Cheetah Mobile Inc. (Cheetah) has filed for an IPO with the SEC, joining what is shaping up to be a long line of U.S. IPOs this year. Its main product is Clean Master, the number 6 application worldwide on Google Play. The company previously listed on the Hong Kong exchange as Kingsoft and they now seem to be listing a holding company further down the chain. Fredrik Oqvist has tweeted that Cheetah may be the best name for a Chinese company since FU listed on the NYSE.
By my calculations, Cheetah’s earnings for 2013 would have been 36% higher if it had selected a different accounting firm. That is because Cheetah uses Ernst & Young (EY), which appears to be taking the position that deferred taxes are required on the undistributed earnings of variable interest entities (VIE). In 2013, Cheetah booked RMB 34 million of deferred tax expense related to “outside basis difference” which I believe relates to the undistributed earnings of the VIE.
This is the third EY client where I have seen this accounting treatment (the others are Autohome and Soufun). I have not seen this treatment on any other U.S. listed Chinese company.
The other firms appear to have decided there is a way to bring back the profits of the VIE on a tax-free basis. As I have previously written, I am skeptical of that approach, mostly because I do not believe that the tax authorities would accept the low values that must be assigned to the assets to avoid gain in the proposed transactions. If the PCAOB were able to inspect the accounting firms in China, I expect it would demand that the firms obtain sufficient audit evidence to support their positions, and I don’t think they will be able to do that. EY apparently agrees with me.
Some Big Four partners have argued with me saying that every client has unique facts. While that is true, I don’t think most Chinese VIEs have significantly different facts that would yield a different result here.
I commend EY on sticking to its principles on this issue, and I personally think they have the right position. But that may be of little solace if they lose clients over it.