China Energy Update

The following note is reproduced from CIMB:

Review of overpayment of acquisition

China Energy announced on Friday that its Audit Committee had engaged Pricewaterhouse Coopers on 19 Mar 08 to conduct an independent review of anadditional payment of Rmb190m related to the acquisition of Jiutai Energy (Guangzhou) Co., Ltd. Back in 25 Aug 07, China Energy announced its acquisition of Jiutai Guangzhou for Rmb197.8m, based on an NAV valuation by an independent valuer in China. This acquisition amount was in line with the estimated Rmb200m stated in the prospectus dated 13 Dec 06. However, it was recently brought to the attention of the Audit Committee that subsequent to the completion of the acquisition, a further sum of Rmb190m was paid by China Energy (as at 31 Dec 07) to settle Jiutai Guangzhou’s liabilities.

The Audit Committee has engaged PwC to review:

1) the nature and circumstances related to all payments made by China Energy to Jiutai Guangzhou;

2) the financialpositions of Jiutai Guangzhou as at Nov 06, Aug 07 and Dec 07; and

3) the due diligence process and appropriate disclosure in China Energy’s prospectus.

Comments Concerns over accountability.

The key concern raised is the actual payment of about Rmb390m to Jiutai Guangzhou, when the net asset valuation and prospectus disclosure only valued the company at about Rmb200m. In our phone calls with management, management explained that the Rmb190m in question was paid to contractors post-acquisition for outstanding amounts related to the construction of Jiutai Guangzhou (corresponding to “Other payables” in Figure 1). This brings China Energy’s total investment to Rmb390m, fairly in line with Jiutai Guangzhou’s property, plant and equipment balance at the date of acquisition (Rmb380m). Management further explained that the Rmb190m was paid using internal cash flow, while the acquisition of the 100% stake in Jiutai Guangzhou at Rmb198m was fully compliant with disclosures in the prospectus. Figure 1: Fair value of Jiutai Guangzhou during acquisition Jiutai Guangzhou Net assets acquired Rmb mProperty, plant and equipment 375.7 Intangible assets 76.3 Other receivables 34.4 Prepayments 8.2 Inventories 13.0 Deferred expenditure 0.4 Trade payables (10.7) Other payables (199.3) Long term loan (100.0)197.9 Source: Company FY07 financial statements [ 2 ] No financial impact, but unable to assess until review is completed. There shouldnot be any impact on China Energy’s operations and expansion. However, the share price is down 42% in the past two weeks, and we expect volatility to continue until the completion of PwC’s review. We will be monitoring developments, but at this juncture, we are dropping our Outperform rating in favour of a not-rated view.