Emerson Analytics: Sound Global – a Water Specialist in Deep Water

http://www.emersonanalytics.co/downloads/SoundGlobal-HK_0967-StrongSell.pdf

Posted by LIN Liye, Year 4 undergrad at the School of Economics, Singapore Management University

Sound Global is one of the players in the Chinese wastewater treatment industry and is engaged in the construction and operation of treatment plants, either as a contractor or as a BOT (build-operate-transfer) operator. A lumpy business segment allows it to slip in 40% of non-existent revenue and hide many cases of revenue exaggeration.

Summary 

1. Bogus revenue: unknown company does Rmb1bn of undisclosed technology business a year
An appraisal report on Sound Global for Chinese regulators but somehow put in the public domain unveils a “secret” segment of “engineering technology service” that Sound Global has never discussed with its shareholders despite the “fact” that it supposedly accounted for roughly 40% of the listco’s revenue during 2011-13. We certainly have not been able to find enough projects to account for the listco’s revenue. Instead, we’ve found a mysterious subsidiary that leaves no trace in the Chinese water industry, a strong indication that the revenue just didn’t exist.

2. Catch-22: the Anshan mystery
All evidence suggests Sound Global completed the Anshan plants in 2012 but the company says Anshan was its biggest revenue source in 2013. We are convinced that the company had accounted for Anshan in 2012 as a BOT project on percentage completion basis, which then leaves a hole in the 2013 revenue with no big projects to account for. But if the company had not accounted for Anshan in 2012, that raises the question of which projects contributed to the 2012 revenue and additions of service concession receivables. Either way, there’s a hole somewhere in Sound Global’s accounts.

3. Confusing accounting: reporting profit before building anything
We suspect Sound Global simply makes up its stories as it feels the need to impress investors. In the 2010 Hong Kong listing document, it shows that 90% of revenue from two Jingzhou projects has been booked in 2008. However, the company did not sign the construction contract until early 2009. We also examine two other cases that raise questions over the management’s trustworthiness.

4. Interest income fails the acid test
All these issues above suggest that Sound Global has been doctoring its books for many years and that a substantial amount of its revenue just doesn’t exist. The exceedingly low interest income suggests that the company’s real cash/bank balances probably averaged merely one-third of the amounts disclosed. This is another strong indicator that the revenue and profit figures have been significantly inflated.

5. True 2013 profitability merely one third of announced
By ignoring the mysterious Rmb1bn “engineering technology service” revenue and the Rmb380m hole
left by Anshan, we estimate that Sound Global’s real profitability in 2013 was just about Rmb113m, or
slightly more than a quarter of the amount that it announced. Adjusting for the non-existent cash/bank
balance, true 2013 net book value would be slightly less than Rmb1bn.

6. Stock worth about HK$2.4 per share
Applying the prevailing historical 2013 P/E of 23x on Sound Global’s reported numbers to our adjusted
profit estimate, we are of the opinion that the stock is worth about HK$2.4 per share.

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