Gaming industry companies' financial reports often exhibit characteristics such as light assets, high goodwill, high sales expenses, small and dispersed customers, and complex cash flows. Under the pressure of merger and acquisition (M&A) performance bets, the acquisition targets or listed companies frequently inflate profits through false records, which has become a focus of regulatory attention. Since 2024, gaming industry listed companies and related parties have frequently received penalties from Chinese regulatory authorities.
Another gaming company has received a penalty notice from the regulatory authorities.
On September 14th, ST Huicheng (002168.SZ) announced that it had received the "Administrative Penalty Decision" from the China Securities Regulatory Commission (CSRC). The gaming subsidiary, Du Ke Meng, acquired in 2017, was found by the CSRC to have false records inflating profits by more than 300 million yuan. The then-chairman, vice president, and the person in charge of Du Ke Meng, as well as the vice president and CFO of Du Ke Meng, were fined 1 million yuan, 3 million yuan, 500,000 yuan, and 500,000 yuan, respectively. Additionally, ST Huicheng was warned and fined 2 million yuan. At the same time, due to the penalty for false records in the annual report, Huicheng Technology was given a risk warning and labeled with "ST". From the opening on September 19th to the closing on September 24th, it experienced five consecutive daily limit-downs.
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This is not the only case announced by gaming listed companies in 2024. Since the beginning of the year, a total of five gaming industry companies have received penalty letters, with two receiving administrative penalty notices from the CSRC and three receiving regulatory letters from local securities regulatory bureaus. There are only 25 gaming companies listed on the A-share market.
By examining the penalties imposed on multiple companies, it is evident that there are industry-wide commonalities.
Since 2015, M&A has been an important means for gaming listed companies to grow and strengthen. However, most high-premium M&As involve performance bets. Under this model, many gaming listed companies or management teams have taken risks to complete performance bets, inflating profits in various ways: falsely listing prepayments, not conducting impairment tests as required, fabricating or prematurely confirming software copyright transactions, fabricating cash flows, etc.
The performance commitment brought by high-premium cross-border M&A
High-premium acquisition first, followed by a performance commitment with growth potential. ST Huicheng's acquisition eventually fell into the situation of being recognized as inflating profits.
ST Huicheng originally focused on new polymer electrical insulation materials as its main business. Over the years, the company's development has been lukewarm. From 2012 to 2015, the company's revenue decreased from 433 million yuan to 209 million yuan, and net profit increased from 35.66 million yuan to 128 million yuan. The increase in net profit in 2015 mainly relied on securities investment income, while the revenue from the main electrical business continued to decline.
In April 2016, ST Huicheng issued a detailed equity change announcement. The original actual controllers, He Ping and Ren Jinsheng, signed a share transfer agreement with Zhongchi Jixu. Zhongchi Jixu acquired 86.74 million shares of ST Huicheng held by He Ping and Ren Jinsheng for a cash payment of 1.65 billion yuan. After the acquisition, the shares held by Zhongchi Jixu accounted for 11.11% of all shares of ST Huicheng, becoming the largest shareholder. The transfer was completed in June of the same year.Zhongchi Speed (later renamed "Zhongchi Hui Cheng") is 100% controlled by Xinzhongli, with its actual controllers being the couple Wang Chaoyong and Li Yifei. Wang Chaoyong is one of the pioneers in the investment industry, being one of the first Chinese students to enter Wall Street. He has served at J.P. Morgan, Standard & Poor's, and Morgan Stanley, among others. After briefly participating in the investment banking department of the China Development Bank, Wang Chaoyong founded the private equity firm Xinzhongli Investment in 1999.
The takeover of Zhongchi Speed has provided the market with a great deal of imagination. After the detailed equity announcement, ST Hui Cheng once had five consecutive daily limit-ups, and the market had high expectations for Zhongchi Speed and its actual controllers, the couple Wang Chaoyong and Li Yifei.
The new controllers have indeed actively promoted the asset injection and acquisition of ST Hui Cheng, looking for new profit growth points. In March 2017, the draft of ST Hui Cheng's major asset acquisition and reorganization was released. The company planned to acquire 77.57% of Duo Ke Meng's shares for 1.383 billion yuan, and another 55% of Qun Li Century's equity for 575 million yuan, with both transactions being cash payments.
The main asset of this cash transaction is Duo Ke Meng, whose main business is traffic operation based on big data precision marketing and the research and development, development, and game platform business of mobile games. Its 100% equity valuation is 1.786 billion yuan. As of the end of 2016, the company's net assets were 62.4609 million yuan. In 2015 and 2016, Duo Ke Meng's revenue was 31.8107 million yuan and 165 million yuan, respectively, with net profits of 470,300 yuan and 33.5025 million yuan, respectively. According to the net assets and net profits of 2016, Duo Ke Meng's price-to-earnings ratio and price-to-book ratio are 53.21 times and 28.54 times, respectively.
Regardless of whether it is the price-to-earnings ratio or the price-to-book ratio, Duo Ke Meng's premium is very high. Therefore, the transaction counterparties proposed a performance commitment that increases year by year. The transaction counterparties Kou Han and Lin Jia Xi committed to achieve a net profit of not less than 145 million yuan, 188 million yuan, and 245 million yuan in 2017, 2018, and 2019, respectively. Kou Han received a cash consideration of 1.023 billion yuan in this transaction, and the profits in subsequent years must increase by at least twice compared to 2016, and must maintain continuous growth.
To support this high premium acquisition, the acquisition report also compared with the peer internet companies at that time. After excluding companies with negative profits, there were a total of 30 peer internet companies, with an average price-to-earnings ratio of 70.57 times and a price-to-book ratio of 6.9 times. Duo Ke Meng's price-to-earnings ratio is lower than the industry average, and the price-to-book ratio is higher than the industry average.
This acquisition was completed in December 2017. The audited data released the following year showed that Duo Ke Meng achieved a net profit of 149 million yuan in 2017, which was only 3 million yuan more than the performance commitment in 2017.
ST Hui Cheng's announcement shows that in 2018 and 2019, Duo Ke Meng achieved net profits of 324 million yuan and 265 million yuan, respectively, which were 135 million yuan and 8.85 million yuan more than the performance commitment, and both years exceeded the performance commitment. The acquisition effect seems to be very good.
The truth was revealed by the change of audit institutions.
The lid of Duo Ke Meng and related parties' inflated profits was lifted by the changed audit institutions.In November 2020, ST Hui Cheng announced its intention to replace Daxin Accounting Firm as the auditor for the fiscal year 2020, ending the continuous audit services provided by Shang Hui Accounting Firm since 2016. This was also the first year after Duo Ke Meng had just met its performance commitment. Even in July of that year, when Shang Hui Accounting Firm issued a special report on impairment testing, it still stated that there was no obvious impairment of Duo Ke Meng.
On April 30, 2021, Daxin Accounting Firm issued an audit report with a "qualified opinion." It stated that it could not obtain sufficient and appropriate audit evidence regarding the company's prepaid promotion expenses, payable game revenue sharing, goodwill impairment, and the purchase of minority interests in subsidiaries at the end of 2020, and could not determine whether there were material misstatements in other information related to these matters.
At the end of April 2022, ST Hui Cheng corrected its previously consolidated financial statements, making corrections to relevant accounts from 2017 to 2021. This also led to false records in the financial statements for 2019 and 2020. As a result, the China Securities Regulatory Commission (CSRC) initiated an investigation into the company on November 15, 2022, for suspected violations of information disclosure laws.
According to the annual report disclosed by ST Hui Cheng, the balance of prepaid accounts at the end of 2018 to 2020 were 132 million yuan, 395 million yuan, and 428 million yuan, respectively. Among them, the balance of prepaid accounts for Duo Ke Meng from 2018 to 2020 were 129 million yuan, 330 million yuan, and 393 million yuan, respectively. The main components of the listed company's prepaid accounts are Duo Ke Meng and its subsidiaries, Shanghai Xu Mei Network Technology Co., Ltd., Shanghai You Zhan Network Technology Co., Ltd., and Shanghai Ji Yu's prepaid advertising fees for game promotion.
It was disclosed that Duo Ke Meng and its subsidiaries and related parties, in cooperation with several advertising agencies from 2017 to 2020, did not include the consumed recharge amounts in sales expenses and operating costs but instead had a large amount of prepayments. After comparing the business and financial data provided by both parties, the CSRC found that Duo Ke Meng and related parties had not accounted for the consumed recharge amounts as sales expenses and operating costs but instead had a large amount of prepayments.
Considering that the funds between Duo Ke Meng and various agencies have been settled, and the advertising promotion business has been completed, with no creditor's rights and debts or performance obligations between the two parties, and no objections to the situation of fund transfers and the data of fund transfers being objective and effective, the CSRC adjusted the prepaid accounts to each period based on the funds. To restore the actual situation of Hui Cheng Technology's sales expenses as much as possible, four different methods of adjustment were taken for different agencies.
After the adjustment in the above manner, the CSRC determined that ST Hui Cheng understated sales expenses by 221 million yuan, understated operating costs by 8 million yuan, and inflated profits by 230 million yuan in 2019; in 2020, it understated sales expenses by 76.24 million yuan and inflated profits by 76.24 million yuan. Among them, the inflated profit amounts for 2019 and 2020 accounted for 140.19% and 7.88% of the disclosed total profit for the respective periods; in 2019 and 2020, the inflated assets were 253 million yuan and 329 million yuan, respectively, accounting for 6.53% and 16.40% of the disclosed total assets for the respective periods.
The CSRC believes that the above-mentioned understatement of sales expenses and operating costs, and inflation of profits and assets by ST Hui Cheng in 2019 and 2020 violated the relevant provisions of Article 78(2) of the Securities Law and constituted the circumstances stipulated in Article 197(2) of the Securities Law.
In addition to ST Hui Cheng being warned and fined 2 million yuan, and relevant financial officers each fined 500,000 yuan, the main responsible person was also fined a large amount. Kou Han served as the vice president of Hui Cheng Technology, chairman, and general manager of Duo Ke Meng from March 2018 to November 2022, responsible for the comprehensive management of Duo Ke Meng and its subsidiaries, as well as the business management of Shanghai Ji Yu.
He bears direct responsibility for the inability to accurately transfer sales expenses from the prepaid accounts of Duo Ke Meng in a timely manner. He signed and confirmed the company's annual reports for 2019 and 2020 and is the person directly responsible for the company's above-mentioned illegal information disclosure. The CSRC fined Kou Han 3 million yuan.Not only that, Kou Han is also facing civil compensation claims from ST Hui Cheng.
Due to accounting errors, the transaction party of Duo Ke Meng needs to pay ST Hui Cheng a total of 491 million yuan in performance compensation, of which Kou Han needs to bear about 447 million yuan. For this reason, ST Hui Cheng sued Kou Han in December 2022, and in January 2023, the local court in Chongqing ruled that Kou Han needed to pay the relevant compensation. As of August 31, 2024, Kou Han has paid ST Hui Cheng a total of 120 million yuan in three installments, and there is still 327 million yuan to be executed.
Wang Chaoyong was fined 1 million yuan. The China Securities Regulatory Commission believes that Wang Chaoyong was the actual controller of Hui Cheng Technology from June 21, 2016, to August 1, 2021, and served as the chairman of the listed company from December 30, 2019, to July 12, 2021. After Kou Han and Wang Chaoyong had conflicts over debt issues in 2019, Duo Ke Meng resisted the control of the listed company. As the chairman and actual controller of the listed company, Wang Chaoyong did not take effective measures to strengthen the listed company's control over Duo Ke Meng in terms of financial accounting and other aspects, and did not fulfill his duties diligently. He signed and confirmed the 2019 and 2020 annual reports of the listed company, and was the person directly responsible for the above-mentioned illegal information disclosure of the listed company.
Before the Duo Ke Meng issue emerged in the second half of 2020, the stock price of ST Hui Cheng had been falling continuously for nearly three years since September 2017. During this period, the controlling shareholders and related parties also continuously increased their holdings through the secondary market to stabilize the stock price. However, this was still of no avail. The sharp drop in stock prices led to increased debt pressure on Zhong Chi Hui Cheng and related parties who bought stocks with debt, forcing them to sell or be forcibly executed and transferred. In July 2021, Zhong Chi Hui Cheng reduced its stake by 2%, and the controlling shareholder changed to the local state-owned green development and construction in Chongqing.
After the adjustment, Duo Ke Meng lost its original growth potential. In 2023 and the first half of 2024, Duo Ke Meng's revenue was 27.7349 million yuan and zero yuan, respectively, and its net profit was 4.0294 million yuan and -0.8347 million yuan, respectively. As of the end of June 2024, its net assets were 116 million yuan. The cash acquisition of 1.383 billion yuan has now become a zero-income company.
Why does the game industry frequently inflate profits?
In terms of quantity, the active period of mergers and acquisitions in the game industry started in 2014, with a total of 55 cases, a rapid increase from 2013, and has been at a high level for two years since 2015. In 2015, there were 55 cases of A-share listed companies acquiring game targets, and in 2016, there was a slight increase to 61 cases. After that, in 2017, it fell to 39 cases under the control of supervision. With the impairment of goodwill brought by the performance change of the并购 targets in the early stage, the enthusiasm of A-share listed companies for并购 in the game industry has decreased, and there have been few large-scale game并购 in recent years.
Mergers and acquisitions are a double-edged sword.
In 2023, 17 out of 25 game companies achieved positive growth in net profit attributable to the parent company. Among them, Sanqi HooYu and Century Huatong's revenue both exceeded 10 billion yuan. Sanqi HooYu ranked first in the industry with a net profit attributable to the parent company of 2.659 billion yuan. Both of the above companies have achieved continuous growth in scale through continuous mergers and acquisitions.
Of course, there are also some companies that have lost their ability to continue operating due to too fast pace of mergers and acquisitions, or have been forced to delist due to continuous decline in performance and stock price falling below the face value of 1 yuan. In 2022, *ST Youjiu, *ST Aige, and *ST Changdong, three listed companies involved in the main business of games, were terminated by the exchange. On September 5, 2024, *ST Dinglong was also terminated by the exchange.Due to the high premium mergers and acquisitions, the industry's goodwill has remained high. Despite multiple impairments over the years, Wind data shows that as of the end of June 2024, the total year-end goodwill value of 25 gaming companies in the Shenyin & Wanguo gaming secondary industry was 35.051 billion yuan. Among the listed gaming companies, the highest goodwill exceeded 10 billion yuan, with an average of about 1.402 billion yuan per company, still at a relatively high level.
According to the accounting policies for impairment of related assets, when the performance of mergers and acquisitions does not meet the standards, listed companies must conduct impairment tests on goodwill and provide for impairment. To prevent significant changes in performance, listed companies often under-provide or do not provide for impairments. For example, in cases investigated by the China Securities Regulatory Commission (CSRC), some gaming companies have not conducted impairment tests as required for three consecutive years, leading to insufficient provisions and inflated profits.
Some gaming companies also虚构 transactions or inflate revenue by recognizing it prematurely. For instance, when some listed companies find that there are issues with meeting their performance commitments at the end of the year, they hastily sign copyright transfer contracts worth hundreds of millions of yuan with third parties for games under development, recognizing revenue that should have been recognized in the following year prematurely. Others fabricate one-time transactions with long-term partners by inflating the copyright to meet their performance commitments.
Goodwill is an accounting subject that regulatory authorities pay close attention to, and some less noticed accounting subjects, such as accounts receivable, also hide the possibility of manipulation. For example, the practices of ST Kevin, which was recently penalized by the Guangdong Securities Regulatory Bureau, belong to this category.
It was disclosed that to reduce the bad debt losses of accounts receivable, ST Kevin, in the process of conducting business with suppliers, transferred funds from the company or its subsidiaries through suppliers to designated customers. The relevant customers then made payments to the company or its subsidiaries as required. ST Kevin used the received payments to offset accounts receivable, resulting in an under-provision of bad debt provisions of 15.25 million yuan in 2021, inflating profits by 15.25 million yuan, accounting for 15.55% of the disclosed profit for the period. The Guangdong Securities Regulatory Bureau thus determined that its 2021 annual report contained false records.
According to the investigation by the Guangdong Securities Regulatory Bureau, the above illegal facts are evidenced by company announcements, relevant bank account statements, accounting vouchers and original vouchers, situation explanations, and inquiry records, among others.
Based on this, the Guangdong Securities Regulatory Bureau imposed penalties: ST Kevin was ordered to correct its违法行为 due to illegal and non-compliant information disclosure, was given a warning, and was fined 4 million yuan; six relevant responsible personnel were also given warnings and fined 500,000 to 2.5 million yuan each.