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Some Puzzling Aspects of This Reverse Takeover Deal

Goodwill This merger brought to Haitong Securities great amounts of goodwill. The CNY 205 million in goodwill, as stated in financial statements, consisted of 200 million coming from the merger and 5 million coming from previous acquisitions of the former Haitong Securities. In fact, the CNY 200 million was a part of the takeover agreement, to be paid in cash to the shareholders of Dushi Corp. in consideration of their loss in the split-share structure reform.

However, Haitong Securities did not disclose any basis for such accounting treatment. Although on the surface Dushi Corp. exchanged their 3.031 billion shares for 8.734 billion shares of Haitong Securities in the merger, the Haitong shareholders actually obtained the 89.43 percent marketable shares of Dushi by giving away a 10.57 percent stake (equity ownership from 100 percent to 89.43 percent) and bringing on board Dushi shareholders. Haitong Securities wrote off the CNY 200 million in goodwill in the 2007 annual report, and gave no reasons or references, making the accounting treatment in this merger questionable.

Consolidation of Financial Statements and Information Disclosure In its interim report, Haitong Securities claimed that this was "a merger between companies not under the same control." However, Haitong adopted an accounting treatment similar to that commonly used for mergers of companies under the same control. There was basically no increase in the value of net assets; that is, no new assets were formed. In accordance with applicable International Financial Reporting Standards (IFRS) rules, the information stated in the consolidated statements in the interim report seems fine. But such information is unreliable to faithfully reflect the merger and give a true and fair view of the operating results and financial position of the surviving company.

Business Valuation As the financial advisor in this merger, Huatai Securities calculated Haitong's book value of equity per share to be between CNY 2.10 and 2.38 using the price-to-earnings (P/E) ratio method, and 2.10 per share using the present value-based income method. It determined the book value of equity per share at CNY 2.01 per share. The closing price of CNY 5.80 per share of Dushi Corp. on the last market day before the trading halt was determined as the reference price for the exchange of shares. Huatai's position on business valuation was that over the next decade, the Chinese securities industry would see 20 percent year-over-year growth and securities firms would have a P/E ratio between 25 to 35, therefore concluding that Haitong Securities had a P/E ratio between 30 and 34, and a book value to share price ratio of CNY 2.10 and 2.38. There is a problem in this statement. Obviously, there is a lack of evidence, making the reliability of such valuation questionable. According to the financial statements released by Haitong Securities, the net asset value per share was CNY 0.37 as of September 30, 2006. Assuming that the price was at CNY 2.1 per share, the price-to-book ratio would be 5.68 as of September 30,2006. Considering the market conditions at the time, the resulting business valuation, based on the P/E ratio approach or income approach, would not be sound enough to be rational and reliable.

Accounting Treatment of Loss In the consolidated statements of Haitong Securities, the retained earnings were CNY 5.267 billion in red at the beginning of the year and 2.432 billion in black at the end of the accounting period. However, the pretax profit was listed as only CNY 3.263 billion on the income statement of the same period. This means that Haitong did not use the pretax profit to make up for loss. According to the statement of changes in ownership interests, during the same accounting period, Haitong reduced its share capital by CNY 5.703 billion, increased retained earnings by 5.515 billion, and added 188 million to capital reserves. This was done for reasons other than owners' capital contributions and share-based payment recognized into owners' equity. In fact, the reduction of share capital reflected the reduction in the shares of the former Haitong Securities (from 8.734 billion to 3.031 billion shares) in the exchange of shares for the purpose of the merger. It was by such accounting treatment that Haitong Securities turned a deficit into a surplus.

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