CAT was blind to pitfalls in China

One year ago, I looked at Peoria, Ill.-based Caterpillar Inc.’s $580 million, 86-percent write down of its $677 million purchase of ERA Mining Machinery Ltd.

ERA was the Hong Kong-listed parent of Siwei, a Chinese mining equipment specialist, which produced roof tunnel supports for the underground mining market. In tandem with CAT’s acquisition of South Milwaukee-based Bucyrus International Inc., its acquisition of ERA was to usher in a new era of dominance for CAT in China’s massive coal mining industry.

Voted one of the top deals of 2012, it was the toast of the evening of Nov. 16, at the ultra-luxurious Island Shangri La in Hong Kong. But, as the toasting and back slapping began, the deal was sinking in red ink, torpedoed by massive fraud.

The very same night that CAT was receiving accolades, three Caterpillar lawyers were finishing up an eight-hour interrogation of Wang Fu, Siwei’s chairman, which focused on the massive fraud uncovered at the company’s headquarters in Zhengzhou. Two months later, on Jan. 18, 2013, five months after the acquisition closed, Caterpillar announced it had uncovered “deliberate, multi-year, coordinated accounting misconduct.” Wang was fired

What one insider had said was going to be CAT’s calling card in China turned out to be a massive joke.

According to Reuters, after a review of hundreds of pages of public documents, and interviews with former employees, board members, bankers and advisers, it was clear that accounting problems were rampant at Siwei before Caterpillar bought it.

Yet, despite multiple red flags at different stages of the transaction, Caterpillar’s management and board plowed ahead with the deal.

According to a story published by Reuters on Jan. 23:

  • Steve Wunning, the Peoria-based president of Caterpillar’s mining equipment division, Resource Industries, and then-chief financial officer Ed Rapp pitched the idea of buying Siwei to the company’s board of directors in October 2011.
  • On Nov. 7, 2011, the board received a two-page memo explaining that Siwei would need an immediate $50 million loan for working capital. The memo explained that Siwei’s customers weren’t paying what they owed. It also noted Siwei hadn’t made overtime payments to its workers and didn’t hold operating permits required by Chinese regulations. Fixing these and other issues, the memo said, would cost CAT as much as $30 million.
  • The board was unfazed. That same day, the directors voted for the acquisition, authorizing the purchase of Siwei for up to $964 million. It was to be the biggest foreign machinery acquisition in Hong Kong or China since the country opened up for business in 1978. The board also authorized the loan for working capital.
  • In March 2012, the board received another memo signaling trouble at Siwei. The company had missed its 2011 financial targets, and its parent company, ERA, was going to report a $2 million loss rather than a $16 million profit. Wunning also told the board that Siwei’s average receivables had grown to an extraordinary 371 days.
  • Corporate filings show the amount owed to Siwei by customers had risen 58 percent per year since 2008, overtaking total sales in 2011. Some 90 percent of those debts were overdue when Caterpillar launched its bid.
  • Today, Siwei, according to sources within the company, has no orders and its workforce has been cut in half (given no orders, one wonders what they are doing).

Siwei’s former CEO, Wang, has started a competing company and has been quoted saying he believes his former clients will follow him. In an interview with Reuters, he says his books were a mess but he committed no wrongdoing. Wang said he knew Siwei’s accounting methodology was bad, and its finance team was too inexperienced to make improvements. He said as CEO, his primary concern had been chasing market share. “Better to have market share than to solve every single problem and lose the market.”

So why did CAT pursue the deal? Three reasons: a heavy pitch by two CAT insiders; the presence of three American investors; and the allure of playing global chess.

Sitting in Peoria and making decisions about business on the other side of the globe sounds grand, especially when you are a massive player looking at the big game, but the realities of business in unfamiliar areas do not follow our gaming assumptions.

Ignoring red flags, because your ideas are too big to fail, has been the Achilles heel of many companies. In the case of the management and the board of CAT, it was a moment of hubris which is still playing out. Interestingly, other than a few management scapegoats, there has been no perceptible fall out for the board members involved, other than few pesky shareholder class actions.

So what can you take from this case study?

Repeat the mantra…when abroad, trust nothing, verify everything. Do not make assumptions. Listen to people on the ground, not half a world away. Just because foreigners are involved, do not assume the deal is on the up-and-up. Never wait for red flags. Just do the due diligence and keep your ego in check.

There are few major companies that have not had their challenges in China.

What was surprising was that Caterpillar was no newbie in China, having done business in China for more than 30 years, with more than 20,000 China employees, dozens of manufacturing, research, logistics and parts centers, a large dealer network, nine new facilities under construction. And having just completed the $8.8 billion purchase of Bucyrus, one would expect they knew the lay of the land.

Einar Tangen, formerly from Milwaukee, now lives and works in Beijing, China. He is an adviser to Heilongjiang Province, Hebei Province QEDTZ,, China International Publishing Group, Beijing Baotong and DGI DESIGN. He is also a weekly public affairs commentator for CCTV News’ Dialogue and the author of “The Kunshan Way,” an economic development history of China’s leading county level city. While in Milwaukee, he was a partner at Jackson, Morgan and Tangen, president of E-Tech and a senior vice president at Stifel Nicolaus. He chaired various boards in Milwaukee and was a member of the Federal Home Loan Bank of Chicago. Readers who would like to submit questions or suggest areas of interest can send an e-mail to

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