Shares of Caterpillar, the world's largest construction equipment manufacturer, are falling in pre-market trading today following the company's announcement of a big writedown, made Friday after the closing bell.
The $580 million charge relates to an acquisition Caterpillar made in China last year. It paid $800 million for the company, Siwei, but the target company's management team had apparently been fudging the books for quite some time before that, leading Caterpillar to wildly overpay for the acquisition.
BofA Merrill Lynch analyst Ross Gjilardi has a good summary of the writedown:
Big impairment charge tied to Siwei acquisition
After the Friday close, Caterpillar announced that it will take a $580mn, or $0.87 per share non-cash goodwill accounting charge in Q412. The impairment comes in connection with the acquisition of ERA Mining Machinery and its Siwei subsidiary. The impairment arises from a determination by Caterpillar that Siwei senior managers engaged in accounting misconduct for several years prior to Caterpillar's $800mn acquisition of Siwei in mid-2012. The size of the charge equates to less than 1% of CAT's market cap (but nearly 10% of adjusted 2012E EPS), but does not help perception of CAT's China growth strategy, which is important to the long-term investment case, in our view.
Accounting related issue - ongoing investigation
Caterpillar has determined that several Siwei senior managers engaged in deliberate misconduct beginning several years prior to the acquisition. According to CAT's 8-K, the managers have been dismissed and replaced with a new leadership team, with the manufacturing operations rolled into Caterpillar's China operations division. CAT's extensive review identified improper revenue recognition practices and cost allocation that resulted in overstated profit. Caterpillar is reviewing litigation closely and other options to recoup losses and is conducting an ongoing investigation.
As Gjilardi noted, the charge will come out of Q4 2012 earnings, to be reported Monday, January 28.
James Parker notes at the Diplomat that Siwei was part of one of the infamous "reverse mergers" that have plagued Chinese listings in recent years:
Caterpillar last June acquired ERA Mining Machinery Ltd, a HK-listed company that was in fact the result of a "backdoor listing" of Siwei, a Zhengzhou-based company which provides equipment for the mining industry. Siwei had undertaken a "reverse merger" with ERA Holdings Global Ltd (a "secretarial services" company listed on HK that had no relation to mining or construction) in 2010, and had thus been effectively trading on HK's Growth Enterprise Market.
Reverse mergers, which rose to infamy during recent short-seller provoked attacks on such firms trading in the United States and Canada, are a common way for companies to be listed without going through the more expensive (and revealing) regulatory and media scrutiny of an Initial Public Offering (IPO).
Below is the full press release issued by Caterpillar, complete with a Q&A:
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