South Korean biotech company NKMax has been accused of manipulating its accounts to avoid capital erosion. The company sold a partial stake in its U.S. subsidiary, NKGen Biotech, generating a book profit of $72 million (100 billion won). NKMax claimed that this book profit resolved its capital erosion problems, but the company’s external auditor has challenged this assertion.
NKMax had already been facing delisting for failing to disclose information on stock collateralized loans and countertrade activities of a major shareholder. An accounting firm’s recent refusal of audit opinion has added another reason for delisting. The auditor pointed out the limited scope of the company’s audit and raised doubts about its ability to stay afloat in the year ahead.
NKMax announced that Taesung Accounting Corporation, its auditor, refused to provide an audit opinion on the financial statements for the last fiscal year, according to the Financial Supervisory Service’s electronic disclosure system (DART) on April 15. The auditor cited uncertainties regarding the status of NKMax as a going concern, also known as the ability of the company to function without the threat of liquidation in the next 12 months, and restrictions on key audit procedures for the refusal.
The auditor appears to have raised issues regarding the gains recorded from the disposal of subsidiary investments. “We were not provided with sufficient evidence to conduct key audit procedures, such as the impairment assessment of investments in subsidiaries and receivables,” the auditor stated. “As a result, we could not determine whether any modifications were necessary to the company’s financial statements.”
The company posted an operating loss of 60.8 billion won, and a net loss of 32.8 billion won last year. The net loss was smaller than the operating loss because it included a gain of 101.3 billion won from the disposal of investments in subsidiaries.
Until the third quarter of last year, NKMax categorized NKGen Biotech as a subsidiary. NKMax used to own a 57.66% stake in NKGen Biotech. But in the fourth quarter, the company sold part of its stake, reducing its ownership to 46%, and reclassified NKGen Biotech as an associate company.
When a company owns a stake in another entity, it is classified as a subsidiary if the holding exceeds 50% and an associate company if the holding ranges between 20% and 50%. By selling off part of its shares and losing majority control, NKMax redefined its relationship with NKGen Biotech as an associate company. Following this change, the company reassessed the enterprise value and reflected this adjustment in its net income.
This has raised suspicions that NKMax may have employed a tactic to circumvent capital erosion. It is estimated that NKGen Biotech, previously a subsidiary, had net assets of minus 66 billion won at the end of 2023. After being reclassified as an associate, NKGen Biotech’s fair value increased by 35.8 billion won.
When combined, these figures match the gain on disposal of investments in subsidiaries recorded by NKMax. In reclassifying the subsidiary to an associate, the subsidiary with negative net assets was eliminated, resulting in a profit of 66 billion won. Additionally, the increase in NKGen Biotech’s fair value by 35.8 billion won inflated the book value by about 100 billion won.
Capital erosion is when a company’s cumulative losses exceed the capital invested. If more than 50% of the capital is eroded for two consecutive years, or if a company falls into complete capital erosion, it may have to delist.
