Advisers on Caterpillar Inc's $677 million purchase of ERA Mining
Machinery Ltd. picked up an award for cross-border deal of the year.
The purchase was billed as a coup for Caterpillar, the world's top
maker of tractors and excavators. ERA was the holding company for Zhengzhou Siwei Mechanical & Electrical Equipment Manufacturing Co
Ltd., one of China's biggest makers of hydraulic coal-mine roof
supports. Siwei would help Caterpillar gain traction in the world's
largest coal industry.
"Siwei was going to be our Chinese business card," said a person
with direct knowledge of Caterpillar's strategy.
The night of the awards on November 16 three Caterpillar lawyers
were wrapping up an eight-hour grilling of Wang Fu, Siwei's
chairman. Major accounting problems had been unearthed at Siwei
headquarters in the gritty Chinese city of Zhengzhou. Two months
later, on January 18, 2013, Caterpillar said it had discovered
"deliberate, multi-year, coordinated accounting misconduct" at
Wang was sacked. Caterpillar took a non-cash goodwill impairment
charge of $580 million — 86 percent of the value of the deal. The
company says it was caught unaware by the problems at Siwei and only
discovered them in November 2012, five months after the deal closed.
A Reuters review of hundreds of pages of public documents, as well
as interviews with former employees, board members, bankers and
advisers, reveals a more complex story. Accounting problems were
rampant at Siwei before Caterpillar bought it. Yet at multiple
junctures, Caterpillar chose to ignore existing or potential
problems and push ahead with the deal.
A year and a half after directors of the Peoria, Illinois-based
company signed off on the deal, it has become a case study in how a
foreign company with decades of experience in China can still
flounder in that market. It also shows how willing some
multinationals are to accept risks they might otherwise avoid to
establish themselves in the world's second-largest economy.
The deal has triggered legal action against Caterpillar. In May,
Caterpillar announced it had settled a dispute with Siwei's
controlling shareholder, owned by an heir to the Crown Worldwide
logistics company fortune and the former head of the American
Chamber of Commerce in Beijing. Four shareholder suits filed in the
United States in Caterpillar's home state of Illinois are
Meanwhile, Siwei has foundered. Former employees told Reuters that
as of September, the company had no new orders in 2013, and it had
fired or furloughed about half of its workforce.
Siwei's former CEO, Wang, says his books were a mess but he
committed no wrongdoing.
"We were a legend in the industry," Wang, 52, told Reuters, in his
first media interview since the announcement of the write-off. Wang
is now pursuing a second act: He has launched a new company with a
nearly identical name in the same business. He has yet to build a
factory, but says he can take Siwei's old customers when he does.
BECOMING A CHINESE MANUFACTURER
When it bought Siwei, Caterpillar had been doing business in China
for more than 30 years. It had amassed 20,000 China employees,
dozens of manufacturing, research, logistics and parts centers and a
broad dealer network. It had nine new facilities under construction,
and had just completed the $8.8 billion purchase of Bucyrus, a
mining and earth-moving company with significant China operations.
When former Chinese president Hu Jintao dined with a group of
American businessmen in 2011, Caterpillar Chief Executive Doug
Oberhelman was included.
But the company was slow to ramp up production of construction
machinery in China and lost out on market share as a result, says
Anthony Farmer, a former executive at Caterpillar. It didn't want to
make the same mistake in coal mining equipment.
China's coal industry is the largest in the world, but it also
insular. Local companies, particularly state-owned enterprises,
prefer locally made products, said Farmer, now at construction and
mining consultancy Millton Group.
Siwei was attractive. It once was state-owned, but no longer. That,
and the fact that it was listed in Hong Kong — under the name of ERA — made it much easier for a foreign company to buy.
Moreover, the roof supports it made — spatula-like hydraulic arms
that keep underground coal mines from collapsing — were lucrative,
since 80 percent of China's mines are underground.
Siwei retained close ties to the government. In 2012 alone, it was
visited twice by the Communist Party leader of Zhengzhou.
Adding to the appeal, Siwei also had three high-profile investors
with American ties.
Li Rubo, an American-trained mining engineer and an early Siwei
investor, had arranged mining deals in Russia and Mongolia — sensitive undertakings that would have required political
Emory Williams, an American business associate of Li, was a major
shareholder and chairman of Siwei's parent. He had invested in a
Beijing concrete business back in the mid-1990s. The son of a former
senior Sears executive, Williams had also served as chairman of the
American Chamber of Commerce in Beijing. And along with Li, he had
founded another Chinese mining company recently sold to another
American mining equipment maker.
The third investor was Jimmy Thompson. He was Li Rubo's son-in-law — and the son of billionaire Jim Thompson, who founded Crown
Worldwide, the transport, relocation and storage giant.
Li and Williams were part of the reason Caterpillar felt comfortable
with the acquisition, several people with direct knowledge of the
"They provided loans, they helped finance the company," one of those
Beyond that, their influence was limited. "The show was run out of
Zhengzhou on a day-to-day basis. Unfortunately, they were further
away from the business than I had expected," that person said. "Our
reliance on them was the blind leading the blind."
Li, Thompson and Williams declined to comment for this story.
Steve Wunning, the Peoria-based president of Caterpillar's mining
equipment division, Resource Industries, and then-Chief Financial
Officer, Ed Rapp, pitched the idea of buying Siwei to the company's
board of directors in October 2011. It was codenamed "Project
Sequoia." The board expressed support for the strategy, according to
court documents filed in the United States.
The first sign of trouble surfaced quickly. On November 7, 2011, the
board received a two-page memo explaining that Siwei would need an
immediate $50 million loan for working capital. Excerpts of the memo
were contained in the court documents.
The memo explained that Siwei's customers weren't paying what they
owed. It also noted Siwei hadn't made overtime payments to its
workers and didn't hold operating permits required by Chinese
regulations. Fixing these and other issues, the memo said, would
cost CAT as much as $30 million.
The board was unfazed. That same day, the directors voted for the
acquisition, authorizing the purchase of Siwei for up to $964
million. It would be the biggest foreign machinery acquisition in
Hong Kong or China since the country opened up for business in 1978.
The board also authorized the loan for working capital.
Four months later, in March 2012, the board received another memo
signaling trouble at Siwei, court documents showed. The company had
missed its 2011 financial targets, and its parent company, ERA, was
going to report a $2 million loss rather than a $16 million profit.
Wunning also told the board that Siwei's average receivables had
grown to an extraordinary 371 days, according to filings in
connection to the court case.
Corporate filings show the amount owed to Siwei by customers had
risen 58 percent per year since 2008, overtaking total sales in
2011. Some 90 percent of those debts were overdue when Caterpillar
launched its bid.
Mining equipment companies typically finance at least part of their
customers' purchases. However, once accounts are more than 90 days
old, they are almost always disqualified from being counted as
collateral for loans. At six months, they are widely recognized as
needing to be turned over to a collection agency, or they are
written off or reserved in full, according to one of the four
shareholder suits filed in the United States. The complaint says the
receivables issue rendered Siwei's revenues and assets "highly
suspicious and most likely wholly illusory."
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Unsold goods were also a problem for Siwei. At the end of 2010, the
average number of days Siwei's products sat in storage was 414,
double what it was during China's economic slowdown in 2009.
Caterpillar spokesman Jim Dugan said the company would not comment
directly on matters of "pending litigation."
But he said Siwei's accounting problems were unrelated to the profit
warning and other issues the company found during its due diligence
of the acquisition.
"The Siwei accounting issues that led to the goodwill impairment
charge involved Siwei's falsification of its books," Dugan said in
an email. "Therefore, Siwei's profit warning and failure to meet its
2011 targets, the $50 million working capital loan to Siwei, and
other issues that came up in the course of Caterpillar's diligence
were not 'red flags' as to the accounting fraud."
The news release announcing Caterpillar's tender offer went out on
June 6, 2012.
Documents produced for one of the Illinois court cases show that
Caterpillar's board of directors did not ask for the results of the
due diligence investigation, which ran from about September 2011
until June 2012. The board also did not look into whether Siwei's
financial problems had been resolved. And it did not adjust the
offer price, the documents indicate.
Siwei had been focused almost entirely on gaining market share.
Getting customers to actually pay their bills came to seem like an
afterthought, former executives told Reuters.
"They would take orders without down payments, so they had to
finance the whole thing," said a person with direct involvement with
Siwei. The point "was to try to get market share." This person
added: "These were all things we felt we could fix once we were on
Caterpillar was so bullish on China, it may have been willing to
overlook some of Siwei's problems, former insiders say.
"There was also a lot of euphoria. We were really going to dominate.
Not only in mining but also in China," the person said, and old
China hands Williams, Li and Thompson would help. "Obviously it was
too much, and we got burned."
LEGEND IN THE INDUSTRY
At first, Wang Fu was equally exuberant about the deal. Siwei's
former CEO is a native of the northeastern Chinese province of
Liaoning with nearly 30 years experience in the machinery industry.
His first job out of college in 1984 was with the state-owned
company from which Siwei would eventually be spun out in 2003.
In Siwei's first year of operation after the spinoff, sales were
less than 20 million yuan. Growth came quickly amid China's
insatiable hunger for coal. By 2011, revenue approached 2 billion
yuan ($500 million).
On June 8, 2012, two days after the acquisition was completed,
Caterpillar executives addressed Siwei's first post-merger board
meeting in Zhengzhou. They pledged to preserve Siwei's culture and
way of doing business.
Wang says he was inspired. Siwei would retain independence, but be
able to draw upon the experience and expertise of its new Fortune
The excitement faded quickly. Accounts of what went wrong, why and
how, now diverge completely in Peoria and Zhengzhou.
In the interview, Wang said he knew Siwei's accounting methodology
was bad, and its finance team too inexperienced to make
improvements. He said as CEO, his primary concern had been chasing
market share. "Better to have market share than to solve every
single problem and lose the market." But his finance team, he said,
couldn't keep up as the firm grew and orders poured in.
Wang said he was proactive about the accounting problems. He raised
it two or three times at Siwei board meetings, he said, hoping
Caterpillar's more experienced finance team could help. He said the
board gave him half a year to resolve the issue.
Caterpillar denies that. Spokesman Dugan said Wang never brought the
issue up and said Siwei's accounting problems — including the
existence of a second set of books — were only discovered in
November 2012, after Caterpillar found inventory discrepancies.
Wang says there was no second set of accounting books.
THE GAME IS UP
Wang said he mobilized employees in finance, sales, manufacturing
and technology to dig into the accounting issues following the
acquisition. At the time, Wang said, nobody knew exactly how bad
By October 2012, Wang found that costs were sometimes allocated to
incorrect projects. Other times, the company had simply not
capitalized costs, or had accounted for them improperly on Siwei's
balance sheet. Siwei had also double-booked some sales, which led to
At the same time, however, by Wang's estimates, the company's income
had been underreported by about 170 million yuan because it had
under-valued equipment made in-house.
Caterpillar spokesman Dugan said this account was not accurate, but
did not respond to specific questions about whether Caterpillar had
written off too much. Requests to interview Caterpillar Chairman and
CEO Oberhelman were declined.
In the months to follow, Wang's relationship with Caterpillar
soured. Every decision, it seemed to Wang, had to go through
Caterpillar's lawyers, and Wang said he rarely interacted with
senior Caterpillar executives.
At the end of Wang's marathon grilling by Caterpillar attorneys on
November 16, the day of the awards ceremony in Hong Kong, the
attorneys concluded there had been mismanagement but no fraud, Wang
Two months later, Wang says he was told to drop by Caterpillar's
China headquarters in Beijing at the tail end of a business trip.
Company lawyers fired him, he says, and refused to answer his
The written notice said: "Your misconduct and serious dereliction of
duty have caused severe damage to the company. You have also
seriously violated company rules."
Since Caterpillar bought Siwei, it has had no new orders for
hydraulic roof supports, two former employees with knowledge of
customer accounts said.
The number of working employees fell to about 1,900 in September
from about 4,300 at the start of the year, one former office
employee said. Four other former employees corroborated the scope of
Wang feels Caterpillar never had a "comprehensive understanding" of
Siwei's financial situation and believes he was the scapegoat.
"It looks like it is precisely to justify and cover up a dereliction
of duty by their so-called elite teams that an easily discovered
management issue is labeled as deliberate, intentional fraud," he
Caterpillar stands by its allegation of fraud. And it is trying to
open a new era at the company it acquired.
On November 8 it announced the company name had been changed to
Caterpillar (Zhengzhou) Ltd. The Siwei brand, it said, would be
(Reporting by John Ruwitch and Clare Baldwin;
by Alina Selyukh; editing by Bill Powell and Bill Tarrant.)
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