Australian executive exposes China agribusiness scam

AN Australian CFO was headhunted last year for a top job in a large privately owned Chinese agribusiness corporation.

AN Australian chief financial officer with an outstanding record of success in Asia was headhunted last year for a top job in a large privately owned Chinese agribusiness corporation.

He threw himself into the stimulating new work -- based in the northern port city of Tianjin -- including preparing the company for a float on the London Stock Exchange. Then came the bombshell.

He was trying to reconcile the books in preparation for a presentation to British and European analysts, and in frustration started to ask his colleagues some tough questions.

Late one night, during this process, all became clear. A whistleblower emerged to provide him with some intriguing raw data. When he untangled and analysed it, he realised that what he now had was something he had certainly not sought.

It was a most inconvenient truth. The data comprised ample evidence that the owner of the company was using a scam to cheat the Chinese government of many millions of dollars in subsidies every year.

The owner denied it. The Australian executive, who has requested anonymity to be able to reveal this cautionary tale, was forced to leave the company, and has since provided considerable corroborating evidence to the Chinese authorities -- at some risk to himself.

The story casts some valuable light on the ways in which corners can be cut in China's tumultuous business world, placing at risk whole industries -- and in this case the many thousands of families whose living comes from China Haohan Group.

It illustrates both the extraordinary potential of Chinese agribusiness, and its fragility at this difficult transitional stage as ambitious players seek to leverage up to become global leaders.

Cayman Islands-domiciled China Haohan is the second largest producer of tomatoes in China and, with 2 per cent of the global market, one of the world's 10 biggest makers of tomato paste.

Its charismatic founder, chairman and chief executive is Kang Yi, who is in his mid-40s, married three times, a wearer of sharp suits and usually driven by a chauffeur in an S-Class Mercedes.

Kang was contacted by The Australian to comment on this story and the allegations but he did not respond.

Kang was a successful trader of tomato paste who five years ago was persuaded by his clients to form a manufacturing company. He raised more than $50 million from banks and from private investors in Hong Kong and built six state-of-the-art manufacturing centres in the vast northwestern Xinjiang autonomous region where the tomatoes are grown by farming families and bigger groups.

His board contains directors from banks and private equity firms in Singapore and Taiwan.

The seeds of the scam emerged from the risks associated with the long working-capital flows that the industry requires. Kang had not taken into account that this cycle could last up to nine months, during which he or his bankers had to wait for a return. 

The process starts in October, as the major tomato paste customers consider the quantities they wish to order. This enables the producers to start planning. In February they buy the seeds they need, provided by local sources as well as by end customers, according to the type of paste the market is seeking.

Japanese firm Del Monte, American company Heinz and European corporation Unilever are major buyers, each with its own requirements. The EU used to subsidise growers, but now instead largely imports from China and elsewhere.

The seeds are developed in greenhouses in Xinjiang for two months, then the seedlings are given to farmers -- on credit usually, not through cash sale -- who bring the crop to maturity in about four months, using fertilisers and pesticides.

In August the tomatoes are delivered to the factories, which have a capacity of about 1.5 million tonnes.

They are harvested and trucked to CHG's plants and, subject to yields, can be processed into 225,000 tonnes of paste. That is when the farmers are looking for immediate cash payment.

Some of the paste that is produced is sold domestically, but most is shipped by rail across northern China to Tianjin's deep-water port for export via an associated company named Bositeng.

Once the ship is loaded, Bositeng takes the bill of lading to its insurance company, which provides accreditation for the cargo to its bank, and then approval is granted for the ship to sail.

This is where Kang manoeuvred -- successfully, until being caught out recently -- to solve, at least temporarily, his payment problem.

He negotiates to sell the paste for, say, $600 a tonne. But then he issues a contract for a higher price, say $710. He issues a credit note covering the difference.

The clients would agree to the odd double-bookkeeping arrangement, since tomato paste has been in short supply, so they appreciate fixing a guaranteed source, and because they would end up paying the lower price anyway or receiving a credit to bring the price down to that figure.

Kang takes the invoices with the higher figure to the banks, which typically provide trade financing up to 80 per cent -- about the same as the limit on home mortgages. So he receives higher trade financing, helping him to cover the long period in which he has to cover many costs, before he again receives revenues.

But the biggest benefit is that such agribusiness producers receive subsidies from the central government via the Customs department. The higher the value, the greater the subsidy.

The tomato-growing season usually ends in the first week in October. Most of the harvest is sold by Christmas, so stocks should be empty by the start of the calendar year.

The shipping manifestos appeared to confirm that the stock had all been shipped out. So what was going on with the data the whistleblower had pointed towards? The inflated invoices indicated that there was still 20 per cent or so more income yet to be collected.

The whistleblower left CHG because of the risks she faced. She had worked out what was happening, but left it to the Australian expert to untangle, mainly from the accounts receivable.

The enormous gap that couldn't be explained could be attributable only to "bad business, bad debt or bad accounting".

It was only through detailed forensic investigation that the answers became apparent. The money -- about $30m across two years -- was never meant to be collected from the buyers. It was just a paper trail for the benefit of China's Customs staff, to leverage the entitlement for subsidies.

When questioned by the auditors, Kang responded that the money went through Hong Kong, and that this somehow accounted for the 20 per cent or so inflation. But he would not show the bank statements to prove it.

The overriding conclusion appears to be that sales, net profit and trade receivables were overstated, and rather than being a highly profitable company it is technically insolvent. Most of the money went back into the business, which it needed because of the industry's structural problems and the way the company was financed. It required treasury facilities to match the problems, which were compounded because Kang was over-invested, a common issue in China. He had built almost twice as many production plants as he needed.

The situation also points to ways in which China's gross domestic product is inflated, with trade figures frequently overstated.

The departure of the Australian meant that the London listing could not proceed because he was the key figure in planning arrangements with the British team. He also alerted the auditor, PwC.

The London float -- probably of 40 per cent of the firm, of which Kang owns 52 per cent -- would have enabled him to make his big exit in a highly profitable flourish. That's now a remote prospect.

The Australian CFO involved continues to live and work in China and requested anonymity because of his residential status.