DISCUSSION Caterpillar treads on in China

by Yolanda Villafuerte _______30th January 2013
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Caterpillar treads on in China 

To be fair, not all is gloom and doom for Caterpillar Inc., the world’s leading manufacturer of construction and mining equipment. In its year-end results it not only announced record 2012 sales and revenues of $65.875 billion, but also that profit per share was also an all-time high at $8.45.

Yet it has warned of “measly world growth” and a cautious outlook for 2013, projecting a profit of $7-9 a share on revenue of $60-68 billion. The fourth-quarter profits for 2012 announced in the same press release were also bleak. Fourth-quarter 2012 profit was $697 million, a figure that looks particularly dismal when compared with the $1.547 billion in the fourth-quarter of 2011.

Caterpillar’s poor fourth-quarter can be written off as being the result of the decision to focus on reducing inventory; however reduced production levels are not the whole story. The $580 million write-down of Caterpillar’s recent acquisition ERA Mining Machinery Ltd. that took place in the fourth-quarter also had a large part to play.

On January 18th 2013 Caterpillar announced that an internal investigation at Siwei, the Chinese subsidiary of the Hong Kong-listed firm ERA Mining, had revealed “deliberate accounting misconduct”. Siwei manufactures roof support products for underground coal mines, and at the time of its acquisition in June 2012 was seen as a good find, in line with furthering Caterpillar’s aim of expanding their role in the Chinese coal mining industry. These sentiments had faded by 2013, as CAT announced it would be taking a $580 million loss on the $700 million acquisition.

The investigation revealed that the senior management at Siwei had engaged in “wrongful revenue recognition practices” for years to overstate profits. Substantial discrepancies with what Siwei had stated in its accounting records were found, as well as improper revenue recognition practices, which included logging non-existent sales of untraceable inventory.

“We were deliberately misled by the accounting misconduct at Siwei,” said Caterpillar’s Chief Executive Doug Oberhelman during a conference call on Monday. He has taken the blame for drastically overpaying for the company.

Assigning blame is one thing, but working out how Caterpillar’s executive and its investment advisors failed to discover the accounting issues before completing the acquisition is another. Fraud managers only discovered the issues when they began trying to “reconcile Siwei’s physical inventory with its books” in the fall of 2012. In its statement Caterpillar defends its due diligence, saying that it is “rigorous and robust”, and that ERA was a publically traded company with audited financial reporting to the Hong Kong stock exchange. Yet it still doesn’t quite add up: there was six months between the deal being announced and closed, so how did an accounting misconduct worth $580 million go unnoticed?

Such misconducts are not unknown in China, as auditing has been exposed in recent years as being “far from reliable when it comes to China’s business practices” – so this could be written off as simply one of the hazards of doing business in China.

Yet Caterpillar is not a newcomer to the region – they opened their first joint venture in China in 1994. Today Caterpillar currently has 23 existing manufacturing facilities in Chinaand four more under construction, as well as four Research and Development centers and three logistics and parts centers. They have been expanding aggressively in China and have managed to capture a market share of about 6 percent of the country’s machinery sector.

Caterpillar has indeed done much better than other multinationals in China, for example Mattel, who closed their flagship Barbie store in Shanghai in 2011. Best Buy and Home Depot have had equally rough starts. But there is competition from Chinese rivals, who have taken market share away from their foreign competitors through aggressive marketing, attractive financing and improving technology.

Local rivals still have one significant advantage over multinationals coming fresh onto the scene: their relationships and contacts. Siwei already has a significant presence in the local Chinese market, so along with their accounting misdeeds, they brought are also bringing their valuable guanxi to Caterpillar.

If those relationships pay off, maybe Doug Oberhelman will be proven right in defending the acquisition.

 

Sarah Primmer is a research volunteer at Tomorrow’s Company. She is currently studying Chinese and History at SOAS.

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