In this post I want to take a look at China Education Resources [CHN], a Chinese company listed on the TSX-V exchange in Toronto.
I’m choosing to talk about this company for two reasons: firstly, it looks like it has made incorrect filings to Canadian authorities, and secondly, because it speaks to the lack of information available to China concept stock investors in Canada.
CHN is in the online education industry in China, where it has the cersp.com portal, which it runs and has developed in collaboration with the curriculum development centre of the Ministry of Education. Coupled to this web portal is a set of online educational services:
a) A school platform, which is a form of online system for sending messages between participants (Teachers, Students, Parents etc.), as well as providing the infrastructure for online tests etc. It has been described as the Facebook of teaching in China.
b) An online tutoring programme, where students sign up for lessons with teachers over the Internet platform. The students prepay the service.
c) Distribution of CD products, containing sample education software for trial purposes. Students can then sign up for the full offering online.
In order to conduct its business the company reports having three WFOEs (CEN Network, China Education International Inc. and CEN China Education Overseas Corporation), as well as two 90% owned subsidiaries (CEN Smart, and TTTC). TTTC also owns 54% of another consolidated entity ZYCY (Or 60% according to the MD&A filing).
There is no mention of which one of these entities supposedly holds the licenses necessary to operate the business, but with the information we’ve been given, it looks like none of these entities could legally hold them. This is due to the fact that they are operating in restricted areas of the Chinese economy, which don’t allow foreign ownership.
The norm for a company operating in this line of business would be to have a VIE structure, where there is a contractual relationship to a consolidated Chinese company that holds the licenses and conducts the business in the restricted area. These types of structures are very common in China these days, but have a lot of risks attached to them.
However, CHN explicitly states in their latest annual filings that they have no VIEs.
The question then seems to be whether one of the entities consolidated under equity ownership is in fact a VIE (this would likely be TTTC as they seem to be the direct holders of the web portal), or whether the licenses etc. are held by others, which would mean the company doesn’t actually own any of the key assets they’ve presented as their own.
This could be a case of a primitive form of VIE arrangement managing to list overseas without going through the normal steps of solidifying the structure. If this is the case what we’d likely find is that unconsolidated related parties hold the licenses. Think VIE arrangement without any real control agreements, similar to what was found at Sino-Forest.
At present, the lack of information provided by the company makes it very hard to say how it actually operates, but it seems clear that none of the consolidated entities could in fact run the business. So we may assume that there is in fact more to this story than the financials tell us, even if we don’t quite know how much more.
I believe Canadian investors need more detailed disclosure requirements from Chinese companies listed in Canada, in general, and especially where VIE structures are involved. The amount of details available, even regarding disclosed VIE structures, is very limited and sometimes doesn’t even include the nature of the contracts that make up the basis for consolidation. This is nowhere near enough to give investors the information they need to make correct calls about risks in these investments.
There are currently over 50 Chinese companies listed on the stock exchanges in Canada. Not a huge number, but enough to warrant some special attention from the regulators when it comes to disclosures.
Full disclosure: I hold no position in CHN, nor do I intend to take any position in the company. I have alerted relevant authorities in Canada about these issues.