Tuesday, September 13, 2011

Taia Global's Report On Huawei's Bank Loan Controversy

Yesterday, I wrote about a little-reported story of how Huawei is under investigation by Chinese authorities for allegedly abusing its employees' stock purchasing program to effectively generate bank loans without having to report them to the government. My post surprised Huawei US VP for Government Affairs William Plummer who wasn't aware of the scandal but in a private email to me, Mr. Plummer expressed skepticism on the accuracy of the report. Consequently I've tasked some of Taia Global's China experts (all native speakers) to take a deeper look at Huawei's employee incentive plan and how it impacts the company's debt ratio, which depending upon the math involved could go as high as 82% rather than the very low 61% figure provided in Mr. Plummer's Huawei Overview .ppt deck.

Taia Global's Report on Huawei's Bank Loan controversy

Internal financing has been part of Huawei’s employee incentive plan since the 1990s, but this program has become an indirect method for Huawei to borrow money from banks. According to a blog on Tianya, an online community for Chinese overseas, before 2007, the amount of internal stock allocated to each employee was based on the number of years the employee had served and the economic contribution the employee had made in the corresponding year.

Internal stock was one of the three key benefits for employees, in addition to salary and stock dividends.  In recent years, each employee was allowed to purchase a higher proportion of internal stock shares with 15% down payment, and the remainder was paid via bank loans borrowed at a 6% interest rate in the name of the employee, who must pay back at least 20% of the loan’s net value each year.  The down payment ratio was increased to 40% in 2010.  Although dividends were high, most were used to pay back loans for internal stock purchase.  If an employee left Huawei, the employee would only sell the stock share at the original purchase price, with no capital gain for such an internal investment. 

Huawei’s approach (which has been in place since at least 2000 and perhaps earlier) has two consequences.  First, Huawei, as the company entity, received borrowed money in its employees’ names and avoided having to identify it as debt on their balance sheet, which enabled the company to polish its financial performance.  A Chinese blogger –Kuai Dao Hong Qi, whose real name is Chen Hui Min陈惠民, an influential media professional – listed financial data from Huawei’s financial statement from 2008 to 2010.  According to his blog, in 2010, the debt ratio (debt in 105.6 billion yuan/ assets in 160.8 billion yuan) of Huawei was 66%, a little lower than 70%, the financial warning line.  If Huawei added back 11.4 billion yuan, the accumulated borrowed money through this employee incentive plan, the debt ratio would be 68% (adjust debt in 117 billion yuan/adjusted assets in 172.2 billion yuan).

Second, this plan is very risky for employees. In order to receive more dividends in the future, employees borrowed money to buy stock shares and then used received dividends to pay back loans, so they were giving up short-term benefits in pursuit of long-term rewards.  Their assumption is that Huawei will maintain high growth rates as they have had historically, which is not easy due to slow market expansion and high research expenses for exploring new business sectors.

Another potential and well-hidden problem about Huawei’s financial performance is the accelerated recognition of sales revenue. By 2010, Huawei had sold its account receivables of 84 billion yuan in total to banks so the company could recognize revenue quickly. However, Huawei is still liable for sustaining losses if banks fail to collect money back from Huawei’s clients. According to both Chinese and American accounting standards, this is a type of contingency and should be classified as debt. If Huawei also followed this rule, its adjusted debt ratio in 2010 would be 82%, much higher than the warning line of 70%.

No Chinese official media reports on Huawei’s financial issues, although some information can be found online. Meanwhile, according to a person working in Huawei, the employee incentive plan was approved by the Guangdong government, so most people inside Huawei do not think it is risky.

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