13 May, 2016


Family Games in HK and SG

Gillem Tulloch

Given that related party transactions are somewhat of a national sport in Asia and a key component of most accounting frauds, it is somewhat surprising that no-one’s gone through and detailed each company’s involvement in them. Well, that is until now. Yes, we locked two analysts in a room and told them to download the annual reports of every company with a market capitalisation over US$1bn in Hong Kong and Singapore, around 360 of them. They were then instructed to trawl through each annual report and calculate related party transactions as a percentage of sales and expenses. Three weeks later our analysts emerged somewhat paler and thinner. Their results are cause for concern.

It's a national sport

Over 90% of all companies were engaged in some form of related party transactions in 2014. It makes us wonder if the remaining 7-8% simply forgot to declare them! These transactions averaged 7% of combined sales and expenses which is highly material to profit. A whopping 13% (46 companies) had related party transactions in excess of 20% of combined sales and expenses. However, of these, 31 were state owned enterprises (SOE) which clearly do a lot of business with other SOEs. Who knows whether they conduct business at market prices or in line with government policy? What we’re really interested in are those private companies with a large amount of related party transactions because that’s where minority shareholders are at greatest risk. That leaves us with just 15 companies which we list in alphabetic order below:

RPTNeither Hanergy or Silverlake top the list

It probably comes as no surprise that Silverlake (SILV SP) and Hanergy (566 HK) make our short list given recent news articles; however, they don’t top it. That dubious honour goes to Kuangchi Science (439 HK) although, arguably, it’s because the company was in the process of being taken over. Related party transactions have fallen in 2015 but they are still material.

Who are we to judge?

Let’s be quite clear that we are not passing judgement on these companies and nor are we expressing an investment opinion. Some have a perfectly legitimate reason for high related party transactions. For example, Jardine Cycle & Carriage’s (JCNC SP) car assembly joint ventures sell to its auto dealerships. What all of these companies have in common is that these levels of related party transactions are highly unusual. In order to save on legal fees, we’re not going to talk you though our findings. Instead, we’ll give you a flavour of what some of these companies are up to and you can work out the rest yourselves. That is, unless you want to become a subscriber?

  • Company 1: The largest related party balances of any company GLOBALLY, at US$6.2bn. It is paid interest income on amounts owed to it but doesn’t pay interest on amounts it owes. This boosted 2014 pre-tax profit by 20%.

  • Company 2: Two CEOs have been sent to jail in the last decade.

  • Company 3: Around 45% of expenses routed through two companies owned by the founder. One of these paid the founder an estimated US$22m in dividends over the past two financial years.

  • Company 4: Building the world’s 5th tallest building in China, financed with a US dollar loan from a related party.

  • Company 5: Over 35 pages of connected party transactions.

Now we’re working on the rest of Asia. Time to lock the analysts back in the dungeon again. Speaking of dungeons…