It was almost five years ago now that our Motley Fool Global Gains research team started visiting China, regularly searching for overlooked investment opportunities in the country. We were attracted to the market for the same reasons every business and investor is attracted to China -- it's the world's fastest-growing economy and will someday be the largest as well. Furthermore, because of infrastructure development, rising consumer purchasing power, increasing demand for food and energy, and a growing need for higher quality health care, there's not an industry in the world that can look at China and not see the potential for a growth bonanza.
Investors beware
Yet there are realities about China that make doing business and investing there very difficult -- particularly for foreigners. While we knew it was a relatively dicey business culture, aware of stories of companies keeping two or three sets of books, breaking contracts, bribing officials, and so on, our perspective was that the relative opportunity made it worth the real risks -- and that we could solve for the risk by doubling down on our assessments of management, demand massive margins of safety on any purchase, keeping our exposure to any individual Chinese company small, and getting some of our exposure to China through well-known multinationals.
More importantly, we believed that time was on our side. Our expectation was that business practices in China would get better over time. It turns out that may have been naive.
A tough week for China
While accusations of fraud against small Chinese reverse mergers have been ongoing, two more recent events illustrate just how dicey China really is and how it may not be improving. The first is the incredible story of Longtop Financial (NYSE: LFT ) , a Chinese financial software company that was at one time capitalized at more than $2 billion and counted some very savvy investors among its shareholder ranks. Following accusations of financial shenanigans, the company's auditor, Deloitte Touche, resigned. There's nothing very remarkable about that, but what is remarkable is the story Deloitte told in its letter of resignation.
Although Deloitte had already received confirmation letters from Longtop's banks concerning the balances in Longtop's accounts, Deloitte felt it necessary to go the extra mile and actually visit the banks. When they did so they discovered that Longtop's stated balances and the relevant confirmation letters did not match what they found at the bank when they accessed the accounts via tellers. In other words, some relatively senior person at Longtop's Chinese bank, which is undoubtedly state-owned, was complicit in helping Longtop deceive Deloitte and its investors. Unfortunately, Deloitte's letter does not name which Chinese bank or banks were involved, but my guess given Longtop's ostensible size is that it was a high-profile one. That means fraudulent practices may be systemic in China's financial system -- undermining any confidence foreign investors like us might have had.
Investors beware
Yet there are realities about China that make doing business and investing there very difficult -- particularly for foreigners. While we knew it was a relatively dicey business culture, aware of stories of companies keeping two or three sets of books, breaking contracts, bribing officials, and so on, our perspective was that the relative opportunity made it worth the real risks -- and that we could solve for the risk by doubling down on our assessments of management, demand massive margins of safety on any purchase, keeping our exposure to any individual Chinese company small, and getting some of our exposure to China through well-known multinationals.
More importantly, we believed that time was on our side. Our expectation was that business practices in China would get better over time. It turns out that may have been naive.
A tough week for China
While accusations of fraud against small Chinese reverse mergers have been ongoing, two more recent events illustrate just how dicey China really is and how it may not be improving. The first is the incredible story of Longtop Financial (NYSE: LFT ) , a Chinese financial software company that was at one time capitalized at more than $2 billion and counted some very savvy investors among its shareholder ranks. Following accusations of financial shenanigans, the company's auditor, Deloitte Touche, resigned. There's nothing very remarkable about that, but what is remarkable is the story Deloitte told in its letter of resignation.
Although Deloitte had already received confirmation letters from Longtop's banks concerning the balances in Longtop's accounts, Deloitte felt it necessary to go the extra mile and actually visit the banks. When they did so they discovered that Longtop's stated balances and the relevant confirmation letters did not match what they found at the bank when they accessed the accounts via tellers. In other words, some relatively senior person at Longtop's Chinese bank, which is undoubtedly state-owned, was complicit in helping Longtop deceive Deloitte and its investors. Unfortunately, Deloitte's letter does not name which Chinese bank or banks were involved, but my guess given Longtop's ostensible size is that it was a high-profile one. That means fraudulent practices may be systemic in China's financial system -- undermining any confidence foreign investors like us might have had.
安然宝贝
