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NOVEMBER 5, 1999 VOL. 25 NO. 44
Bleeding Chips
The way forward for black-and-blue mainland affiliates in Hong Kong
By YULANDA CHUNG Hong Kong
Their business associates could be forgiven for not recognizing the three men in the dock. James Huang Xiaojiang, Xie Ping and Chen Libin no longer exude an air of command. Wearing wrinkly shirts instead of their trademark double-breasted suits, the mainland Chinese executives listened anxiously to the Cantonese translation of the English proceedings of an $11-million embezzlement case against them in Hong Kong. Huang is the former general manager of Hong Kong-listed supermarket group Guangnan Holdings, while Xie and Chen were directors of a Guangnan subsidiary. One colleague, assistant general manager Li Ruihua, is on the run after jumping bail in January. Resigned group chairman Sun Guan is being investigated.
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Welcome to the diminished world of Hong Kong's mainland companies. Red chips - firms incorporated in Hong Kong but whose main businesses are in China - and H-shares (mainland enterprises with a secondary listing in Hong Kong) were the stock market's darlings in 1997, when China resumed sovereignty over the British-run territory (see chart). The smart money expected them to replace the London hongs as main drivers of Hong Kong commerce. It has not worked out that way. Many of those running the 1,800 or so mainland-affiliated companies are simply not up to the job. "They are chosen for their political reliability, political history, trustworthiness and upright character," says Wang Jun, an economics professor and adviser to Guangdong senior vice governor Wang Qishan. "So they often fail to adapt to the free market."
As the spate of financial irregularities shows, some may adapt all too well. "Power corrupts," says Zhu Yuening, who heads tourism-and-transport red chip China Travel Service and chairs the Hong Kong Chinese Enterprises Association, which groups all Hong Kong-based mainland corporations. "In the mainland, senior managers don't dare smoke [imported] 555 cigarettes in public - they put them in a Chinese-brand pack. In Hong Kong, there is no such worry." When times are good, incompetence and corruption tend to be glossed over. That is no longer the case after the Asian Crisis.
A cash shortage is adding to the pressure. Foreign banks turned off the taps after Beijing repudiated guarantees that local officials extended to creditors of their investment arms. Investors will be closely watching an international conference in Guangzhou Nov. 13. Topping the agenda: reforming Guangdong-affiliated companies in Hong Kong, which are under particular scrutiny because of the spectacular failures of GITIC and Guangnan-parent Guangdong Enterprises. Guangdong companies make up about a third of all mainland enterprises in Hong Kong.
A report last week by KPMG Peat Marwick, the accounting firm in charge of liquidating GITIC, reveals the extent of the rot. The Guangdong investment company folded under more than $2 billion in bad debt, China's largest-ever corporate collapse. "At GITIC, loans are lent and forgotten," says KPMG Peat Marwick partner Louis Choi. "There's something wrong from the core business to almost everything. It strikes me that it invests for investment's sake. Nobody does any follow-up work." The liquidators say only 7.2 billion yuan ($867 million) in loans are recoverable - about a third of total intra-group and outside lending. Most of the loans were granted without legal backing and proper documentation.
Choi blames the "absence of monitoring" by parent companies. At the same time, mainland executives in Hong Kong are under tremendous pressure from their bosses back home. "You have to make money," says one executive. "Your province doesn't care if there's a financial crisis. If you can't make money in your core steel-making business, try your hand in stocks and property." Many apparently made brash investment decisions. A property agent says he once sold three luxury apartments to a director at a red-chip company for tens of millions of dollars. "He paid me in cash," recalls the realtor. "I needed a cart for the money." Presumably no cart was necessary for the director's profits, as the Crisis subsequently pummeled Hong Kong property and stocks.
Even during boom times, there is no guarantee that mainland executives could make money. "The average time executives spend in Hong Kong is only three to five years," says economist Shi. "Just when you start coming to grips with business operations in a market economy, you are asked to leave. The posts will forever be filled by amateurs."
What to do? Zhu Yuening of China Travel Service - the unlisted state-owned enterprise is seen as a reasonably well-run company - is trying a new approach. "We're changing to a contract system, a two-year tenure renewable on good performance," he says. "I have studied Marx as if he's a god. Still, I have sacked many people here." Some analysts suggest stock options, on the theory that executives with a personal stake in the company will be more enthusiastic about the bottom line. There is a precedent. Larry Yung Chi-kin, the son of China's former vice-president Rong Yiren, owns 20% of red chip Citic Pacific (1998 profit: $363 million on sales of $1.7 billion), a constituent stock of Hong Kong's benchmark Hang Seng Index.
Openness to outside expertise can be a plus. "After acquiring Hongkong Chinese Bank last year, China Resources hired outside financial expertise to look after the purchase," says Charles Cheung, vice-president at Salomon Smith Barney in Hong Kong. "The bank has turned around in the first half of this year." Unlike other red chips, the property-based group is run by professional managers, not government bureaucrats. "The chairman and managing director are overseas-educated," says Cheung. "The chairman [Ning Gaoning] has worked at the company since his 20s after finishing an MBA in the U.S." China Resources earned $148 million on turnover of $708 million last year.
All this is fodder for the November conference, which will be hosted by Guangdong's top officials and attended by executives from 19 multinationals, including the ING Group, Goldman Sachs and Merrill Lynch, and World Bank senior vice president Joseph Stiglitz. Nobody expects the meeting to do anything about the politics of China business, as exemplified by the case of China Everbright's Zhu Xiaohua. But Peat Marwick's Choi is optimistic that real change is coming. The liquidation of GITIC, he believes, "signifies that China has entered an era when politics - all the talk about guanxi [connections] and the Chinese way of doing business - is being subordinated to the rule of law." Don't count out the red chips just yet.
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