Fishy Loan Undercuts Jiumaojiu's Corporate Governance Image

By Doug Young

The board of trendy restaurant operator Jiumaojiu International Holdings Inc. (OTCPK:JIUMF, 9922.HK) thought it smelled something fishy when it recently noticed a suspicious 80.7 million yuan ($11.2 million) loan made in January to a company called Guangzhou Yanshang Investment. It did some sniffing around, and quickly discovered the ultimate borrower was none other than Guan Yihong, the company’s chairman and founder.

While this kind of insider lending isn’t illegal, it should be vetted with the company’s board to avoid any semblance of impropriety. And listing rules also require that shareholders should be informed. Neither happened in this case, and the board said in an announcement late Friday it only discovered the loan when it was preparing the company’s interim results announcement, published on Aug. 22.

In fact, the amount of the loan was quite small, especially compared with Jiumaojiu’s cash holdings that stood at about 4 billion yuan as of June 30. The company operates the trendy Tai Er restaurant chain, which is famous for its “sauerkraut fish” stewed in Sichuan-style pickled vegetables. It also has a newer, fast-growing chain called Song Hot Pot, whose revenue more than quadrupled in the first half of the year from the same period of 2022.

This kind of freewheeling insider lending is all too common in many Chinese companies, which are often used by their founders as personal piggy banks to lend money to themselves and their associates for purposes that don’t necessarily benefit the company.

Perhaps the one reassuring element in this story is that Jiumaojiu’s board detected the loan and issued a statement disclosing it, even if that statement came more than half a year after the loan was granted. That means that the company’s board is indeed acting independently of Guan, which is how boards are meant to act. Many Chinese company founders still exercise huge control over their boards, with the result that the founder often puts heavy pressure on the board to keep suspicious actions secret when they are uncovered.

We should also note that Jiumaojiu landed at the center of a similar controversy about a year ago, when it announced a questionable investment in a mega commercial project in its hometown of Guangzhou. More on that shortly.

But first we’ll review the details of this latest case of questionable corporate governance involving a loan made by Jiumaojiu’s Pin Xin Yue Gu unit to Guangzhou Yanshang Investment, which is ultimately owned by Guan. That loan carried an annual interest rate of 2.6%, and has now been fully repaid, according to the company’s disclosure last week.

It said people at the company failed to inform the board of the loan due to “a combination of errors in judgment.” It also pointed out that company officials believed the loan represented a good use of Jiumaojiu’s big cash reserves because it offered “an opportunity to utilize part of its idle cash to earn a more favorable interest income than a demand deposit with bank and more flexibility than a fixed deposit with bank.”

Good governance

The Hong Kong Stock Exchange was closed on Monday morning for a typhoon, so it wasn’t immediately clear how shareholders might react to the new disclosure. But the reaction was quite negative after the company disclosed a similarly dubious transaction last October that seemed to benefit Guan but wasn’t necessarily that beneficial to Jiumaojiu.

In that instance, Jiumaojiu disclosed that the company would invest a far larger sum of up to 1 billion yuan for 26% of a company developing the Guangzhou IFC Mall project in Guangzhou, which also happens to be Jiumaojiu’s hometown. At the time Jiumaojiu said it was making the investment because it planned to relocate its headquarters to the mall in the future.

Perhaps that was really true, but investors didn’t seem to think Jiumaojiu should be making such a big investment in real estate, which is quite far removed from its core restaurant business. Jiumaojiu’s shares tanked by 20% after it disclosed the investment, wiping out about HK$4.6 billion in market value – far more than the size of the proposed investment.

Not long after that negative reaction, Jiumaojiu issued another announcement saying it had changed its mind, and that Guan would invest the money personally rather than through his publicly traded company. Such investments actually aren’t uncommon in China, as businesspeople are often pressured by local government officials to assist in local projects, especially when those projects run into financial difficulties.

But at least in that instance, shareholders used their wallets to express displeasure that their money was being used by Guan for such a purpose.

This kind of corporate shenanigan certainly isn’t specific to Jiumaojiu, though it has taken a toll on the company’s stock. Jiumaojiu listed in 2020 by selling IPO shares at HK$6.60, and saw them shoot as high as HK$31 the next year as the Tai Er chain’s popularity soared. But the stock has fallen back to earth since then, and is down by more than half this year, closing at HK$10.76 last Friday.

Those declines have left Jiumaojiu with a forward price-to-earnings (P/E) ratio of 15, putting it in the middle of the pack among Chinese food and beverage companies – far different than earlier days when the company was a clear leader. KFC operator Yum China (YUMC; 9987.HK) now trades at a higher forward P/E of 19, while hot pot chain Haidilao (OTCPK:HDALF) also trades higher at 25. But premium tea shop Nayuki (2150.HK) trades lower at 11, and global giant Restaurant Brands International (QSR) also trades lower at 13.

At the end of the day, Jiumaojiu still operates one of China’s more successful mid-range restaurant chains with Tai Er, and may have found a new winner with Song Hot Pot to keep its winning streak alive. Some might even commend the company for its transparency about disclosing mistakes when it discovers them. Still, the decline in its share price and P/E ratios show it may take some time for Jiumaojiu to earn back the big premium it once commanded over its peers.

Disclosure: None.

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