New Silkroutes plans independent review into deals signed with China entity

SINGAPORE (THE BUSINESS TIMES) - Healthcare and energy firm New Silkroutes Group will appoint an independent public accounting firm to conduct an independent review into matters relating to two agreements involving its China subsidiary and the valuation of its stake in a Thai firm.

This comes after the mainboard-listed company's independent external auditor Deloitte & Touche had included a disclaimer of opinion and an emphasis of matter on the group's financial statements for the fiscal year ended June 30, 2020.

Deloitte had said in its Oct 14 report that it was unable to obtain sufficient audit evidence on matters including the business rationale, commercial substance and structuring of two agreements that New Silkroutes' wholly-owned subsidiary, Shanghai Fengwei Garment Accessory (SFGA), had signed with a Chinese entity in April.

In response to the Singapore Exchange's (SGX) queries, New Silkroutes said on Wednesday night (Oct 28) that the need to ease its cash flow was a key reason for the management agreement (MA) inked with the entity.

As for the other agreement - a management service agreement (MSA) - New Silkroutes said it will conduct an independent review into whether there are potential tax exposures and the impact of any non-compliance with regulatory or legal requirements arising from it.

The review will also look into the commercial substance of both the MA and MSA, to address Deloitte's concerns.

New Silkroutes disclosed on Wednesday that the Chinese entity in both agreements is Shanghai Minlin New Textile Materials Sales Centre, whose ultimate beneficial owner, Lin Jie, is an acquaintance of New Silkroutes' executive director and substantial shareholder, Shen Yuyun.

Under the MA, Shanghai Minlin will manage and expand the business of SFGA. New Silkroutes replied to SGX that the subsidiary's order book has increased as a result of Shanghai Minlin's services. The Chinese entity also helped procure additional manpower and raw materials to fulfil the increased volume of products in June.

The New Silkroutes group will receive upfront a guaranteed profit of about US$2.8 million (S$3.8 million) for Jan 1, 2020, to Dec 31, 2021, under the MA. On Wednesday, the Singapore-listed firm noted that this sum will be provided regardless of whether SFGA actually made a loss or a profit lower than that amount. The US$2.8 million consideration was about 42 per cent higher than the subsidiary's profits in 2019.

New Silkroutes added that entering into the MA was a commercial and business decision, to ensure the subsidiary "could make a profit despite the grave uncertainties" at the onset of the coronavirus pandemic.

Moreover, the manufacturing sector in China is competitive, thus it will be beneficial for SFGA to collaborate with external parties such as the Chinese entity to market its non-woven material to downstream factories and to explore vertical integration for direct sale to consumers.

The MA also allowed New Silkroutes to receive upfront cash, part of which was used to repay a loan from Haitong International Products (Singapore), thus averting defaults in the Singapore-listed group's credit facilities.

Meanwhile, under the MSA, the subsidiary is to receive services such as human resource management, corporate image planning, production process management, marketing development and financial management from Shanghai Minlin.

During the MSA's service period of April 1, 2020 to Dec 31, 2020, SFGA's profit after deducting the monthly management service fees should not be lower than its base profit. If SFGA's actual profit is less than the base profit, the Chinese entity will make up the shortfall to SFGA.

New Silkroutes replied to SGX that the management service fees for April to June had ranged from nearly 10 million yuan (S$2 million) to 20 million yuan.

It also noted that SFGA's revenue had increased by about 100 million yuan after the MA and MSA were inked, thanks to new orders introduced by Shanghai Minlin.

Without the two agreements, revenue for the quarter ended June 30, 2020 "would have decreased significantly" as there were limited marketing and orders downstream, the company noted. This is because while SFGA has the capacity to increase its production output, it lacks the capabilities to secure sales contracts downstream to increase revenue targets.

Meanwhile, in Deloitte's report, the auditor had noted that the group's financial asset measured at fair value through other comprehensive income (FVTOCI) related to a 4.5 per cent stake in Thai General Nice Coal and Coke.

The group recorded a fair-value loss of about US$2.5 million on the financial asset at FVTOCI as at June 30, bringing its carrying amount to some US$17.2 million.

However, the Thai firm had not begun operating by end-June. Deloitte thus could not determine the appropriateness of the valuation methodology on the stake in the Thai firm, and could not obtain reliable supporting information to evaluate the reasonableness of the key assumptions underlying the forecasts.

On Wednesday, New Silkroutes reiterated that it will continue to request from the Thai firm's management more visibility on its future plans and developments as well as for access to its records.

"The current Covid-19 pandemic further hinders progress, with travelling restrictions," it added.

The board also said it believes the FVTOCI of US$17.2 million is reasonable and appropriate, as it is lower than the independent valuation of US$17.4 million by JLL under the income approach.

Nonetheless, the board and the management will continue to explore with the incoming auditors on other methods of valuation that are acceptable to them.

Deloitte's disclaimer of opinion was published on the same day as the company's announcement on the resignations of Goh Jin Hian as chairman and William Teo as finance director.

Separately, in September, New Silkroutes disclosed that Dr Goh and Mr Teo were assisting the Commercial Affairs Department with investigations. The alleged offence is false trading and market rigging pursuant to Section 197 of the Securities and Futures Act in relation to share buybacks and acquisitions of shares.

Also assisting with the investigation is Kelvyn Oo, who was the executive director and chief corporate officer of New Silkroutes until he left on Aug 1.

Shares of New Silkroutes last traded on Wednesday at 8.9 cents.