In 1999, Guangdong Kelon Electrical Holdings was the only mainland firm listed as one of the world's 300 best small companies by Forbes magazine. In May 2000, a glowing article in Time magazine said Kelon, China's biggest refrigerator maker, repeatedly won awards as the best-run and most investor-friendly firm in China. The article quoted a Credit Suisse First Boston analyst as saying: 'Kelon is the best managed company in China.' In 2003, Gu Juchun - Kelon's chairman since 2001 - was named one of China's Economic Figures of 2003 by CCTV and given the Economic Personality of the Year Award by Beijing Central Television. But trouble was already brewing. In 2002, an investigation by the China Securities Regulatory Commission (CSRC) found that Kelon had advanced 1.2 billion yuan to former controlling shareholder Rongsheng Group through a series of undisclosed connected transactions involving bank borrowings, the purchase of raw materials, payment of advertising costs, bank guarantees and debt transfers. On May 10, the firm - listed in Hong Kong and Shenzhen - admitted it was the target of another CSRC investigation for alleged breaches of securities regulations. Also this month, Deloitte Touche Tohmatsu resigned as Kelon's auditor after issuing a qualified opinion on Kelon's financial results last year, in which it posted a net loss of 44.6 million yuan. In each of the three years since Mr Gu bought a controlling stake in the firm in 2001, its auditors have issued qualified opinions on its annual reports. A worsening operating environment has helped expose corporate governance problems in firms such as Kelon, said Ivan Chung, managing director of Xinhua Far East China Ratings, a mainland credit rating agency. 'In good days, a firm can mask its problems by getting additional bank loans. When operating conditions turn sour and banks begin tightening credit, problems emerge into the spotlight,' Mr Chung said. Rising prices for raw materials such as steel and plastic, as well as the shortage of refrigerator compressors, are eating away at earnings at mainland refrigerator companies. This is accelerating consolidation in China's refrigerator industry, the world's largest, where the number of mainland players is projected to shrink by more than half in two years. The profits of Henan Xinfei, one of China's biggest refrigerator makers, had single-digit growth last year, said its international sales director Andrew Ng. 'If not for high raw materials prices, our profits could have grown in double digits.' The government of Henan province owns a significant stake in Xinfei, which has an annual production capacity of 3.6 million refrigerators, one million air conditioners and 600,000 freezers. Steel prices have risen 40 per cent in the past six months, Mr Ng said. 'A lot of companies are trying to absorb the increase because they cannot pass the cost to consumers.' Mainland refrigerator makers such as Xinfei are under pricing pressure from foreign rivals including Siemens of Germany and Electrolux of Sweden, hoping to gain market share in China by keeping their prices low, Mr Ng said. 'Smaller companies with no funds for research and development, no economies of scale, will consolidate or wither off.' Xinfei is exploring mergers and acquisitions of other mainland refrigerator makers, Mr Ng said. Another company on the acquisition trail is Midea International, a white goods giant based in Guangdong. Earlier this year, Midea bought a majority stake in Hefei Royalstar, a refrigerator maker based in Anhui province. Last November, Midea bought a controlling 42.3 per cent stake in Hualing Holdings, one of China's eight largest refrigerator makers. Hong Kong-listed Hualing saw net losses widen to $628.7 million last year from $76.9 million in 2003, in financial results that received a qualified opinion from auditors. Midea's investment will improve Hualing's sales, cost control, component and raw material supply as well as management, said Hualing chief executive Liu Liang. The number of mainland refrigerator makers will fall from 50 to less than 20 within two years and in the long run, only a handful of giants will dominate the mainland industry, predicted Global Sources, a Nasdaq-listed trade facilitator, after visiting 15 refrigerator firms in China and surveying another 44. Global Sources senior analyst Michael Kleist said: 'Even some small makers tell us their rivals won't survive. Small players say it's getting difficult and profit margins are tight. Every maker we talked to mentioned the shortage of compressors as an issue.' Rising steel and plastic prices on the mainland have caused a 25 per cent increase in the cost of a refrigerator, while there is an estimated shortage of five million refrigerator compressors, according to Global Sources. Nonetheless, China's refrigerator exports grew 40 per cent last year and will grow another 30 per cent this year, said Global Sources managing editor Meghla Bhardwaj. China is the world's biggest producer of household refrigerators, producing 30 million units or 30 per cent of global output last year, of which 12 million were exported, she said. Despite the woes of large manufacturers such as Kelon, local governments have a stake in ensuring they survive, to preserve the jobs of thousands of workers, said an industry source. Mr Kleist said: 'Kelon's production volume is so high, its international customers need it to stay in business. Chinese fridge makers like Kelon and their customers have a relationship to make sure Kelon doesn't go out of business.' Kelon exported 3.5 million refrigerators last year to customers such as Electrolux, according to Global Sources. Kelon has the capacity to churn out one million refrigerators per month from its 150,000-square metre facility in Shunde, which with Zhongshan are the two major refrigerator production cities in Guangdong. Last year, Guangdong exported US$364 million worth of refrigerators and freezers, accounting for 35 per cent of mainland production, according to Global Sources.