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China has 3,583 companies listed on the Shanghai and Shenzhen stock exchanges. Photo: EPA

More Chinese companies scramble to issue profit warnings as debris field from M&A boom begins to surface

  • More than 280 mainland companies revised their earnings outlooks for 2018 by a deadline on Thursday, in a wave of write-downs tied to the M&A boom, analysts say

Hundreds of Chinese companies have revised their earnings outlook for 2018 before a deadline late Thursday, warning that results will fail to meet expectations as economic growth eases, forcing heavy write-downs.

Of 2,488 companies that made preliminary announcements, more than 280 revised their estimates, while 59 warned earnings would be down by more than 66 per cent from their previous estimates.

Among those warning of the sharp downward revision, 42 cited impairment of goodwill as a factor.

Goodwill is an accounting term referring to an intangible asset class arising from one company acquiring another for a premium value. As such, goodwill has to be assessed periodically in case of impairment that could affect asset value.

However, uncertainty stemming from the timing and amount of any impairment in goodwill amounts to a potential black swan that could hit investors.

A record 1.45 trillion yuan (US$215.3 billion) worth of goodwill is sitting on the books of Chinese listed companies as of the end of September, according to China Business News.

The enormous value of goodwill is a result of the wave of mergers and acquisitions (M&A) that started in 2013, fuelled by easy credit.

Concerns are that the status quo that led to these huge valuations is now beginning to unravel, amid a darkening economic outlook complicated by uncertainties that range from drug pricing to the US-China trade war.

In one example, Shanghai-listed Humanwell Healthcare Group announced on Tuesday it will write down 3 billion yuan for impairment in “goodwill and other intangible” assets.

Humanwell recorded 2.7 billion yuan worth of goodwill after acquiring US drug maker Epic Pharma in 2016.

The company said the impairment was related to a price change affecting a product from Epic Pharma, according to a filing by Humanwell on Wednesday. Delays by the US Food and Drug Administration in approving another drug developed by the company was also cited as a factor in the impairment.

However, on the same day, regulators at the Shanghai Stock Exchange questioned why Humanwell did not make an impairment to goodwill in 2017.

“The revenue of the target company already declined in 2017 … and regulatory hurdles in the US have been there since the acquisition, but the company did not write down any goodwill in 2017,” securities regulators said in the letter.

Humanwell shares have slumped by nearly 50 per cent since the acquisition was announced in March 2016.

“Normally when you see a very large intangible asset, there is obviously an upside as those represent knowledge, trademarks or cutting edge know-how. But they also represent risks as well,” said Andrew Lam, a director with accounting firm BDO Hong Kong.

In 2017 Chinese companies accounted for half of the top 10 largest deals globally backed by venture capital. A Didi Chuxing driver in Beijing. Photo: Reuters

Accounting standards used by mainland listed firms are in line with Hong Kong and international accounting standards, Lam said.

He cautioned that goodwill involved subjective considerations, even as there are internationally recognised ways to calculate the value.

“It is not always easy to find market comparables, and not always easy to make revenue forecasts … in other words, the timing and amount of any impairment could be very subjective,” Lam said.

In recent years, goodwill has become a tool for Chinese companies to dress up their balance sheets. In some instances, companies will change the values they assign to goodwill as a way to avoid taxes or help inflate earnings, industry insiders said.

On November 16 the China Securities Regulatory Commission warned against random goodwill impairment, urging listed companies to conduct timely impairment tests at the end of each financial year.

On January 4 an advisory board of the Ministry of Finance proposed changes to the goodwill impairment regime.

The accounting model currently in use treats goodwill as an asset with uncertain service life, with one consequence being bigger profit volatility, he said.

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