Investors in Poly Culture IPO should take note of its firepower

Mainland's top auction house goes to market but bidders for the stock should consider its weapon dealer directors, business and trusts

PUBLISHED : Saturday, 22 February, 2014, 1:08am
UPDATED : Tuesday, 28 April, 2015, 11:23am

China's art market has soared to become the world's second-largest after the United States and most of the top 10 deals last year involved Chinese artists. Now its top auction house is doing a public share offering.

But before jumping on to the Poly Culture bandwagon, there are certain things with "Chinese socialist characteristics" that investors should be aware of.

First, the management. Poly Culture is owned by Poly Group, which originated from the People's Liberation Army. Yet, the dominance of weapon dealers on the board of such a culture business is still extraordinary.

In line with its princeling and army roots, the firm is headed by former Poly Group chairman Chen Hongsheng, the son of Jiangxi's first party secretary, according to its draft prospectus.

The track records of all three Poly Group-related companies … are not promising

Among its six non-independent directors are Wang Lin, the chairman of an artillery shell and grenade producer; Zhang Zhengao, the Poly Group's general manager who delivered four navy vessels to Ghana in 2012; and Zhao Zigao, who was recently reprimanded as the head of an explosives manufacturer which was involved in an accident that killed 33 people.

Zhao and Wang are respectively the chairman and general manager of Poly Technologies, which has been subjected to US sanctions for selling weapons to rogue states.

Two other independent directors are what we call "career directors" - lawyers and accountants who sit on the boards of many companies. The remaining one is an academic.

Poly Culture has tried to mitigate the sensitivity of its army links to attract Western investors, with Poly Technologies selling its 21.44 per cent interest to another Poly Group unit. However, given its board combination, that transaction is largely cosmetic.

In contrast, Sotheby's 12-member board features 10 independent directors - five business founders and executives, an ex-president of Columbia University, a former New York state superintendent of banks, a corporate lawyer, an investment banker and a heir.

Its chairman and chief executive is a fine arts graduate, who has spent 34 years at Sotheby's. Its vice-chairman is the duke of Devonshire, a major art collector.

Poly Culture's army roots are not easy to cut. After all, the firm has been relying on Poly Group for loans and guarantees. And who said selling weapons requires no business skill?

Second, is business. Thanks to the mainland's newfound wealth, the auction house has made international headlines by putting together mega deals, such as the 293 million yuan (HK$372.8 million) record set for a Li Keran painting that celebrated Mao Zedong.

Its enjoys a profit margin of 71 per cent, compared with 30 per cent for Sotheby's, which, together with other international rivals, is barred by mainland law from dealing in non-contemporary art.

Yet, behind the profit is a poor payment rate. Only 52.9 per cent of the value set at Poly Culture auctions had been paid by October last year. That was a sharp drop from the 74 per cent in 2010.

Interestingly, its account receivables had dropped by more than half to 76 million yuan because of its active collection measures, the company said.

A key collector is perhaps executive director Zhao Xu, who reportedly once donned a towel to track a buyer down in a sauna to secure late payment.

In the meantime, the company has seen 20 per cent growth in its inventory, which stood at 39 per cent of revenue in 2012. Rather than things not selling well, the company said, it was because it had been aggressively buying low as the market slowed.

(Poly Culture also runs cinemas and puts on theatre performance such as Cats. However, they account for less than 20 per cent of its profit.)

Third, the investment trust. This is not a typo. Poly Culture has been an active participant in the investment trust business, with the size of its trusts having grown by 300 per cent since 2010.

One of the schemes goes like this. The trust lends to the borrower, who uses a painting or sculpture as collateral. Poly Culture gets a fee for verifying whether the painting is genuine and setting a value on it. If the loan is not repaid, Poly will sell the piece for the lender and "might" have to pay the shortfall.

The company said it had incurred no obligation for such payments so far. Returns on this business have not been disclosed.

None of this sounds too encouraging. Yet, some may say these are acceptable risks given the growth in the mainland's auction market and the company's army backing.

Well, Money Matters is no expert on auctions but the track records of all three Poly Group-related companies listed in Hong Kong and Shanghai are not too promising.

They have underperformed the market significantly in the past three years. Poly Property has dropped 44.3 per cent, compared with a 4.34 per cent fall in the Hang Seng Index and a 44.53 per cent gain in state-owned rival China Resources Land .