Caterpillar Inc. : Departure Of Caterpillar Executive Linked To China Writedown -Source
01/19/2013| 04:25pm US/Eastern
By James R. Hagerty, Colum Murphy and Bob Tita
An accounting scandal at a Caterpillar Inc. mining-equipment unit in China helped lead to the departure of a senior executive, a person familiar with the situation said.
Peoria, Ill.-based Caterpillar, the world's largest maker of construction and mining equipment, disclosed late Friday afternoon that it would write down the value of a Chinese mining-equipment subsidiary, ERA Mining Machinery Ltd., by $580 million. It blamed "accounting misconduct" at ERA designed to overstate profitability before it was acquired by Caterpillar last June for about $700 million.
Caterpillar said in a separate statement that Luis de Leon, a vice president responsible for mining products, was "leaving the company to pursue other opportunities." That departure was partly related to Caterpillar's displeasure over problems at ERA, though Mr. de Leon wasn't being accused of accounting misdeeds, according to the person familiar with the situation. Mr. de Leon couldn't be reached for comment. He joined Caterpillar in mid-2011, when the company completed its $8.8 billion purchase of Bucyrus International Inc., a Milwaukee-based maker of mining equipment where he had been chief operating officer.
Caterpillar for years has emphasized China as vital to its long-run success.
"We're going to play offense (in China) and we're going to win," Doug Oberhelman, chief executive officer, vowed to investors in 2010. At that time, the company couldn't keep up with demand for construction equipment in China and was losing market share to local rivals. Caterpillar raced to open new capacity in China in 2011, just in time for a slump in that market that has left the company and many of its competitors awash with excess inventory.
Caterpillar has been investing heavily in for decades in China, where it has more than 15,000 employees, about 12% of the global total. The company has 23 manufacturing plants and four research and development centers there, and four new facilities are under construction. Yet China accounted for only about 3% of the company's total sales, a Caterpillar official said last April.
Caterpillar's $580 million writedown amounts to less than 1% of the company's market value of about $63 billion, and Caterpillar isn't the first Western company to trip over Chinese accounting problems. Even so, "this kind of thing doesn't bode well for perception," said Jean Kester, a Beijing-based partner for LehmanBrown International Accountants.
Citigroup Global Markets Asia Ltd., a unit of Citigroup Inc., was Caterpillar's financial adviser on the ERA purchase, while Freshfields Bruckhaus Deringer LLP served as the legal adviser. Representatives of Citigroup and Freshfields didn't immediately respond to requests for comment.
Caterpillar said it didn't expect the problems at ERA to have "a significant impact on Caterpillar's 2013 sales and revenues or profit." The company is due to release fourth quarter results and update its outlook on Jan. 28.
Caterpillar was particularly eager to bulk up in coal-mining equipment, given China's huge dependence on coal for generating power and making steel. Coal accounts for about two-thirds of China's energy consumption, and improving the safety of mines is a national priority.
Caterpillar said Friday that it considered its policies for examining potential acquisitions "rigorous and robust." The company blamed "deliberate, multi-year, coordinated accounting misconduct" by several senior managers at ERA before the acquisition. Caterpillar said those managers, whom it didn't name, had been dismissed. Caterpillar said it believed the accounting misdeeds had been "perpetrated without the knowledge of any Caterpillar employee who did not come over to Caterpillar as part of the ... acquisition."
The accounting problems surfaced in November when Caterpillar found discrepancies between ERA's inventories and the inventory numbers recorded in ERA's books, Caterpillar said. An investigation then found "inappropriate accounting practices involving improper cost allocation that resulted in overstated profit," according to Caterpillar's statement Friday. ERA's products include roof supports for underground coal mines.
In October, Caterpillar announced the retirement of Rich Lavin, a group president whose responsibilities included China. Caterpillar praised Mr. Lavin for expanding the company's Asian operations and for his "remarkable leadership and strategic vision." His former China duties are now held by Ed Rapp, another group president, based in Singapore.
Mr. Lavin moved from Peoria to Hong Kong in 2010 in an effort to put more urgency into Caterpillar's efforts to expand in China and elsewhere in Asia. "We have got to win in China," Mr. Lavin said at an industry trade show in Las Vegas in March 2011. The market is so huge, he said, that over the long term "if we don't lead in China we're not going to be the global industry leader."
Before attracting a takeover bid from Caterpillar, ERA obtained a stock market listing in Hong Kong by taking over a firm already listed there. Such "reverse takeovers" of listed companies require less public disclosure than initial public offerings of stock.
Accounting problems have ensnared other Western investors in China. According to documents filed to the Delaware District court recently by Starr International Co., an investment vehicle run by Maurice "Hank" Greenberg, an arbitration committee in Hong Kong recently found that China MediaExpress - in which Starr had invested more than $40 million - had fraudulently induced Starr's investment and awarded the U.S. fund $77 million in damages.
In 2011, Longtop Financial Technologies Ltd., a China-based software company, was delisted from the New York Stock Exchange. U.S. regulators charged that it failed to file accurate financial reports. Longtop has denied wrongdoing.
Caterpillar said the accounting problems at ERA wouldn't change its strategy for the mining-equipment business in China. "China produces and consumes more coal than any other country in the world," the company said.
Caterpillar's acquisition of ERA closely followed the purchase by rival Joy Global Inc. of another Chinese maker of mining equipment, International Mining Machinery Holdings Ltd. IMM manufactures machinery for shearing coal from the walls of underground coal mines.
The acquisitions were motivated by the Western equipment makers' difficulty in penetrating the Chinese market, where many mine operators are loyal to domestic machinery brands.
But a weak market for Chinese coal in the past year, caused by China's slowing economy, raised questions about the timing of Joy Global's and Caterpillar's pursuit of Chinese mining equipment companies. "Our International Mining Machinery acquisition has been a challenge in 2012," Joy Global CEO Michael Sutherlin said in December.
--Dinny McMahon and Li Yue contributed to this report
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