterly report for December 31, 2010, China Biotics reported cash of $132 million, or 54% of its assets.  China Biotics’ has cash of $5.94 per share, with the stock trading at $11.85. The shorts have set up a website to remind the companies auditors, BDO Hong Kong, to check the cash balances carefully.   

Deloitte will get a chance to test its cash confirmation procedures on another company that has fallen into the crosshairs of the short sellers.  Longtop Financial Technologies (NYSE:LFT) reported a whopping $423 million of cash at December 31, 2010, or 57% of its balance sheet.  That is $7.41 per share with the stock at $18.91.  Longtop also has a March 31 year-end so the 10K will be filed soon.  

So, place your bets.  Are the auditors going to sign off or not?  When the dust settles from these cash confirmation plays, the PCAOB ought to take a hard look at the auditing standards for cash in a high risk environment like China. 

Update:

Longtop failed its cash confirmation exercise - in spectacular fashion.

On June 23, China Biotics failed its cash confirmation exercise - in a new way - they tried to fake the bank's website!


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