China’s economy is in transition with the government taking steps to become a part of the global capitalist economy while maintaining its stronghold on domestic companies. In order to join the World Trade Organization, China lifted regulations preventing foreign issuers from listing on its exchanges. Officials are now trying to boost the country’s flailing Shanghai and Shenzhen exchanges.
Membership in the WTO also raised the proportion foreign stakeholders can own of Chinese companies. ‘Chinese companies have certainly discovered the benefits of western-style capital markets, and are trying to improve the quality of their own [market],’ explains Frederick Grede, COO of the Stock Exchange of Hong Kong.
These changes suggest a move towards US-style capitalism. However, against this backdrop of free enterprise reform, the government continues to hold majority shares in many listed companies. So while the country moves quickly to join the international marketplace, its state-sponsored monopolies may be weighed down by their antiquated ownership structure.
What is happening inside Chinese companies is in some cases miles ahead of what parliament is cautiously moving towards. Two mainland Chinese companies offer a window into how domestic businesses are tapping international capital pools. Legend Holdings and China Mobile exemplify the growing pains and successes of companies in a transitional market. Both of these companies listed in Hong Kong to raise foreign capital. Anticipating their need to return to raise more capital, these companies have been quick to adopt corporate governance reform to compete with foreign issuers.
Becoming a legend
Legend Holdings, the investment arm of IT enterprise Legend Group, is a perfect example of a Chinese company that has had success in the international marketplace. Founded in 1984 by a group of Chinese Academy engineers, the company has become legendary for pushing the envelop in Chinese entrepreneurship.
At Legend’s inception, the Academy invested Rmb200,000 in the enterprise and, in a revolutionary move for China, the government allowed the founding engineers a 35 percent holding. Brainpower, it seems, commands respect and ownership rights. ‘Personnel and human resources are very important for such a technology company,’ explains Alice Li, director of corporate communications and IR at Legend Hong Kong.
Beginning with a Chinese language PC card, the company was soon making China’s top selling PC and has since moved steadily up the value chain with palm, internet and laptop models. Legend also started producing software, ISP services and web portals.
‘In general Chinese companies are not known for their IR,’ admits Li. In 1988, she joined the company in Beijing and moved to Hong Kong in 1994, the year Legend joined the Hang Seng index there: ‘There is a language and culture issue.’ State-owned companies are not used to competition, so they have a completely different management style. ‘Their top management are not owners and many of them are government officials, so their way of communicating to investors is somewhat bureaucratic.’
Legend has always operated in a different competitive environment from state-run monopolies. Its growth strategy is similar to western technology firms that simply grab market share while demand for product is high. ‘We increased our PC market share in China from 3 to 30 percent in seven years, which really impressed investors,’ notes Li.
The management team meets regularly with investors and, according to Li, ‘appreciates their feedback and suggestions.’ Li reports mainly to CFO Mary Ma and keeps close contact with division heads. Conscious of the importance of internalizing IR, her team circulates a monthly report on market conditions and sentiment throughout the company.
Despite her success in building an international IR program, Li is aware of a cultural gap. ‘Our management is all Chinese and our investors are all foreign,’ she says. ‘Investors find it difficult to understand Chinese markets and technology, so communication is very tough.’ Li tries to provide background information about the environment in China and she finds the gap is shrinking after years of close communications with investors. Her efforts were recognized at the first Investor Relations Magazine Asia Awards in 2001. At the event, Legend Holdings received an honorable mention for best overall IR by a small-cap company.
Li is committed to fulfilling the needs of minority shareholders. ‘The role of the IR department is to help directors and management understand more about minority shareholders so they can make better decisions,’ she says. Li feels that investors of technology companies have different needs: ‘They are very demanding of information and the market changes fast. We have to get information from our staff at plants spread all over China, so we have to have good relations with them.’
International mobility
China Mobile offers another example of a mainland China company that has been successful in attracting international capital. Lu Ping is the head of China Mobile’s four-strong investor relations department in Hong Kong. Before taking over this position, he worked in the foreign affairs department of the Ministry of Post and Telecommunications in Beijing: ‘Not only is China in transition, but I am as well.’
Moving from bureaucracy to transparency is no small feat, claims Ping. An engineer by training, Ping had to get his head around ‘the rules and regulations for listed companies, securities and capital markets,’ he says. He admits he needed guidance in the beginning. ‘There were complaints from some investors asking for more information, but most of them now say it has improved dramatically compared with three years ago,’ he reports. Indeed the company took home prizes for best investor relations for a mainland China company and best IPO at the Investor Relations Magazine Asia Awards 2001. Today Ping swaps ideas about boosting investor relations standards regularly with other mainland companies listed on Hong Kong’s stock exchange.
Unlike Legend, whose founders grew it from the ground up, China Mobile is an offshoot of the original China Telecom. At the time it was spun off, the government set targets for the company, which was the only mobile carrier in China. ‘After we listed, we had to do a market survey to assess the potential market and then take into account the company’s financial and operational condition and produce our annual results,’ explains Ping.
‘That meant we had to know the market and the employees had to change their operational philosophy. We had to know the customers’ requirements; so we did customer segmentation and divided the market into different groups for different products,’ Ping adds.
On the face of it, China Mobile does not seem like a safe haven for minority shareholders. China Mobile Hong Kong is 75.7 percent owned by the government and the remaining investor base is made up of public shareholders like Vodafone which currently holds a 3.27 percent stake.
After listing in Hong Kong and adding an ADR in New York, the company tapped into an international pool of equity, debt and convertible bonds. Mostly through Hong Kong, the major holders of the free float are US institutions like Fidelity, Alliance, Janus and Schroders. Between them these minority holders effectively financed the company’s expansion across the country. Ping describes this process as ‘organic growth plus strategic acquisition.’
Recognizing the apparent conflict of interest involved in buying the majority owners’ assets with minority shareholders’ funds, China Mobile’s board appointed an independent firm to scrutinize the acquisitions. With its continuous need for capital, management is as mobile as its product, roaming on roadshows to Europe, Tokyo, the US and Southeast Asia to explain the deals.
There will be more opportunities to tap into international equity for mainland Chinese companies. Under WTO rules, the maximum foreign stake in Chinese companies will soon rise to 35 percent, and recent indications are that foreign companies may even be able to take majority ownership of Chinese companies.
Flexibility & support
At his point, Ping is unsure whether China Mobile’s parent company will take the opportunity to float more stock. ‘I think they will be careful,’ he says.
From an investor relations point of view, Ping has had enough flexibility and support from management to be able to respond to shareholder pressure. After fund managers pointed out that they could only invest in companies that pay dividends, Ping was able to meet their demands. ‘In the past we believed this company was having a high growth period, so we reinvested everything,’ he explains, adding, ‘But this year the board listened to opinions from both sides to try to reconcile the different demands.’ The decision was made to pay a dividend, even if it was only a small amount.
Recognizing the value of minority shareholders, especially large institutional investors, China Mobile is refocusing its strategy. ‘Our target is to maximize the company’s value so we must change the operations’ philosophy of our provincial subsidiaries,’ says Ping. ‘In the past, we only served our customers and our mobile subscribers but now we have to provide better services both to them and the minority shareholders.’ While under the government’s protective wing, very few understood China Mobile’s value, but since it became listed, minority shareholders have become key players, he adds.
It’s wonderful for these mainland companies to have foreign investors help finance their growth. However, these IROs need to ask themselves why institutions take a minority stake in their companies. While Legend and China Mobile have produced some strong results in the last few years, they still appear as somewhat precarious investments when placed on the world stage of risk and reward.
According to David Webb, a corporate governance expert based in Hong Kong, ‘peer group pressure’ drives capital eastwards. ‘These companies form such a large part of the index that the fund managers feel they have to be in them,’ he theorizes. Ironically that’s the same reason so many fund managers had Enron and WorldCom in their portfolios.
John May of smartstockinvestor.com recently did a survey of Asian companies, including China Mobile and other mainland giants listed in New York. He discovered Asian companies are not necessarily improving in accounting transparency but that the gap between US and Asian disclosure standards has lessened. ‘US companies are in fact getting worse,’ he suggests. ‘The S&P 500 average difference between Gaap and pro-forma earnings has gone from 10 to 57 percent in the last 15 years, and it’s going to be a lot worse in 2002.’
In contrast, May says Asian companies are much more credible. Specifically, they report more realistic pension fund earnings and stock option costs, and are less likely to use pro-forma accounting. IROs in Asian companies are in some ways more focused on transparency than their US counterparts. Due diligence, it seems, is a staple for companies trying to survive a transitional economy.
What the expert says
Corporate governance expert David Webb says the market sees Legend Holdings as one of the more transparent mainland companies. ‘They even do quarterly reporting,’ he says. However, he adds, there is some doubt as to just how independent the company is from the government since Jiang Zemin’s son is in the Academy of Sciences.
China Mobile has a different story. Webb points to the company’s history to demonstrate what can go wrong when a state-owned monopoly changes hands. ‘It’s now a duopoly with China Unicom but it was once a monopoly and investors believed the story circulated by the investment banks and other share promoters, that China would always structure its telecom to look after the foreign shareholders, rather than the consumers, by letting it remaining a monopoly,’ he recounts.
The company did not, of course, remain a monopoly and today customers are the real beneficiaries – not stakeholders – as prices for China Mobile’s services have come down by almost three quarters. On the IR front, China Mobile’s management is ‘reasonably accessible’ to investors, says Webb.
