China deal ends distraction, but not questions, for Caterpillar

China deal ends distraction, but not questions, for Caterpillar

Fri, May 17 2013

By James B. Kelleher

CHICAGO (Reuters) – Caterpillar Inc’s (CAT.N: Quote,ProfileResearchStock Buzz) deal to cut the purchase price of a Chinese mining-equipment maker it bought last year ends an embarrassing episode that overshadowed the company’s effort to expand in China and distracted its executives for months. Now, analysts say, comes the hard part: Proving to investors that ERA Mining Machinery, the Chinese maker of hydraulic roof supports that Caterpillar purchased, really can help penetrate China’s huge underground mining market. In January, Caterpillar took a $580 million impairment related to the ERA deal after discovering what it characterized as a “deliberate, multi-year, coordinated accounting misconduct” at Siwei, a subsidiary that handled ERA’s principal business. Late on Thursday, Caterpillar said it reached a deal with the former controlling shareholders of ERA to cut $135 million from the $886 million purchase price – a move welcomed by analysts even if the money involved was, in the words of one, “a blip” in the U.S. company’s overall finances. “Outside of the reduction in purchase price, the chief benefit of the settlement is to eliminate the management distraction caused by the issue and get on with realizing the potential that led Caterpillar to buy this company in the first place,” said Alex Blanton, a senior analyst at Clear Harbor Asset Management in New York. “Whether or not it realizes the potential is another question,” he said.The deal reduces the outstanding obligations Caterpillar has to MML, and to former ERA directors Emory Williams and John Lee, as well as MML shareholder James Thompson, to $29.5 million. Caterpillar still owed the four about $164 million.

In exchange, Caterpillar agreed to end any litigation targeting the Chinese company’s former directors or auditors related to the alleged accounting misconduct.

A Caterpillar spokesman declined to comment on the settlement on Friday, citing “pending litigation” – a reference to the shareholder lawsuits over the charge.

Eli Lustgarten, an analyst at Longbow Securities, said the dispute overshadowed ERA’s real importance to Caterpillar: giving it the product line and distribution it desperately wants in China, which produces and consumes more coal than any other country in the world.

Caterpillar, long the world’s largest maker of construction equipment, has also become the world’s largest mining equipment maker in recent years.

One question that remains is how Caterpillar will account for the $135 million, which – potentially – could lift its earnings as a noncash, nonrecurring item.

“From an economic standpoint, for Caterpillar’s business and for Caterpillar’s shareholders, it’s rather de minimus,” said Morningstar analyst Adam Fleck. “But it’s real savings.”

In its most recent quarterly earnings report, Caterpillar told investors it was gaining market share in China despite a slowdown in economic growth there. Sales of its distinctive yellow construction and mining machines were up in the first quarter of 2013 over the same period of 2012 even as its inventories there declined.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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