(MENAFN - AFP) Caterpillar's revelation it found fake accounts at a just-acquired Chinese firm which will cost it hundreds of millions of dollars is a cautionary tale for those looking to enter the hugely promising market.
The US equipment giant said this month it would take a 580 million charge after uncovering "accounting misconduct" at Siwei Mechanical and Electrical Manufacturing Co., which it bought last year for at least 650 million.
Caterpillar, one of the first US manufacturers to start exporting to China nearly four decades ago and which opened its first Beijing office in 1978, said it had removed several top Siwei managers for overstating profits.
Analysts said the stumble by a Chinese market veteran served as a reminder of the pitfalls of doing business in the world's most populous country.
"This is going to teach firms that they've really got to do due diligence, especially when they see a company as large as Caterpillar run into a situation like this," said Ben Cavender, of Shanghai-based consultancy China Market Research Group.
But there would still be strong demand to invest in it, he added.
Foreign investors have poured more than 1.0 trillion into China since it launched economic reforms in 1978, with 112 billion last year alone.
The country became the world's second most attractive location for foreign investment in 2008, behind only the United States, according to the Organisation for Economic Co-operation and Development.
Foreign companies that arrived early and persisted are now among the most successful, analysts say, but some met spectacular failure.
The travails of American Motors Corp. -- later bought by Chrysler -- to produce its iconic Jeep brand in China in the 1980s are documented in the book "Beijing Jeep" by the author James Mann.
US aircraft maker McDonnell Douglas announced in 1994 it would manufacture 20 MD-90 planes in China, but fell way short due to technical and regulatory issues. The project was quietly scrapped after Boeing took over the company.
Analysts see a link between Caterpillar's experience and a series of accounting scandals involving Chinese firms listed in the United States and other overseas markets which burned shareholders.
Investors in Toronto-listed Sino-Forest Corp. lost hundreds of millions of dollars when it collapsed following allegations it had misstated its revenue and exaggerated the size of its plantations in China.
"There's been a whole series of disclosures which relate to very poor due diligence of US-listed Chinese companies, and there's a parallel there," said Steve Vickers, founder of a Hong Kong-based risk consultancy.
Sharp increases in profits and a firm which has been through a reverse takeover -- in which a private company seeking to go public merges with an already quoted one but controls most of the new entity -- are warning signs, Vickers said.
Financial reporting requirements are not as stringent for reverse takeovers as they are for traditional initial public offerings and the technique became controversial after Chinese firms that used it to list in the US were found to have accounting problems.
"Reverse takeovers, sudden rises in profit of massive scale are glaringly obvious examples of what people should look for. To me, that would be a huge alarm bell," Vickers said.
Siwei become publicly traded by taking over Hong Kong-listed ERA in a reverse takeover. In turn, Caterpillar announced it was buying ERA in 2011, saying the deal would allow it to find more customers in China.
Caterpillar discovered the problems five months after completing the transaction, and said it believed its process for vetting mergers and acquisitions was "rigorous and robust", according to a statement.
It said it was still investigating and would consider options, including litigation, to recover its losses, adding it was unaware of any criminal investigations by the Chinese or US governments so far.
The Wall Street Journal reported that two foreign investors controlled just under half of ERA's shares before the Caterpillar deal: former head of the American Chamber of Commerce in China, Emory Williams, and James Thompson III, son of the founder of moving company Crown Worldwide Group.
A spokesman for Caterpillar, based in the US state of Illinois, declined to comment on Friday.
