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China Dairy flagged by Muddy Waters prepares for liquidation

China Huishan Dairy Holdings, the Hong Kong-listed company targeted by short sellers including Muddy Waters Capital, is preparing for provisional liquidation in a move that could protect its assets as it negotiates with creditors.

[SHANGHAI} - China Huishan Dairy Holdings, the Hong Kong-listed company targeted by short sellers including Muddy Waters Capital, is preparing for provisional liquidation in a move that could protect its assets as it negotiates with creditors.

The firm had told its Cayman legal advisers to make the preparations, it said in a Hong Kong stock exchange filing on Thursday (Nov 16). Huishan's board earlier found that the net liabilities of its units in China "could have been" 10.5 billion yuan (S$2.15 billion) as of March 31, the company said. A provisional liquidation generally is used to safeguard a company's assets before a court rules what action to take.

Huishan, which was considered one of the biggest operators of dairy milk farms in China, was described last year by Muddy Waters founder Carson Block as "worth close to zero." He engaged in a war of words with Huishan, which accused his firm of making allegations that were groundless, malicious and false. Huishan's shares have been suspended since they tumbled 85 per cent on March 24, the day after its creditors held an emergency meeting to discuss a cash shortage at the company.

Block, in an interview on Friday, said his firm has exited its position on Huishan.

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"The most interesting part is the statement by the directors that net liabilities of the company could be 10.5 billion yuan and I compare that to the last published financials from September 2016 and the company was showing net assets of 12.9 billion yuan," he said. "That's a clear affirmation that Huishan was a fraud."

Six calls to Huishan offices in Shenyang and Hong Kong weren't answered on Friday. Lorraine Chan, a spokeswoman for Hong Kong Exchanges & Clearing, said the exchange operator didn't comment on individual companies.

Huishan "will take into account, as far as possible, options available to the company to preserve the assets of the group," it said in the exchange filing. With the majority of its assets held through units in China, any debt restructuring will be subject to Chinese law, Huishan Dairy said.

The provisional liquidation could lead to liquidation potentially, or some form of restructuring, according to Keith Pogson, a managing partner at Ernst & Young in Hong Kong.

The group's estimated total indebtedness was about 26.7 billion yuan as of March 31, including about 18.7 billion yuan of bank loans and 4.25 billion yuan of non-bank loans, it said in June.

A liquidation would still need approval by shareholders or creditors, according to Shen Meng, director of the boutique investment fund Chanson & Co. Huishan's move may be aimed at forcing creditors to accept its restructuring plan, which would result in only some repayment of debt, he said.

Huishan peaked at a market value of about US$5.9 billion in November 2013, but that slumped to about US$720 million by the time its shares were suspended. Muddy Waters alleged in December last year that the company had overstated its sales, misrepresented its self-sufficiency in alfalfa and made an unannounced transfer of assets to an entity controlled by Chairman Yang Kai. Huishan said the allegations were groundless and contained misrepresentations.

China's dairy industry, which imports about a fifth of its milk supply, is recovering from a worldwide raw milk price slump that's weighed on the profits of producers including China Modern Dairy Holdings that's controlled by China Mengniu Dairy Co.

But Huishan's troubles are largely due to its own capital entanglements and not to wider market trends, said Guangdong Dairy Association Director Wang Dingmian. The company's milk supply largely goes to manufacturing dairy products under its own brand, according to Wang. Huishan's existing farms are operating normally, he said.

"It is a very small supplier in the overall market and its troubles will not affect the supply of milk in China," he said.

China's dairy farming landscape is dominated by smaller-scale farmers, which means that Huishan was one of the bigger industrial farms while still accounting for only a small portion of nationwide milk supply.

The company had said in November it's on track to post positive cash flow from normal operations by end of March next year, before filing the notice of provisional liquidation.

More than half of the company's onshore creditors backed a debt restructuring, the company said in a statement to Hong Kong's exchange dated Nov 1. Those onshore creditors represent more than two-thirds of the outstanding amount due by Huishan Dairy or Yang and other companies as of March 31, it said.

Huishan said in June after an exodus of its treasury officials that there was a "significant discrepancy" in its cash position. Based on the group's "incomplete management accounts," its cash and cash equivalents as of March 31 came to about 2.9 billion yuan "but the bank confirmations received from the banks amounted to approximately 467 million yuan," it said.

The company also said at that time that it was liaising with banks and other creditors to negotiate a standstill to ensure the continued operations of the group.

Huishan's troubles should be a cautionary example for investors, said Charles Macgregor, head of emerging markets research at Lucror Analytics. "There is very likely more Huishans out there, this type of behavior is hardly isolated to a few bad apples."