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| Confessions of an S-chip CEO |
| Written by Leu Siew Ying of The Edge Singapore | |||
| Monday, 03 August 2009 00:00 | |||
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The European-style architecture of the complex includes a colonnaded administrative block, paths shaded by fig trees and an amphitheatre that can accommodate 4,000 students. Wang founded the school in the mid-1990s, and built it up into a thriving private education enterprise that now includes a kindergarten, a primary school, two middle schools, an international school and boarding facilities for students. But, five months ago, he told the board of Oriental Century, which earns revenue from managing the school, that he had been siphoning off money from the company and falsifying its accounts. “The fraud is quite extensive,” says Lai Seng Kwoon, lead independent director of Oriental Century, after the company’s annual general meeting in June. “It’s not just false payroll or false cheques, but academic records and bank statements. The school is real. The building is there. The students are real, but not all of them are real.” According to a special audit by PricewaterhouseCoopers, Oriental Pearl College had only 2,200 students as at December 2008, versus the 3,000 it had reported to Oriental Century. The special audit by PwC also revealed that Oriental Century had a bank balance of only RMB1.78 million (RM915,542) at end-2008, instead of the RMB234.4 million it reported in its published accounts. Wang, a lawyer who was once a prosecutor in China’s navy, accepts responsibility for the whole scandal. But, he maintains that he hasn’t benefited personally from it. Instead, he claims that all the money he secretly channelled out of Oriental Century went to support the debt-laden, privately held company that effectively owns Oriental Pearl College. Wang also claims that some of the terms of Oriental Century’s contract to manage the school are unfairly skewed in the company’s favour. And, he suggests that its business was unsustainable, given the debts of the private company that owned Oriental Pearl College. Investors stung by the fraud are unlikely to buy everything Wang says, of course. Nevertheless, his story of how Oriental Century was created and sold to public investors in Singapore is a cautionary tale that anyone thinking of investing in S-chips or sitting on their boards ought to hear. In a lengthy face-to-face interview, the chain-smoking Wang provides an account of how he inflated the student enrolment figures reported to Oriental Century and artificially boosted the cash levels on its published balance sheets over two years. More interesting than the details of his fraud, however, were the circumstances that he claims led him to it. The story began in the 1990s when China’s economic reforms were taking off, dragging the country haphazardly towards a capitalist system. The Chinese government provides its citizens with nine years of free mandatory education — from kindergarten to high school. However, migrants to big cities like Shanghai and booming provinces like Guangdong are not allowed to enrol their children in government-run schools. “It’s a way of ensuring that local resources are reserved for local residents,” explains Luo Chu, a retired school principal in Guangzhou. That created an urgent need to provide schools for the children of migrants, which the government was unable to meet. To solve the problem, businessmen were encouraged to get into the education business. There was one snag, though. Private schools had been shuttered in 1949 when the Communists took over, and building new ones from scratch required significant upfront capital that the would-be education entrepreneurs couldn’t raise. Eventually, a coal transporter in Guangdong named Chen Zhonglian, who was trying to build a private school, hit upon the idea of collecting “reserves” from parents who wanted to enrol their children. The funds were used to build facilities, or simply deposited in banks where they earned interest that was used to pay for the cost of running the schools. The money was repaid to the parents once their children left school. This business model put large amounts of cash in the hands of private-school operators, and was clearly open to abuse. But, it seemed to work, and it was condoned by the authorities. It was quickly adopted by other private education providers, with some schools collecting as much as RMB300,000 a student. “It made millionaires of many people who started private schools,” says Luo. According to Xin Lijian, who runs a rival private-school enterprise in Guangzhou, the question of whether any of this was legal never came up because there were so few laws to break at the time. “In any case, in China, whatever rules or laws there are, we have been breaking them for the sake of economic reform.” Against this backdrop, Wang — whose parents and wife are schoolteachers — decided to jump on the bandwagon. He was working in Shenzhen at the time, but was unable to find affordable land in the booming city to build his school. Finally, a banana plantation in Dongguan came up for sale at a good price and Wang plunged in with four partners. According to him, Oriental Pearl College initially collected RMB60,000 for each student. But, as it became more established and its reputation spread, this rose to RMB180,000, then to RMB200,000 and finally to RMB230,000. By 1996, however, things began to go wrong for China’s fledgling private education sector. Bank-deposit rates declined quickly from more than 10% per annum to as little as 2% as runaway growth and inflation slowed sharply. Oriental Pearl College, which relied on the interest income from reserves deposited with banks, suffered a revenue crunch, Wang says. “We could have shut down, and nobody would blame us, because they would understand that we were caught by the system.” But, it managed to survive by turning to the parents of its students for support and by borrowing from banks, Wang adds. Things were about to get even worse, though. In the wake of the Asian financial crisis, the Chinese authorities became concerned about how private schools were managing their reserves. In 1999, the Guangdong government suddenly ordered all private schools in the province to refund their reserves to parents and begin charging fees instead. However, many schools simply weren’t able to come up with the funds at that point. Of the 60 private schools in Guangdong, only about 10 survived the shock, according to Xin, the Guangzhou private-school operator. Oriental Pearl College was among the schools that were caught in a bind, but Wang says he was determined to keep it open. “Closing the school meant 200 teachers would have no jobs and 1,000 students would have no education. With my upbringing and military background, I felt a strong sense of social responsibility to carry on.” So, Wang struggled on, trying to improve the reputation and revenue of the school and borrowing from banks whenever he could. A couple of years later, as the appetite for Chinese equities began growing, Wang says he was approached by his partners with the idea of raising money from the equity market to pay off Oriental Pearl College’s debts once and for all. He hadn’t thought that a listing would have been possible, because the school wasn’t generating much cash flow at that point, he says. “But, people said, ‘Don’t worry, you will have cash flow when you list.’” Turning dross to gold? Some explanation about the corporate structure of private schools in China is necessary here: China actually forbids the commercialisation of basic education. So, companies in the business don’t own the schools, but the land and assets used by them. Their revenue is generated from rent and management services charged to the schools. Oriental Pearl College’s land and assets are owned by Dongguan Baisheng Investment Development Co, an investment holding company controlled by Wang and his partners. However, it wasn’t Baisheng Investment that was sold to public investors. Instead, a separate company was created — Oriental Century — which earned management fees from Oriental Pearl College and paid Baisheng Investment RMB3.75 million a year to lease the school’s premises and assets under a 20-year agreement. Meanwhile, Baisheng Investment continued to hold the assets and land of the school, which were pledged to banks for loans. And, it was still responsible for the reserves owed to parents of its students as well as the expansion and maintenance of the school. “We wanted to go for an asset-light model,” says Oriental Century’s independent director Lai, when asked why Baisheng Investment wasn’t listed directly. En route to its IPO, Oriental Century built a junior high school in Nanchang, the capital of Jiangxi province. It also planned to use S$1.8 million of the S$7.5 million it hoped to raise to build a kindergarten in Humen, a township in Dongguan. Sold to investors at 35 cents a share in the IPO, Oriental Century was listed on the Singapore Exchange on June 1, 2006. The stock performed well at first, rising to a high of S$1.64 by February 2007, valuing the whole company at S$272.5 million. Every year after its IPO, the listed company reported healthy revenue and profits, and its reported cash holdings swelled to RMB234 million by end-2008. The company even attracted the attention of Chew Hua Seng, founder and CEO of Raffles Education, a fast-growing private education company that has been expanding in China. In December 2006, Raffles Education began accumulating shares in Oriental Century and Chew later sounded out Wang about a possible takeover of his company. Raffles Education currently holds a 29.9% stake in Oriental Century. The IPO of Oriental Century did not solve Baisheng Investment’s problems as Wang had hoped, though. In fact, it only made things worse. Baisheng Investment owed banks some RMB100 million and parents of the college’s students a further RMB100 million, according to Wang. The plan was for Wang and his partners to use money they obtained through the IPO of Oriental Century to help Baisheng Investment pay off these debts. But, some of Wang’s partners reneged on the deal. Wang says he pledged his own stake in the listed company to UOB some time in late 2006 or early 2007. Together with the funds that he obtained from the partners who kept their word, he managed to raise a total of only RMB70 million to revive Baisheng Investment. Some RMB50 million of this was paid out as reserve refunds and the balance used to service its loans and for operational expenses, Wang says. That still left Baisheng Investment in debt. And, the company was now receiving only the meagre lease payments from Oriental Century instead of the management fees and rent from Oriental Pearl College. If Baisheng Investment couldn’t repay its debts and sustain itself before, it was even less likely to do so now with a listed company making a healthy profit wedged between itself and the school. “Let’s just think about this,” Wang says. “Can Baisheng do all this? Should it do all this? Baisheng can’t even service the bank loans, let alone repair the school and refund the reserves and pay other fees and charges.” Wang feared that the financial stress at Baisheng Investment would eventually begin threatening the operations of the school, and he sought to get a better deal for the company from Oriental Century. “After listing, I kept asking for the rent to be increased, but the board refused,” he says. “Our asset is so huge that our rent should be at least RMB15 million.” In 2007, Wang says he informed the board of Oriental Century that the situation at Baisheng Investment was becoming untenable. “I told them it would affect the college. I suggested raising the rent or selling Baisheng’s assets to them.” Wang adds that he also held discussions about this with Chew of Raffles Education during a meeting in Singapore. Lai says Wang’s account of asking for better lease terms from Oriental Century isn’t reflected in the minutes of its board meetings. Chew declined to comment. In the meantime, Wang says he made the “mistake of his life” by illegally channelling money out Oriental Century and authorising the falsification of its accounts. He says he began doing this as soon as he realised that some of his partners weren’t going to help him save Baisheng Investment after the IPO of Oriental Century. According to him, he formed an entire team of people headed by a China-based financial controller to create a set of fictitious accounts for Oriental Century. He also bribed bank employees to issue false bank statements to hoodwink the company’s auditors. The bulk of Oriental Century’s reported cash holdings — some RMB227.66 million — was held at a Beijing branch of Guangdong Development Bank, according to auditors and company sources. “I can’t tell you the details — I’m not a financial expert — but I made the decision and others executed it,” Wang says. However, Wang insists that the funds he took were ultimately used to support Baisheng Investment and ensure that Oriental Pearl College continued operating. According to him, management fees paid to Oriental Century were almost immediately funnelled to a company owned by some shareholders of Baisheng Investment, and then later returned to the college to finance its operations and repay the outstanding reserves owed to the parents of its students. The fraud eventually came to light earlier this year, as a string of scandals at other S-chips prompted heightened scrutiny of Oriental Century’s books. On March 10, after independent auditors KPMG were unable to reconfirm its bank balance, Wang finally came clean. “I know I am a criminal in Singapore. I do not deny that I have wronged investors and shareholders and caused them losses, but I didn’t take a cent for myself,” Wang says. “That is why I called the special board meeting in March and I volunteered a report on the situation. I take responsibility and will do my best to make up for their losses.” Were the terms of Oriental Century’s deal to manage Oriental Pearl College really unsustainable? Was Wang genuinely trying to rescue the school from an IPO deal that would have eventually destroyed it? Or, is he still trying to pull wool over everyone’s eyes? With no information besides Wang’s account of where exactly Oriental Century’s funds ended up, it is impossible to know the truth. Yet, even if Wang’s motives are unclear, his account of how Oriental Century was structured and sold to public investors is a lesson in the dangers investors face when buying into S-chips. Oriental Century’s IPO prospectus did not highlight Baisheng Investment’s financial obligations as a potential risk. Nor was the background on how private schools had funded themselves in the past made clear. The Edge Singapore wasn’t able to find any individual involved with the Oriental Century IPO willing to discuss the due diligence process in detail, though. The Chinese promoter of the listing is believed to be an individual named Wang Daming (no relation of Wang Yuean), a shareholder of Baisheng Investment. Through a Singapore-based contact, he is believed to have approached HL Bank, which took on the management of Oriental Century’s IPO. Officials at HL Bank say three individuals who worked on the deal have since left the bank. Of the three, The Edge Singapore was only able to track down Len Wee, who now works for Kim Eng Securities. Wee says he was shocked when he heard the news about Wang. “We didn’t expect it of a person of his pedigree.” And, he insists that everything had been done according to best practice. “The deal was complicated, but everything that had been done was properly done.” However, he wouldn’t be drawn into a detailed discussion of the IPO exercise as the police are still investigating the case. “Everybody is worried, much as we’d like to think that we had done our best,” he says, adding that the police haven’t been in touch with him yet. Another individual linked to Oriental Century’s IPO was Eric Leow Poh Chin, who was a director of the company from 2003 to 2006 during the run-up to its listing and is currently a non-executive director. Leow was director of UOB Venture Management Co at the time he joined Oriental Century. But, The Edge Singapore was unable to reach him by phone or email. Repairing Oriental Century Ironically, the assets and debts of Baisheng Investment that were excluded from Oriental Century might now find their way into the company. Wang has proposed to turn over the land and assets used by the school to the listed company for a nominal price of RMB1, to make amends for his fraud. According to him, the land could be worth as much as RMB500 million, while loans secured against the property total about RMB180 million. However, Lai, the lead independent director of Oriental Century, says Wang is overstating the value of the land. According to him, the listed company’s own valuers assessed the land in May and determined it to be worth “less than half what [Wang] thinks it is worth”. The board of Oriental Century is still carefully considering whether to take Wang up on his offer, Lai adds. “We are worried there may be liabilities that may not be apparent and that they will only surface after we take over.” The board of Oriental Century is also on the hunt for a new backer with the ability to inject fresh business and funds into the company. That would enable it to unlock the trading suspension of its shares, Lai says, thus freeing its shareholders to take whatever action they want with their investment. “We are looking for a white knight. I need money. Wherever it comes from, I will take it.” In the meantime, Wang says Baisheng Investment and Oriental Pearl College continue to struggle financially. News of his fraud in China earlier this year shook the confidence of bankers and parents of its students, with some demanding their money back. He claims that the school still needs to return some RMB23 million in reserves to parents of its students, and he estimates that it could take as long as three years to do so. That’s assuming that the college actually stays open. Lai says Wang now has no access to Oriental Century’s bank accounts, and that he has stopped sending money to Dongguan. “We have no money to send anyway,” he adds. He is also taking everything Wang says about the affairs of the school with a pinch of salt. “Given Mr Wang’s past record, it is rather difficult for the board to totally believe what he is saying to us, and the board has been apprehensive about his motivations. But, I have to deal with him because I have to have a feel of what is going on.” For his part, Wang — who still owns over 25% of the listed company — says he still wants to work with the board of Oriental Century and any new management team it brings in. “All I am concerned about is to make reparation to shareholders and to ensure the college will make profits for the listed company.” He also reveals that he has found an investor willing to take over the college’s debts. But, he might soon have his hands full dealing with the law enforcement authorities and sorting out his personal problems. The board of Oriental Century has lodged a report with the Commercial Affairs Department and instructed its lawyers to file a report against him in China. Sullen-faced and with bags under his eyes, Wang reveals during his interview with The Edge Singapore that his wife recently divorced him, partly because of the shame his fraud brought to his family. Will Wang’s quest for redemption prompt him to come to Singapore to face the music? He isn’t ruling it out. But, even if he does, with investors here so mistrustful after seeing so many high-flying S-chips become the subject of accounting irregularities and fraud, it could be a long time before his reputation is restored. Leu Siew Ying is associate editor at The Edge Singapore This article appeared in Corporate page of The Edge Malaysia, Issue 766, Aug 3-9, 2009.
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