Caterpillar Lowers The Loss From China Scandal With Settlement

by Trefis Team
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Caterpillar
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    Quick Take 

  • Caterpillar acquired ERA Mining along with its Chinese subsidiary, Siwei, in June 2012, to gain an expanded presence in the China coal mining market, which is poised for long term growth.
  • However, an accounting scandal at Siwei revealed post-acquisition caused Caterpillar to incur a goodwill impairment charge of $580 million.
  • As part of the settlement reached with the concerned parties, Caterpillar reduced its pending obligations under the ERA acquisition by $135 million.

Caterpillar (NYSE:CAT) announced on May 16, that it has reached a settlement with the concerned parties regarding the $580 million non-cash charge it had incurred in January, from the accounting misconduct at Siwei, the Chinese subsidiary of the ERA Mining. [1] Caterpillar had acquired ERA Mining in mid-2012 for around $700 million. [2]

As part of the final settlement, Caterpillar’s outstanding liabilities of $164.5 million to two former ERA directors and an investor have been reduced by $135 million to $29.5 million. [3] This lowers the cost of ERA acquisition for Caterpillar.

We currently have a stock price estimate of $86 for Caterpillar, approximately in line with its current market price.

See our complete analysis of Caterpillar here

Acquisition Of ERA Mining And The Accounting Scandal At Its China Unit

In November 2011, Caterpillar moved to acquire ERA Mining to expand its presence in the Chinese coal mining industry. ERA through its wholly owned Chinese subsidiary, Siwei, manufactured and sells roof support equipment for underground coal mines in China. The acquisition provided Caterpillar with a significant share in the coal mining equipment market of China, which produces and consumes nearly half of the world’s coal.

However, in January 2013, during the integration of ERA, Caterpillar unearthed a multi-year, deliberate accounting scandal at Siwei. Investigations revealed involvement of several senior managers at Siwei in wrongful revenue recognition practices to overstate profits. Involvement of one director at ERA was also brought to the fore, and consequently, Caterpillar moved to terminate the services of all those involved.

In its press release, Caterpillar said that the conclusion of this settlement agreement will allow it to lay greater focus on improving Siwei’s operations and in continuing to expand its presence in the highly important China coal mining market.

Caterpillar Facing A Tough Business Environment

Separately, Caterpillar’s profits had declined by 45% year-over-year to $880 million in the first quarter due to inventory reduction by its dealers in light of the weak end user demand, especially from the mining industry. The company anticipates the tough business environment to continue in the near term and accordingly has forecast its full year earnings to lie around $7 per share, down from $8.48 per share in 2012. (See Weak Demand Clips Caterpillar’s Earnings And Outlook)

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Notes:
  1. Caterpillar takes action to address the accounting misconduct at Siwei, January 18 2013, www.caterpillar.com []
  2. Caterpillar completes the tender offer for ERA Mining, June 6 2013, www.caterpillar.com []
  3. Caterpillar announces settlement agreement related to the Siwei accounting misconduct, May 16 2013, www.caterpillar.com []
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