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 The Morgan Stanley private equity unit put up $300 million for a
minority stake in Tianhe in 2012 after spending over $2 million on
third-party diligence work over a three-year period, according to a
source with knowledge of the matter. Tianhe represents its biggest
equity investment in Asia, while the bank itself was one of the
underwriters of the IPO in June.
Industry insiders say the amount is unusually high for diligence
work.
"Diligence of that level would usually involve deep checks on the
company's financials, its production facilities and its customer
base," said the source, who declined to be identified because of the
sensitivity of the matter.
Anonymous Analytics, on the other hand, says it conducted all of its
investigations using publicly available information, most of it
posted online, combined with a few visits to the offices of Tianhe
customers in Shanghai.
But if the accusations by Anonymous turn out to be true, besides
facing potential losses, the scale of the fraud will represent a
huge loss of face for the Morgan Stanley firm, which manages mostly
third party money such as U.S. pension funds, and has invested
around $2.5 billion in over 50 investments in Asia.
Although Tianhe's shares have been targeted by short-sellers for
weeks, Anonymous said it had not gained from the transactions and
had issued the report for the public good.
It said last Monday that the Chinese industrial firm, which last had
a market capitalization of $8 billion, falsely reported on its tax
statements and provided falsified documents to its auditor,
Deloitte. The report also said Tianhe does not make the revenues it
claims.
Tianhe has denied the charges. The company requested a trading halt
after its shares fell 5 percent on Tuesday, which is still in force.
Morgan Stanley has not commented on Anonymous' allegations.
Sources who have business relations with the Morgan Stanley private
equity firm have told Reuters that it considers Tianhe to be the
jewel in its crown and that the investment was agreed after two and
a half years of negotiations with the company chairman.
An industry insider said deep diligence on a company would extend to
visits to customer's offices and face-to-face meetings. It could
also involve the use of private investigators or external auditors
to check the reputation and business history of the company's
principals.
"It depends how many subjects you look into, and how deep you go,
but it's rare to get a diligence of this size," said the insider,
who added that the usual cost for investigation of a company in
China would be up to around $150,000.
Anonymous Analytics did not respond to e-mailed questions requesting
information about their spending.
"It's strong on documents and documentation, but what it lacks is on
the ground in mainland China; they didn't send someone to go visit
factories or observe the factories, measure production levels, talk
to customers, suppliers and competitors," said Jon Carnes, founder
of Alfredlittle.com, one of the most successful short research
houses targeting Chinese firms.
PATCHY RECORD
Carnes said he usually spends around $100,000-$200,000 researching a
given company before deciding whether to target it with a report or
not.
And while Anonymous has a patchy record of success with its reports,
Morgan Stanley's unit has never made a loss on a China investment in
over 20 years of deals, a record that is the envy of peers who have
suffered reputational and financial damage from claims of fraud at
their China portfolio companies.
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Its past investments include Ping An Insurance Group and Sihuan
Pharmaceutical Holdings Group Ltd, which is seen as a textbook case
of the profits that can be made by buying out overseas-listed China
companies, then relisting them closer to home.
Morgan Stanley Private Equity Asia (MSPEA) is the largest
institutional investor in Tianhe, with 8.6 percent of the company's
stock, according to Thomson Reuters data, and the bank also has 27
percent of the MSPEA fund which invested in Tianhe.
It has also effectively double dipped on the deal as a sponsor of
Tianhe's $654 million Hong Kong IPO, with Bank of America Merrill
Lynch and UBS. All three sponsors can be held liable under Hong Kong
law if the IPO prospectus is proved to be fraudulent.
Sources have told Reuters that MSPEA actively promoted the Tianhe
investment when it was raising its fourth and biggest Asia fund of
$1.7 billion.
Homer Sun, MSPEA's chief investment officer and head of its China
investments team, sits on the Tianhe board as a non-executive
director, along with specialists whose background includes stints at
Dupont, Conoco and Standard Oil.
Morgan Stanley's Asia private equity unit has even invested in
stocks targeted by shortsellers in the past.
In 2011, at the height of a shortselling frenzy targeting
U.S.-listed China companies, MSPEA invested $50 million in
fertilizer company Yongye International, which had been accused of
fraud by shortsellers.
The Morgan Stanley investment saw Yongye's stock soar around 40
percent in one day. It subsequently fell back, but the accusations
faded. In July this year, MSPEA was part of a consortium that bought
out the company.
Anonymous Analytics has published reports critical of other Chinese
companies in the past, including Huabao International, Qihu 360 and
Chaoda Modern Agriculture Holdings, though investors shrugged off
allegations made against Qihu and Huabao.
Sources could not be named as they were not authorised to speak to
media.
(The story corrects para 24 to read 2011 (not 2012) and para 25 to
say MSPEA was part of a consortium that bought Yongye this year.)
(Additional reporting by Lawrence White and Elzio Barreto in Hong
Kong, Engem Tham and Pete Sweeney in Shanghai, and Shanghai
Newsroom; Editing by Raju Gopalakrishnan)
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