Xiaoxiao Education Limited (ASX: XXL) was a Chinese company listed on the ASX but was delisted earlier this year, after shares were suspended from trading for three years.
Xiaoxiao wasn't the only company delisted – another 26 companies were also delisted – but it has by far the most amazing story.
The company
Xiaoxiao was listed on the ASX in February 2010 and operated a childhood education business in China with more than 4,000 enrolled students with another 4,000 children attending extra-curricular programs out of school hours and during holiday periods. Another 8,000 students also attended courses at its Hangzhou Binjiang Art Training School. At the time of listing, the company says it employed 500 staff and had an established track record over 17 years.
In March 2011, the company sought to expand into Australia with the acquisition of the Breakfast Point Childcare Centre for A$257,000. The centre was licenced to care for 25 children and was at full capacity.
From bad to worse
But the company was beset by issues from the start, posting losses in 2010, 2011 and 2012.
In 2010, the Chinese government imposed a 10% increase in labour costs, the strong Australian dollar had a negative effect on the exchange rate – reducing profits and Chinese parents wanted day-care only facilities rather than the full care Xiaoxiao was providing.
In 2011, the company attributed its loss to 1) the Chinese government intervening in the hours that children were allowed to participate in discretionary subjects – reducing Xiaoxiao's fees, 2) rising costs of food and consumables, 3) the strengthening Australian dollar and 4) a change in the economic environment that allows the company to continue its proposed acquisition program (whatever that means).
Clearly, this was a company that was seeing its business eroded.
An unexpected offer
In March 2012, things started to get more interesting.
The company was approached by a third party to acquire a majority of the shares in the company – at the time 81% held by the executive chairperson Madam Yongrong Tong. Madam Tong held 120 million shares out of the 148 million outstanding (81%). In exchange for the shares, the third party, a Mr Xu Zi, was offering the Datong Daluo iron ore mine, located in the Chongqing Province, China.
Mr Xu intended to change the company's business to iron ore mining and dispose of the childcare assets. In March 2012, iron ore was trading around US$140 a tonne, well above today's price of around US$42 a tonne. However, the Datong Daluo iron ore mine was no longer producing iron ore and still required government approval. The mine was reported to have produced ore in the past, but Xiaoxiao appears to have never been made aware of how much production the mine had actually produced.
An independent expert's report declared the offer 'fair and reasonable' (I have no idea how).
The process dragged on, while Xiaoxiao shares were suspended from trading since December 2012 to allow the restructure to proceed. At the time of the suspension, shares were trading at 44 cents, making Madam Tong's holding worth A$26.4 million (A share consolidation of 2:1 was completed in January 2013, making Madam Tong's holding 60 million shares).
Further delays beyond the company's control meant another shareholder meeting needed to be convened to approve the restructure – which was successful in October 2014.
Chairman detained
Then in January 2015, the company advised the ASX that the chairperson of Xiaoxiao, Madam Yongrong Tong, who was also named as a Deputy of the 12th Peoples Congress, had been suspended from her position as Deputy and 'suspected of taking public deposits'.
No further updates were provided, until October 2015, when Xiaoxiao advised the ASX that since the October 2014 meeting, the company had made a number of attempts to contact Mr Xu and his associates, all of which were unsuccessful.
Given the fall in the iron ore price over that time, perhaps Mr Xu decided the iron ore mine was no longer a viable commercial option? Not being able to contact Mr Xu, Xiaoxiao wrote a letter to him, advising that it was terminating the proposed restructure.
The company also advised that it had met with senior Hangzhou Chinese government officials and confirmed that charges had been laid against Madam Tong and she was being detained and the company was unable to contact her directly. The government authorities confirmed that the charges against Madam Tong were for her personal activities and that she had diverted funds which would normally be used to fund the XiaoXiao pre-school network in China.
Business taken over
The Chinese authorities had also taken over control and management of the pre-schools to ensure the children have certainty of continuity. Xiaoxiao tried to have the management of the pre-schools returned to the company, but despite significant documentation to prove ownership, the government refused to hand over management until the legal matters concerning Madam Tong had been completed.
In simple terms, the Chinese government basically confiscated Xiaoxiao's pre-school business because its chairman was suspected of personally being corrupt (and the company was not implicated in any way). Since nothing has been proven, we can only presume Madam Tong's innocence.
XiaoXiao was then forced to sell its remaining Australian childcare centre to pay its Australian creditors. Whether it can even continue as a business is highly doubtful.
Foolish takeaway
This story should be a warning to anyone considering investing in Chinese companies listing on the ASX. Chinese companies are inherently different to Australian companies, structured differently and their business operations are highly opaque.
The Chinese authorities can mandate pay increases, change working conditions or laws and take control of a company's assets with relative ease. A company can instantly find that it has no business, leaving shareholders with nothing and no recourse.
We've highlighted issues with the large percentage of Chinese companies that have been found to be fraudulent, including a number of companies listed on overseas exchanges. Having a Western audit company hasn't helped either.
We've also highlighted several financial issues with ASX-listed Chinese companies including Sunbridge Group Ltd (ASX: SBB) several times (including here) and XPD Soccer Gear Group Ltd (ASX: XPD) here. Interestingly, both companies report substantial cash balances but earn very little interest according to their cash flow statements.
You can't say you haven't been warned.
