When star performer Xu Ziwang quit Morgan Stanley for Goldman Sachs, his old firm was badly hurt. Xu was a linchpin of Morgan’s China plan – a strategy held in awe by competing bankers. Many freely admit the firm is out front in China and Xu’s contribution to building the franchise was second to none. He personally brought in two of Morgan’s landmark deals, the IPOs for Shanghai Industrial and Beijing Enterprises.
The single biggest contributor to success in China is having the right mainlander in place. Does this mean future deals go with Xu to his new employer? Superficially, it looks that way. Since Xu’s arrival at Goldman in May, the firm has led an IPO for airline China Southern and won the global coordinator’s role on the biggest China deal so far, the flotation of China Telecom. Since China International Capital Corporation, in which Morgan Stanley has a 35% stake, is China Telecom’s financial adviser, this mandate appeared to have Morgan’s name on it. Its loss was a severe setback.
The right guanxi
But as with everything in China, the reality is more complex and the rules less clear-cut than they first seem. Goldman won the China Southern mandate three years ago so Xu cannot take the credit, and China Telecom may have gone to Goldman for its telecoms expertise. Employing the right people, having the right guanxi (connections), displaying loyalty, spreading goodwill by supporting difficult deals and avoiding scandals are all important in China. But they don’t guarantee success. Even the best strategy can be scuppered because a particular mandate had to go to a Japanese firm or a US firm as part of the bigger political and economic picture.
Still, capturing Xu from Morgan Stanley was an important step forward for Goldman Sachs, itself under a cloud for cutting back China staff in 1994 and 1995 when the market dived. Xu is a very hot property because he grew up in China and has western banking experience. Born in Shanghai, he spent four years as a farmer during the Cultural Revolution before graduating from university in Shanghai and going to the US to further his education. After six years in the US and two in Canada he was recruited by the Bank of Montreal. He joined Morgan Stanley in 1993 and was quickly sent to Hong Kong. Why did he leave? Xu denies it was for money or because of a falling out.
“I am a son of China,” says Xu. “We all ultimately work for our homeland. After four years building the business at Morgan Stanley, it’s better off for me to work for another firm which is very different in many ways. You aim to build the best credentials for the next thing you want to do.” That, he says, may be government work or setting up China’s own private investment bank. “Whatever will make a difference,” he adds.
Xu represents a new generation of Chinese nationals. They talk in terms of improving their country’s lot. They talk in terms of duty. They carry at the back of their minds an idea that the next century will be a Chinese one. They are not necessarily young. But often they look deceptively so. Xu is 41 but looks as if he’s in his 30s.
“I think more and more Chinese who have been educated abroad will want to go back to the mainland,” says David Li, chairman and chief executive of Bank of East Asia. Many are gaining experience in Hong Kong before they return to China proper. It is estimated that 400 mainland passport-holders are working in investment banking in Hong Kong.
Technology transfer
The big international firms are happy to sponsor the trend. They are training staff at a prodigious rate, and, in order to send the right signals across the border, are involved in numerous conferences and special pro- grammes. BZW is helping fund a new school of middle management in Beijing. Morgan Stanley runs a course at the People’s Bank of China Graduate School of Business, to which even John Wadsworth, chairman of Morgan Stanley Asia, gives a two-and-a-half-hour lecture.
There is a self-interest aspect to this technology transfer. The big firms think that by helping China learn today they may have an advantage tomorrow. The prize everyone is after is a full investment-banking licence.
China’s domestic market is the lure with its promise to be as big or bigger than America’s. By now the numbers have become a cliché – China’s 1.2 billion population represents fantastic potential for any kind of product. But continually restating the statistics doesn’t negate them. The opportunities in finance are particularly seductive. In a country where listing began only five years ago, there are now 700 listed companies (the “A” or domestically available shares) with a capitalization that is already 40% of Hong Kong’s. In three years it is estimated the markets will be equal. China’s citizens have about $550 billion stowed away in savings, much of it ripe to be tapped by the yet-to-be-created mutual fund industry – another dizzying prospect.
Then there are mergers and acquisitions. The merging of small, state-owned companies into newly listed companies will – if done properly – create some of the world’s largest enterprises. Does China need 37 airlines? Does it need 160 elevator companies? And then there’s debt, both government bonds and corporate bonds when companies are finally allowed to issue them. A wilder card is the Euro-renminbi market when the Chinese currency finally becomes convertible.
A full investment-banking licence, it is envisaged, would allow investment banks to trade and underwrite “A” shares and become involved in all facets of domestic business. Currently, international bankers are largely confined to international equity issues. But getting there will not be easy. China is loath to let foreign players dominate its domestic business. Its preference is to restrict foreigners until the country’s domestic investment banks can compete (see The local contenders).
Wang Qishan, the head of Construction Bank, one of China biggest banking groups, tells Euromoney that even in the future a “less open market” will continue in such activities as trading of domestic shares and managing mutual funds (see Wang’s big ambitions). The views of a man who manages half a million staff and is on the shortlist to be China’s next central bank governor are not to be taken lightly.
Many foreign bankers accept these limitations. “To my mind it is inconceivable that the authorities will say ‘come in and do what you like’,” says Kevin Westley, head of HSBC Investment Bank. “But there will be a gradual opening up. Look at the last five years.”
Says Jean-Claude Gruffat, head of Crédit Agricole Indosuez Asia Pacific: “China is not a level playing field. Our role is to push Chinese institutions towards modernization. Ultimately the Chinese government won’t want to see the financial services industry in foreign hands.”
Would, for example, a firm such as SBC Warburg – which has just bought control of Moscow brokerage Brunswick – ever be allowed to acquire a Shanghai broker? “Buying an existing securities firm is an even more serious [proposition] than setting up your own,” say Zhou Yuan, head of UBS’s China business. Bankers accept that this discussion may be a long way off.
The middle way is the joint venture as attempted by Morgan Stanley (see Be bold, page 66), Schroders and Peregrine. In a speech, Peregrine chief Philip Tose stated the advantages of this approach to both sides. “China has proved adept at learning and applying techniques from the outside world, often adapting them to its special circumstances along the way,” he said. “Mostly, this is done through bringing in joint-venture partners who have the necessary technology or expertise. Notable by its absence, however, is the investment-banking industry, where full joint-venture operations are still unknown. It would serve China’s capital needs well to encourage the formation of joint ventures in this area. However, I am not advocating that China allow foreign global investment banks to control or dominate its capital market.”
One interesting feature of the China market is that a bank doesn’t need to be a global player with deep pockets of capital to do well. Good guanxi can compensate for other shortcomings. Take, for example, Zhang Liping, the chairman of Seapower Securities, who built Merrill Lynch’s China business from scratch before moving to Seapower, a little-known firm. The evidence of his past achievements at Merrill adorns his wall – three photos of the thundering herd’s boss Dan Tully and Zhang meeting respectively Zhu Rongji, Li Peng and Jiang Zemin. They are arranged in ascending order as if ploughing a course toward heaven.
Becoming bicultural
His first point of strategy is an obvious one. “You’ve got to get local people to do local business. But they’ve got to be bicultural in order to communicate with headquarters.” Zhang, who is from Shanghai but was educated in Beijing, fitted the bill perfectly at Merrill. A former employee of China United, a branch of the ministry of foreign trade, he worked for Michael Von Clemm at Merrill in New York before being sent to Asia. He suggested Merrill open a representative office in Shanghai in early 1993, making Merrill the first Wall Street firm to do so. An office in Beijing followed the year after.
Zhang was the architect of Merrill’s good fortunes in China. Unlike Goldman, the firm did not retrench during the turndown in 1994 and 1995 and Merrill earned loyalty points when it arranged China’s inaugural yankee bond during this period. The day before launch Alan Greenspan put up rates and the deal was a disaster. But the authorities were impressed by the number of bonds Merrill bought back. “I don’t know the exact figure but I know Merrill suffered heavy losses in the secondary market. So in future they tried to find ways and means to compensate Merrill,” says Zhang.
Now this China business acumen is starting to make things happen at Seapower and the firm is seriously touted as a future player alongside the big names. In the past year Seapower has won more than 10 advisory mandates for Chinese companies. When Continental Mariner injected two properties into the company, “it interviewed five big houses and accepted our proposal. We identified the assets under their umbrella group to be injected. The size was HK$500 million (US$65 million),” says Zhang. Continental Mariner is a red chip – a mainland company listed in Hong Kong.
At Merrill, Zhang launched the 1993 IPO for Shanghai Petrochemical which remains one of the biggest and most important Chinese listed companies. Seapower, with a team of 12 corporate financiers, is its long-term financial adviser – evidence of the strength of the relationship he forged. Seapower will also joint-lead the Wuhan Steel issue later this year and has four other senior roles in the pipeline, two Shanghai listings and two in Hong Kong.
Seapower could easily become a future Peregrine, a quintessentially Hong Kong-Chinese firm that started small but has big clout today. While its boss Philip Tose is English, his mindset is considered more Asian than British. And as far as the China business is concerned, the more important figure is Peregrine’s co-founder Francis Leung.
Leung, while not a mainlander, has employed more young China passport-holders than any other investment bank. The 42-year-old is respected for his knowledge and experience and also for the way he leads deals from the marketing stage through to execution. Clients know there is someone on the spot who can make key decisions. This is where Peregrine differs from the other big players. It is headquarterered in Hong Kong and Tose and Leung call the shots, usually very quickly. There is no need to wait for decisions from credit committees in New York, London or Zürich.
When Shanghai Petrochemical sought to do a placing last year, for example, the company initially roadshowed with Merrill. Then choppy market conditions for petrochemical stocks kicked in and the deal looked as though it would be pulled. Shanghai Petrochemical consulted co-sponsor Peregrine, which said it could do it. Two days later the deal was done – solely by Peregrine. It is a client Peregrine has always been close to. Shanghai Petrochemical’s former company secretary is employed in Peregrine’s corporate finance department.
Peregrine has never retrenched from China, regarding it as a domestic and therefore core market. “We never downsized in the bad years,” says Peter Fu who coordinates corporate finance with Leung, “and now we’ve doubled the capacity. In corporate finance we have close to 50. It’s our bread and butter, for better or worse. The difference between 25 and 10 individuals, how much money is that? Look at the amount of goodwill and loyalty you instil”.
Keeping the team together
As could be expected, Peregrine’s staff has had no shortage of offers to go elsewhere and some individuals have jumped ship: Vincent Shen left for BZW and Wang Xiao Jun went to ING Barings. But, unusually for an investment bank, the Peregrine team remains largely intact.
Peregrine has handled the bulk of the recent red-chip business. The firm estimates that red-chip fundraising since 1994 has totalled $8.2 billion of which it has lead-managed 35% of the issues, either on a joint or sole basis. Peregrine’s Chinese connections help it to bring in business. Leung is a non-executive director of many of the recently listed red chips such as Guangzhou Investment, Shum Yip (the City of Shenzhen’s red-chip vehicle), Beijing Enterprises, Denway Investments, Shanghai Industrial, International Bank of Asia (owned 20% by China Everbright IHD), Stone Electronic Technology and Oriental Metals Holdings.
Peregrine’s own shareholders also help either because they are major inward investors into China, such as Hong Kong tycoon Li Ka-shing, or because clients like to be associated with Peregrine key shareholder Citic Pacific, an influential China-related company.
Similarly Peregrine sometimes takes small strategic shareholdings in stocks it lists, a practice that would be deemed unusual in the west, if only because it leaves the lead manager open to the charge of a conflict of interest with the client over price. Peregrine, which took such stakes in First Tractor, Beijing Enterprises and Shanghai Industrial (and cannot sell them for at least a year) says Chinese clients like this approach because it shows the lead manager has confidence in the company.
If anything the approach was normalized when Morgan Stanley, a firm with whiter shoes than most, followed the practice in May when it led the Beijing Enterprises deal with Peregrine. A year earlier it had declined to do so in the Shanghai Industrial offering, a move it may have regretted when the stock soared over 400% in a year.
Peregrine has a direct investment arm that, apart from taking stakes in its IPOs, also invests diversely in China, for example with French company Danone in Chinese food producer Wa Ha Ha. The bank has a property business and is just about to complete the Peregrine Tower in Shanghai. Its Beijing office has the special status of being a joint venture with the Beijing municipal government, which means it can hire staff freely. Its chief economist for China is based there, a first for any international firm.
Schroders has a similar joint venture in Shanghai to do financial advisory work. Its partner is the Shanghai Foreign Investment Commission which controls the approvals for all inward investment in Shanghai. Schroders, which has operated in Hong Kong for 27 years, first began serious work in China in 1986 when it hired Tim Williams, a former journalist, to scout out opportunities. The chairman of the Chinese joint venture, Gerry Grimstone, is passionate about China. A former British civil servant he was deeply involved in the UK’s privatization programme in the 1980s and first went to China in the early 1990s as part of a small commission advising the government about state-enterprise reform.
The Schroder family is also enthusiastic about China, especially the firm’s president, George Mallinckrodt, who in his role as chairman of the World Economic Forum knows deputy premier Zhu Rongji. The July relocation of Mallinckrodt’s eldest son, Philip, to head corporate finance in Hong Kong has been interpreted as a particularly Asian gesture. Rumoured to have been the richest bachelor in London (his ranking in Hong Kong is not so high), Philip Mallinckrodt ultimately is destined to run Schroders. Putting such a senior member of the family in the region has sent out very strong Confucian signals.
Schroders has already won some impressive (albeit confidential) roles advising mainland Chinese clients, such as acting as defence in Shanghai’s first – and abortive – hostile takeover attempt two years ago. The recent hiring of Jim Walker to head equity syndicate in Hong Kong signals it is moving from pure advisory work to primary equity issuance too. Inside sources say Walker, the co-founder of Crédit Lyonnais Securities Asia, will work with Peregrine on one of the biggest IPOs of 1998.
The fact that both Peregrine and Schroders have been able to forge joint ventures at the municipal level are obvious signs of success. The fact that both emphasize their long-term and unswerving commitment to China has not been lost on rivals. Many claim early allegiances to the country.
Nomura claims it was the first in China. In fact, the firm set up shop in Beijing in 1982 so it was the first in the open-door era rather than into China per se. Then there are firms such as BankBoston whose pitch-book points out that the bank first transacted business in 1784 when it financed the sailing of the Columbia from New England to China. Somewhat more substantively, Hongkong and Shanghai Bank Corp is able to point to its opening in Hong Kong and mainland China simultaneously in 1865. Asked how many staff he has in China, HSBC Investment Bank boss Kevin Westley grins wryly and says about 1,000, a number he reaches by including personnel in Hong Kong. “We’re part of China now, remember,” he adds.
HSBC has been very successful in China. A league table from 1992 to July 1997 of Chinese equity business (excluding red chips) puts HSBC top, followed by SBC Warburg. “As a banking group we’ve financed over 2,000 projects in China in the past 10 years,” says Westley. This includes the commercial bank’s loan book, widely thought to be the biggest of any foreign entity in China.
Ironically, HSBC’s universal banking strategy is closest to fruition in China, if only because it is not plagued there by the name issue, so client relationships merge more naturally. Elsewhere customers ask: “Are you from the commercial bank, HSBC Markets, James Capel or HSBC Investment Bank?” In China, HSBC is known by only the name it’s always had, Waayfoong, meaning “focus of wealth”.
“Our name is extremely well recognized wherever you go in China,” says Westley, whose own Chinese name means “wise thinker”. “I think the general impression is we’re a bank that’s been here a long time – a solid institution that gets things done.”
But history can be a two-way street in China. Is HSBC discriminated against as one of the old colonial institutions? No, says Westley. As an example, he points to the subtle change in the way Beijing’s only English-language newspaper, China Daily, reported the bank’s interim results published in August. In the past such items were relegated to a small column at the back. This time (following the handback of Hong Kong to China) there was a half-page spread complete with a photograph of group chief executive John Bond. Even more startling, the article was included in the domestic activities section. In September, HSBC Group will hold a board meeting in Beijing for the first time.
A problem for banks in China is that mandate awarding can be affected by events beyond their control. In a recent newspaper article, former ING Baring Shanghai head Richard Graham told how, in 1994, a share listing was reassigned to a Japanese firm because at that time too few underwriting contracts had been given to Japanese houses.
Japanese firms have done reasonably well in China but considering they can play the Asian card and are often prepared to sacrifice profitability for market share, their performance has been far from stellar. Chinese memories of wartime occupation and several hundred years of rivalry play a role in this.
Nor do the Chinese like domestic scandals. The Nomura sokaiya scandal earlier this year cost the Japanese investment bank a number of mandates. According to a Nomura source, the mandate to joint-lead the $420 million IPO for Zhejiang Expressways was rescinded after then-president Hideo Sakamaki resigned in March, followed by 20 directors. Zhejiang was launched by BZW in May.
The most obvious example of a firm being punished was the black-listing of Jardine Fleming. The bank’s joint-parent, Jardine Matheson, has had long but troubled connections with China owing to its involvement in the 19th-century opium trade. More recently the company incurred China’s wrath when it shifted its listing to Singapore from Hong Kong and appeared to back former Hong Kong governor Chris Patten’s ill-fated attempts at political reform. Jardine Matheson owns only 50% of Jardine Fleming but the damage was done. Amid the furore Jardine Fleming won no mandates although, in an example of how life in China is never simple, the firm was given a second seat on the Shanghai stock exchange but forbidden from issuing a press release telling anyone about it. Jardine Fleming remains the biggest foreign trader of Shanghai-listed “B” shares – stock targeted at foreigners.
The episode came to a fitting conclusion just before the Hong Kong handover when 18 months of negotiations produced a double breakthrough. Jardine Matheson taipan (big boss) Henry Keswick travelled from London to Beijing to shake hands with Zhu Rongji. This visit took on the grandeur of a state visit and was accompanied by an announcement from the China Securities Regulatory Commission informing potential listing candidates they should no longer discriminate against Jardine Fleming.
Jardine Fleming then won the upcoming “H”-share (Hong Kong-listed) mandate for the $150 million IPO of Anhui Conch Cement and a joint role with Peregrine on the IPO of red-chip Dalian International.
Another firm which looks to have come off the blacklist is Lehman Brothers. In January it jointly led the inaugural yankee bond for the State Development Bank of China, which along with the ministry of finance is China’s reference borrower. Lehman helped the bank with its credit rating, which matched the sovereign ceiling. It was Lehman’s first China-related deal since its $625 million equity issue for Huaneng Power in 1994, the biggest deal out of China at the time.
Lehman’s fall from grace was the result of its decision publicly to sue two major Chinese corporations for $100 million for what it alleged were unpaid debts. “There’s no denying we’ve had some significant disputes in China,” says Lehman’s head of investment banking, Paul Shang, an American-born Chinese with roots in Shanghai. “I think we did a good job working through them in an orderly way. We’ve settled all our disputes in China. It’s been quiet and peaceful, constructive rather than destructive. They were out-of-court settlements, even though they began as litigation.” Lehman has hired 10 new vice-presidents in the past year, most of whom are China-focused – a sign that the firm believes it has a chance of winning mandates again.
Some observers think Lehman’s actions were foolish and guaranteed to produce bad blood. Going public created a loss of face for China. However, the dilemma among bankers is: how far do you change your own rules to accommodate different Chinese practices? Does good business in China always have to be based on kowtowing? And is it necessary to convert your institution into an investment bank with Chinese characteristics or else be flattened? The whip is certainly never far away. For example, the Chinese authorities make foreign firms reapply for their “B”-share trading licences on an annual basis.
Investment banks are right to be hyper-sensitive about offending China’s sensibilities. The $200 million Jiangxi Copper “H”-share deal by Merrill Lynch aroused controversy and since launch in June has traded below its issue price. The reason? Joint lead-manager ABN-Amro Rothschild was ejected from the deal at the last moment by the issuer’s lawyers because the bank’s Chicago-based metals analyst had a less optimistic view of the direction of copper prices than the company. Merrill, on the other hand, agreed with the company’s view. In order for the deal to have a coherent prospectus, ABN-Amro had to go. This scared Hong Kong investors and doomed the deal.
The Dutch house’s view of the copper price has since looked the more accurate of the two. Investors might draw the conclusion that ABN-Amro Rothschild emerges from the deal with integrity. Rival investment bankers, however, say the whole thing smacks of either naivety or poor lines of communication between the bankers and the analyst. A source close to the issuer says: “We were very disappointed. This sort of thing is not supposed to happen.”
It casts a shadow, however temporary, over ABN-Amro Rothschild’s China business. “The “H”-share market is a national objective,” says one competitor. “So you could say they were sabotaging a national objective.”
Most banks admit reputational risk is a concern in China, especially in the case of placing Shanghai and Shenzhen “B”-share IPOs with international investors. Due diligence standards are lower on “B” shares than Hong Kong-listed “H” shares which is one reason why US banks have tended to leave the “B”-share market alone. They fear a scandal should they sell dud assets to their New York clients. Nor do they find the “B”-share market particularly exciting: deals average only between $50 million and $100 million and are less enticing than bigger-ticket “H” shares which usually exceed $200 million or, even better, red chips which often lead to repeat business.
US houses’ neglect of the “B”-share market – which is another national objective – ought to have given a competitive edge to its earliest sponsors, houses such as ING Barings and SBC Warburg. It hasn’t. There is no evidence of US firms being discriminated against or being denied big mandates as a result. Indeed, the US firms have cornered the bulk of the gala mandates. Even firms not usually associated with Asia have done well. The Guangshen Railways mandate is a case in point. This $543 million deal was won by Bear Stearns, a firm which does not even have a railways analyst. Outsiders speculate why the deal went to a firm which has hardly any representation in China.
One explanation is that the firm’s head of China, Margaret Ren, is a superb operator and has good structuring skills and abundant charm. She also has good connections: US-educated Ren is related to a former deputy premier. Even so she was up against equally good guanxi. The other contender for the mandate was CSFB, which employed the daughter of the former minister of railways. Coincidentally, her brother worked with Ren at Bear Stearns. This transformed the chase for the mandate into a battle between brother and sister. Cynics said the reason Bear Stearns defeated CSFB was that the son matters more than the daughter in China. Whatever the reason, the deal was executed well.
While banks fight tooth and nail for every deal, in China some mandates are awarded for political reasons. These are deals given to trusted firms and cannot be turned down. The deals are too important to key figures in the party to be allowed to fail. Usually the importance of such a deal derives from the fact that it is “policy driven”. This often means the company is a basket case into which the favoured investment bank must breathe new life.
Take Angang New Steel Company, sole lead-managed by ING Barings in July. The parent company is a typically awful state-owned enterprise. But it was known that Zhu Rongji had decided to inject some momentum into state enterprise reform. That meant this steel company had to be partly privatized before the Communist Party congress in October. It was no accident that Zhu was visiting the steel mill on the day the issue was priced. Or that China Everbright Group came in as a strategic investor – its boss, Zhu Xiaohua, is close to Zhu Rongji.
ING Barings was asked to do the deal because of its quality research. But it was always going to be an uphill struggle to structure the company in a way that would appeal to investors who were not particularly keen on Asian steel companies in general. The integrated Angang New Steel has 160,000 employees and the part the bank chose to offer to investors was the finishing-mill division, with 4,000 staff.
The fact the deal went well made it a win-win situation for ING Barings. It made money. It curried favour. Had the deal gone badly it would equally have been lose-lose. For investment banks such deals can be a poisoned chalice. But all the investment banks with long-term interests in China know they will face ups and downs, including some well beyond their control.
