THE BEST OF BOTH WORLD
China Southern Airlines plots a very different course through a cloud of accounting systems.
By Yang Jian

China's transition from a state-owned to a market-oriented economy has been remarkable for its speed. But one side effect of the headlong race has been that new accounting systems mingle with the old, and the whole business of reporting can seem ambiguous in the extreme. From a CFO's point of view, the fuzziness is a burden - or a distinct benefit. Take some careful timing plus an even more careful selection of accounting options, add a pinch of deft juggling, and you can significantly improve the performance of a local-market offering.

That is precisely the recipe CFO Xu Jiebo followed for China Southern Airlines' Rmb1 billion (US$121 million) A-share offering in Shanghai. The ride to market in July was turbulent but ultimately very satisfactory and it remains an object lesson on how to turn accounting diversity to a company's advantage.

And diverse it certainly is. Currently in China, there appear to be three ways that a company can opt to report if it lists in the A-share market. These include China's old style of reporting for individual sectors handed down by the state in 1993, newer rules based on International Accounting Standards (IAS) but adapted for China's home market, called Accounting Standards for Business Enterprises (ASBE), and, as witnessed by the case presented here, a mixture of several options involving picking those that put the company's net profits and asset size to best advantage (see box for accounting definitions).

Just to add to the confusion, different accounting models are used even within a single industrial sector. The aviation industry is a prime example, in large part because of the way its different finance chiefs handle the thorny problem of asset depreciation.

Airplanes and re-usable parts (called rotable parts in industry jargon) such as turbines and pumps necessarily make up the bulk of an airline's assets but they are given widely different depreciable lives under different accounting standards. Airline operators with a shareholding structure are using ASBE in their depreciation calculations while others are still using accounting policies promulgated by the Civil Aviation Administration of China (CAAC). And then there is Xu Jiebo and China Southern, which is on a very different flight path.

China Southern is no parvenu in the world of equity financing; it pulled off a dual listing in Hong Kong and New York in 1997. But timing, coupled with an absence of red ink on the books, were crucial to getting a sweet deal in Shanghai this July. The first, most obvious hurdle was that the China Securities Regulatory Commission (CSRC) normally requires companies to be profitable before listing. No problem there, according to the company's CFO, but analysts - already jittery about the effect of such a heavyweight issue on a more-or-less stagnant A-share market - were less sanguine about the company's end-of-year figures.

Despite a forecast of Rmb202.60 million in profit for 2003, they suspected that China Southern might well end the year in the red because it was hit hard by the Sars outbreak. After all, the company suffered a loss of Rmb218.66 million in the first four months of 2003 because of Sars. However, the CSRC decided to give the company the benefit of the doubt and approved its listing application thus saving it the embarrassment of launching the issue after disclosing losses for the first half in the interim report.

After approval, China Southern didn't dawdle; it launched the A-Share issue 6 days later on July 10. The timing was perfect because, despite CFO Xu's confidence in China Southern's profit prospects, one thing was certain: if his company hadn't listed when it did and it had to report a loss at the end of year, there would have been no A-share listing in 2004. "It is against the Securities Law to allow a money-losing company [in a full year] to get listed," explains Tang Qian, a Shenyin Wanguo Securities analyst of China's aviation industry. The timing, however, would have been nothing without Xu Jiebo and China Galaxy Securities, the main underwriter of China Southern's A-share issue, and the deft use they made of accounting policies to interpret China Southern's financial results over the past three years beginning 2000.

Since the company was issuing shares on the domestic market, it was supposed to comply with the ASBE when reporting. However, a comparison between the accounting polices it adopted when preparing the statements with those used by its domestic peers reveals that the company was actually following IAS rules in its treatment of such important items as the depreciation of aircraft, engines and major rotable parts. In addition, China Southern adjusted the accounting policies in line with IAS on the following items: aircraft and aircraft overhaul costs, major rotable parts maintenance costs, provisions for account receivables, basis of consolidation, deferred taxation and leased assets.

A word of explanation is required here: although ASBE is based on IAS, it still deviates from the principles of the "parent" code in several important areas, including amortization of intangible assets, capitalization of interest and revaluation of land use rights. The reason that China Southern opted to pick and choose between the two codes is no mystery given the ultimate effect: a healthier statement of net profit after the multiple adjustments were made. The company's 2002 net profits provide an illustration. Using IAS only, net profits are Rmb575.76. Using ASBE, which it had to do, but with selective choosing of IAS for several individual categories, net profits are a somewhat more modest Rmb513.35 million.

Despite the disparity of the figures, holders of A-shares in China and those of international shares are getting roughly the same numbers. But if China Southern used the CAAC's method of reckoning, there would be a gaping disparity between its reporting to international investors and domestic investors. Under the code designed for China's aviation sector - and used still by other airlines - the company's 2002 net profits would be sharply lower at Rmb212.30 million. Meantime, its earnings per share (EPS) last year would nosedive to Rmb0.06 from Rmb0.15.

The CSRC has never explicitly set a ceiling on the P/E ratio for domestic companies launching IPOs. However, it is widely believed among industry insiders that these days the market watchdog does not allow companies to issue shares during IPOs on the domestic market at prices above 20 times their earning per share in the previous year. If that is the case, without making the accounting policy adjustments in line with IAS principles, China Southern would have been able to raise only a maximum of Rmb1 billion by floating 1 billion A-Shares. With the adjustments made, China Southern managed to raise Rmb2.7 billion by selling its 1 billion A-Shares at Rmb2.7 per share, a price 18 times its 2002 EPS of Rmb0.15.

To be fair, China Southern has good reasons to adjust its accounting polices in accordance with IAS-based codes. The government, after all, has decreed that all companies, with a few exceptions, must conform to ASBE rules by the time they report in 2005, and these are based, by and large, on IAS. And no one has said the approach is in error - or illegal. CFO Xu is confident. He argues that the depreciable life of aircraft and major rotable parts China Southern has made for its fleet are based on the real situation. "According to our past experiences, the residual value of our aircraft has been above 28.75%," he insists.

Yang Jian is a senior writer for CFO China based in Shanghai.