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US-Listed Chinese Companies. Let’s Watch The Sausage Get Made.

Posted in China Business, Legal News

As we are always saying, you can win all the cases you want against Chinese companies in United States courts, but getting them to pay is another thing. Yet the march of Chinese companies to US stock market listings may be changing that ever so slightly. For small-time Chinese firms used to doing business on their own terms, often with little regard for contracts, this can be a radical realization.

This is what makes the spectacle of publicly traded Vision China Media’s (VISN) battles in the New York courts such a great test case. 

Let me explain.

VisionChina’s business is those television screens playing advertisements in just about every elevator, bus and subway in China. This is an industry that has had some amazing revelations recently. Most notably, China MediaExpress (CCME) is facing so many fraud allegations, NASDAQ has halted trading in its stock (this is a fascinating story in its own right). Meanwhile, most every reputable company working for them has walked away. Fraud in Chinese reverse-listed companies has become almost expected, but VisionChina looks a bit different. It secured its NASDAQ listing by going the traditional IPO route and it is now being accused of simply refusing to pay for an acquisition.

In 2009, VisionChina agreed to buy DMG, an industry rival with a foothold in the subway sector. DMG was particularly appealing because it had just won the contracts for the Shanghai subway systems ahead of the 2010 Expo. The deal was structured so DMG’s investors would get $100 million in cash and stock at or about when the deal closed, along with two subsequent $30 million cash installments on each of the first two anniversaries of the closing date. In “Fear The China Joint Venture And Front-Load Your China Licensing Agreements,” we talked of the importance of front-loading payments in your China deals.

The public documents on the case go into too much detail to cover here, but the gist is that VisionChina put the first $100 million payment into escrow to be released a few months after closing and a large portion of that money was released as planned, with several more million of those escrow funds released a few months later.

After that though, things started getting sticky. VisionChina turned in a couple of very bad financial quarters and then it decided it wanted to re-negotiate its DMG deal. Not surprisingly, DMG had little interest in revisiting its already done deal with VisionChina. Then in August, 2010, VisionChina’s CFO, Scott Chen, resigned and VisionChina’s founder and CEO, Li Limin, had this to say in a press release:

Mr. Chen has made significant contributions to VisionChina Media’s financial management and investor relations. Additionally, he led our successful acquisition of Digital Media Group Limited in 2009 as well as the integration of the two companies. We are saddened by Mr. Chen’s decision to resign, but respect his wish to further pursue his career in investment banking. We are grateful to Mr. Chen for his service to the Company and wish him well in his future endeavors

Not exactly the words of a CEO firing his CFO in a fit of rage.

Now let’s fast forward to December 2010. VisionChina is already late on its second installment payment to DMG and it then pre-emptively(?) sues DMG’s investors claiming fraud. The fact that a Chinese company doing business exclusively in China chose to sue in New York is a testament in itself to the new calculation for US-listed companies.

VisionChina’s complaint sets out the following:

On December 24, 2009, just over a month after the Closing Date, VisionChina received Unaudited Interim Condensed Consolidated Financial Statements for the eight months from January 1, 2009 through August 31, 2009, which had been prepared by Ernst & Young (the “E&Y Report”). The E&Y Report revealed for the first time that DMG’s total revenue for the first eight months of 2009 – the period covered by the Management Accounts – was not RMB 104.7 millions, as represented.

*  *  *  *

[DMG’s investors] must have known that they were giving VisionChina false financial information during due diligence in order to induce VisionChina to enter into the Merger Agreement.

In other words, DMG’s investors misrepresented DMG’s financials. Well, maybe.

VisionChina apparently released tens of millions of dollars from escrow on January 2, 2010, more than a week after it said it received the E&Y Report. Then five months later, VisionChina released millions more. VisionChina apparently waited more than a year after reading the E&Y Report to bring its case against the DMG investors. I know nothing more about this case than what I have read in the public documents, but in my experience companies do not usually wait so long to sue in these sorts of circumstances; there is a saying in the legal business that debts do not get better with age.

In his affidavit, VisionChina’s former CFO, Scott Chen states:

I did not think at the time [of closing that DMG’s] revenue report was particularly impressive…I was primarily concerned  with verifying DMG’s subway contracts because of the strategic nature of the acquisition and DMG’s revenue stream was not the primary reason for the acquisition.

*  *  *  *

The [Ernst and Young] SAS 100 Report did not reveal any issues with the 2009 preliminary management accounts that would have prevented the closing of the acquisition of DMG.

At no time in the period between the signing the Merger Agreement and my departure in August 2010 did I participate in any discussions concerning any alleged fraud in DMG’s unaudited financial statements, nor was I aware of any such discussions.

Remember when Mr. Chen resigned in August 2010, VisionChina’s CEO, Li Limin, said he was “saddened” to see him go.

I’m looking forward to watching this case play out for three reasons:

  1. VisionChina is a Chinese company that listed on NASDAQ by way of a standard IPO. The prevailing wisdom says a company is more likely to be on the up and up if it goes through the more rigorous process involved with this type of listing. 
  2. As a U.S. listed company, VisionChina has reasons to be concerned about an adverse New York court ruling and would likely face real consequences if it chooses not to abide by any decisions by that court. 
  3. Given ChinaMedia Express’s recent near total collapse, I wonder what another market player taking a major hit will do to the Chinese media sector. I should stress, however, that unlike with ChinaMedia Express, I have seen no allegations that VisionChina is not a legitimate functioning company — merely that it is reneging on its contracts.

Perhaps, most interestingly, unlike many disputes between Chinese and foreign companies, this drama is going to play out in full public view. It should be interesting and I will be watching. No doubt there will be more lessons to be learned from this case.

What do you think?

  • Twofish

    Divorce proceedings can be so very messy…….

  • HedgeFund Analyst

    I’ve been following VISN for years, and have made a decent profit shorting it. They are simply terrible at acquisitions.
    Its woes actually began in 2008. In early 2008 they made a series of acquisitions. In the filings, the entities that they acquired were actually BVI companies that were started after negotiations were almost complete. They refused to release any details about those acquisitions when I asked. In early 2010, when the stock dropped because of terrible revenues, they admitted that it was due to these companies failing to contribute after their earn-outs were complete. They had not paid for a company, but rather a set of agents with customers. Once the ability to profit was done, there was no incentive to continue working.
    Note that they knew that there was a drop-off in performance from those acquisitions in Q4 — just as they were completing the DMG acquisition. Then they made the exact same mistake with DMG that they made with their previous acquisitions — they simply didn’t value the relationships that the individual agents had. They did a poor job of integrating the DMG staff, as this article makes clear: http://tech.sina.com.cn/i/2011-03-10/01165266162.shtml . VISN again made the mistake of believing that existing contracts would attract clients more than prior relationships with their employees.
    VISN is not in any way a fraud like CCME, it simply made the mistake of doing acquisitions in order to continue its growth, and then failing to actually integrate the new staff.

  • lokokkee

    Hi Dan,
    I have been following your blog on how difficult it is to sue a Chinese company in the States and collect and I am now a victim of the CCME ‘fraud’ to the tune of a token hundred shares. The way the company is structured, there is not much assets here that all those class action suits can lay their hands on, other than maybe the insurance payouts. Is it worth the while for so many lawyers to initiate action then? They may have to hire your firm to collect for them in China.

  • http://www.nextlevelapparel.com/ wholesale blank T shirt

    I’ve experienced this in a smaller scale. An acquaintance was in way over his head and couldn’t hold up his end of the deal, decided he was too attached to the money. He just changes his name and business and starts a new scam. What’s to stop these guys from changing their names and running the same scam on more people.

  • ST

    Fascinating story. Not sure it is really a China story though as this sort of thing happens all the time with American companies as well.

  • Someguy

    Interesting story, but as ST has mentioned this kind of stuff is not that rare even in American business. It looks bad for VisionChina that they’ve already made bad acquisitions in the past and it seems DMG is just another one of those. If they do lose the lawsuit they will simply have to pay for the legal fees and the rest of the consideration for DMG, is that correct?

  • MMT
  • LH

    “… this sort of thing happens all the time with American companies as well”
    It’s relatively unusual I think for an acquiring company in the U.S. to refuse to pay for an acquired company after the closing of the acquisition, unless a substantial and material breach of the “warranties and representations” section of the purchase agreement (a standard section of such agreements) has occurred. A vague claim about misrepresentation of financial position doesn’t cut it; the acquiring company does extensive diligence at the time of acquisition. There has to be something like an undisclosed liability, a false or vacuous claim of ownership of an important asset, something of that kind. It may sound flippant to say so, but the situation in this particular case rather smacks of the habit that one encounters so often in Chinese business of simply refusing to pay for something that has already been obtained. The first exchange of cash for asset has a kind of sanctity here that isn’t enjoyed by, for example, term payments. :-)