CAT’s write-down has lessons for you, too

Caterpillar (NYSE: CAT) purchased ERA Mining Machinery, China’s fourth-largest maker of hydraulic coal mine roof supports in last June 2012, paying $653.4 million. After the deal closed, Caterpillar found accounting fraud. The fraud caused a $580 million write-down, or 87 cents per CAT share in the most recent quarterly earnings report. Caterpillar states that the accounting fraud was deliberate, and began several years before the Caterpillar acquisition.

Caterpillar’s situation raises the following points for other businesses and investors:

  1. The write-off underscores the need for investigation of what one is purchasing. I get multiple calls each week from prospective purchasers inquiring about my firm’s ability to conduct investigations and/or valuations of company purchases. We regularly perform this work in response to some of these inquiries, but I am astounded by purchasers who are unwilling to pay for a quality examination to determine whether it is wise to complete the prospective acquisition, and at what price.
  2. Chinese accounting and related regulation requires improvement. There have been significant losses on fraudulent Chinese investments by Americans, with the Caterpillar write-off being just one example. While purchases of entire companies can be appropriately investigated, the same is not true of stock investments by individuals. Until the Chinese are both willing to fully cooperate with U.S. regulators and improve the audit function with China, one should avoid Chinese investments. This is quite unfortunate, since the Chinese economy otherwise presents numerous opportunities. But, the possibility of losing large amounts of money because of fraudulent accounting is unacceptably high. This article provides additional details, which have still not satisfactorily improved as this is written.


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