Updated January 31, 2021, 8.30 am.

By Mak Yuen Teen

On January 20, UOB Kay Hian (UOBKH) initiated coverage on G.H.Y. Culture & Media (GHY) with a buy call and a target price of $1.08. UOBKH was joint issue manager and joint underwriter for GHY’s IPO in December 2020.

UOBKH’s initiation of coverage for GHY was well covered in the media. The day before, the share price had closed at $0.785. By lunchtime, the share price had increased to $0.81 and closed at $0.845, up 7.6% from the previous day. As of January 30, it had gone back down to $0.68, still above its IPO price of $0.66.

The fact that the company will be “guided by the company’s ‘visionary founder, experienced key management team and reputable team of industry veterans” was highlighted by the analysts. The prospectus said that the founder, Mr Guo Jingyu, is a notable producer, director and scriptwriter in the PRC with more than 25 years of experience and is known as the “King of Legendary Drama”.

From a corporate governance perspective,  GHY screams high risk to me, with “key man risk” involving the founder being a significant risk.

Key man risk

Mr Guo is the controlling shareholder owning 59.6% of the shares, and is GHY’s Executive Chairman and Group CEO, despite having no experience as a director or CEO of a public-listed company. The Board and nominating committee (NC), in assessing Mr Guo’s suitability as Executive Chairman and Group CEO said that he “only retains supervisory oversight in the drama and film projects of our Group and is not involved in the operational aspects thereof”.

However, the prospectus lists the “strong in-house script production team” co-led by Mr Guo as one of the company’s competitive strengths, and said that Mr Guo spearheads the group’s TV program and film production business. Leading the script production team and the group’s TV program and film production business sounds like extensive involvement in operations to me.

Mr Guo has also lent money to the company, guaranteed some of its loans, and is one of the two individual shareholders of the PRC-affiliated entities which undertake the actual operations of the business.

Related parties and associates

Potential conflicts of interest also arise from the close involvement of family members of Mr Guo in the business. Mr Guo’s spouse, Ms Yue Lina, an established actress, is managed by the group’s talent management services business. She too plays a key role in the production and direction of the company’s dramas and film projects. She also acts as a joint guarantor for some of the company’s loans.  Ms Yue is also an executive director on the board. Mr Guo’s brother, Mr Yang Zhigang, is also an actor managed by the group’s talent management services business and acts in the group’s drama and film projects.

Another key executive officer, Mr Xue Xin, is Senior Director of TV Program and Film Production and the other individual shareholder (together with Mr Guo) of the affiliated entities in People’s Republic of China (PRC). He is also the legal representative, executive director and general manager for eight of the nine PRC entities. Given the important role played by the legal representative in PRC companies, one may say he holds the keys to most of the locks. While he is accountable to senior management and the board as an executive officer, the key roles he holds puts him in a powerful position. His different roles may also put him in a position of conflict. Has the board considered the risks associated with Mr Xue holding these different roles and what steps has it taken to address them?

Group adviser

Then there is Mr John Ho Ah Huat, the group adviser and a substantial shareholder, who was also instrumental in the founding of the company. Under the service agreement signed with the company, which is automatically renewed annually unless terminated in accordance with the terms, Mr Ho is paid a monthly fee of not more than $30,000. His role is “to provide advisory services in identifying potential business opportunities and to provide general advice in relation to the business operations” of the group, through introducing business contacts and potential business opportunities. The prospectus said that he is not involved in the day-to-day operations or participate in the execution or implementation of business strategies.

Mr Ho is on SGX’s directors’ and key officers’ watchlist. This followed an SGX reprimand in October 2011 directed at Scorpio East, Mr Ho and several other individuals. The reprimand cited several breaches in listing rules. It said that he had “not demonstrated the qualities expected of directors and management of SGX-listed companies” and failed to act in the interests of shareholders as a whole. The special auditors’ findings pointed to possible breaches of the law, and SGX said that it would refer the case to the relevant authorities.

Several contracts that Scorpio East had entered into were terminated without the approval or knowledge of the board, and were not announced.  There was also “round-tripping” of cash, proposed material remittances without proper due diligence, doubts about veracity of contracts, and lack of proper internal controls. The report said that Mr Ho had taken steps to terminate the contracts without board approval. Further, after he stepped down as CEO and ED and became a consultant, he had directed the finance staff to issue receipts for the terminated contracts arising from the “round-tripping” transactions despite his knowledge that no such refunds had been made.

While Mr Ho is not a director or key officer of GHY, is it prudent for the company to appoint him as an adviser? A director’s reliance on others, such as advisers, should be based on reasonable grounds and in good faith.

Board of directors

While the nine-member board checks the boxes in having a majority of five independent directors, with three being Singapore-based and a lead independent director, the board’s role is likely to be hindered when it comes to overseeing key areas such as strategy, risk, management and operations.

This is partly due to the extensive control and involvement of controlling shareholder Mr Guo and his associates in the group’s operations, but also because the listed company has no direct management control over the PRC-affiliated entities – also called variable interest entities (VIEs) – which undertake much of the actual business. They are also likely to have little input or oversight on the contractual arrangements that are put in place to enable GHY to obtain operational control and economic rights over the VIEs.

Has the board considered its ability to exercise proper oversight, given the complex corporate structure and contractual arrangements in place? This brings me to the issue of GHY’s corporate structure, which to me is the greatest risk of all.

Complex corporate structure

The corporate structure is shown in the prospectus. The risks relating to the corporate structure are generally well explained over nine pages in the prospectus, with the entire discussion of risk factors spanning over 53 pages.

Essentially, there are five layers of companies. The first layer is the SGX-listed company, which is incorporated in Cayman Islands as an exempted company with limited liability. This subjects it to Cayman company law, not Singapore company law. The directors of the listed company therefore owe fiduciary duties and duty of skill and care to the company under Cayman Islands law. This means that regulatory enforcement of these duties is in the hands of the Cayman Islands’ authorities, not the Singapore authorities.  An obvious question is why incorporate the listed holding company in a jurisdiction like Cayman Islands?

The second layer comprises three wholly-owned subsidiaries, two incorporated in Hong Kong and one in Singapore. Of particular significance is G. Yue Culture and Media Limited, incorporated in Hong Kong (HK), as it is the company that owns the next layer of two wholly-owned foreign entities (WFOEs). One of these WFOEs in turn owns 95% of another company incorporated in PRC in the fourth layer, with the other HK-incorporated company in the second layer owning the other 5%. The fourth-layer company owns 100% of another two PRC-incorporated companies. The two WFOEs have also entered into contractual arrangements with four other PRC-affiliated entities/VIEs, which are in turn organised into two layers, a holding company and three wholly-owned subsidiaries.

The complex structure is largely designed to navigate around prohibition in foreign investment in certain industries imposed by PRC, which includes TV program and film production and operation – the business of GHY. A major risk is that PRC’s foreign investment law has not explicitly stipulated that the type of contractual arrangements used by GHY is an acceptable form of foreign investment. If PRC finds these contractual arrangements to be non-compliant with its restrictions, it is not an exaggeration to say that the whole business model of GHY may collapse like a house of cards, or at the very least result in significant adverse financial implications.

Other risks related to the complex corporate structure include  limitations of the contractual arrangements in providing effective control over the VIEs; uncertainties of the PRC legal system which could limit enforceability of the contractual arrangements; certain limitations and substantial costs that may arise from acquisition of equity interest or assets of the VIEs; failure by the VIEs or their shareholders to perform their obligations under the contractual arrangements; loss of use or benefits from licenses and assets held by the VIEs if they declare bankruptcy or are liquidated; significant tax and transfer pricing risks arising from the contractual arrangements; and potential conflicts of interests involving the individual shareholders and directors of the VIEs.

The complex contractual arrangements that underpin the corporate structure are further explained over 23 pages in the prospectus. A reading of these arrangements will give a good sense of all the things that could possibly go wrong in different aspects of the contractual arrangements, once again highlighting the considerable risks involved.

Each additional layer and entity adds to the risks, as the individual shareholders, directors and legal representatives may not act in the interest of GHY – which the company itself acknowledges.

While the risks in GHY apply to many other companies, including tech companies like Alibaba and JD.com, and are largely beyond the control of GHY, should investors accept such risks for a company in a business like GHY’s?

The extensive involvement of the founders and the complex structure brings to mind Eagle Hospitality Trust (EHT), currently mired in a mess that will prove difficult to unravel. While I am not suggesting that GHY will necessarily meet the same fate, it raises the same question: why did GHY decide to list in Singapore, and not Hong Kong or China? This is especially so when one considers that most of its dramas and films are aimed primarily at the PRC markets.

Audits and financial statements

The independent auditor and reporting accountant for GHY is Deloitte & Touche LLP (Singapore), which is also its independent tax adviser. Its Singapore subsidiary, Malaysian subsidiary and two PRC entities are also audited by Deloitte or its affiliates. Other subsidiaries and PRC entities are said to have also been audited by Deloitte (Singapore) or Deloitte (Beijing) for group consolidation purposes, but there is no mention of the auditors of these other subsidiaries and entities. It is well known that PRC audits face some special challenges, including access to working papers of audits conducted by local auditors.

The financial statements disclosed in the prospectus show some unusual trends. While revenue for the latest six months ended 30 June 2020 declined to $37.2 million from S$41.6 million for the comparative six-month period, gross profit increased to $19.6 million from $11.9 million due to a much larger decline in cost of sales. In other words, the gross profit ratio increased to 52.6% from 28.6%. Profit after tax increased to $13.0 million from S$11.6 million.

The gross profit and net profit for the most recent six months were higher than those for the previous full year ended 31 December 2019 even though revenue was $28.8 million or 43.7% lower for the latest half year.

Cash flow from operating activities for the latest six months was positive S$9.5 million, compared to negative $12.7 million and negative $11.0 million for the comparative six-month period and the last full financial year. In other words, the most recent six months’ results were significantly better than the comparative six-month period and the last full financial year.

To be fair, the prospectus does highlight as a risk factor the fact that the financial statements for different periods are not comparable and cited its short operating history and a range of general factors that may cause financial results to vary from period to period.  Notwithstanding, it is unclear why results for the most recent six-month period were considerably better than the past. Investors should bear this in mind and not assume that that latest six-month results are representative of future performance.

Given the significant corporate governance risks, one hopes there would not be real drama at GHY in the near future.

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The author is an associate professor of accounting at the NUS Business School where he specialises in corporate governance. He does not own any shares in G.H.Y. Culture & Media.