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Goldman's Big Bet On China (Int'l Edition)

International -- Asian Cover Story

Goldman's Big Bet on China (int'l edition)

The firm has spent years cultivating government leaders in Beijing. Will its patience finally pay off?

It's 4 p.m. in Hong Kong on Nov. 15. Goldman Sachs Asia Chairman Mark Schwartz is closing a $1.2 billion deal for a linkup between Hutchison Whampoa Ltd., the conglomerate of local tycoon Li Ka-shing and Gary Winnick's Global Crossing Ltd., a fast-growing U.S. telecom company. The idea is to wire mainland China for phone and Internet service sometime in the future. Minutes later, Schwartz hears that U.S. negotiators in Beijing have agreed on terms for China's entry into the World Trade Organization.

The future has arrived.

Goldman Sachs & Co. has prepared for this moment for years. Like other investment banks, it has spent tens of millions of dollars to establish itself on the mainland. But Goldman goes to such great lengths to win official favor that it stands apart from its rivals. Its top brass have spent thousands of hours assiduously cultivating reformers such as Prime Minister Zhu Rongji. Most recently, they have backed one of his pet projects, an executive management training program. They earned yet more guanxi, the indispensible connections needed to do business in China, by helping provincial leaders restructure a huge business group that Beijing let flounder. And they have stood by their well-connected Hong Kong clients through the dark days of the Asian crisis.

Now, it's payoff time. Already, Goldman has secured a position as lead manager of a $5 billion-plus initial public offering of a newly formed state-owned behemoth, China National Petroleum Corp. (CNPC) early next year. Tens of billions of dollars' worth of debt and share issues will be up for grabs as China privatizes state enterprises. And hundreds of foreign businesses will be trying to break into China's teeming markets. Within four days of the WTO accord, for example, Marcus Wallenberg, chief executive of Sweden's Investor, flew into Hong Kong to discuss with Goldman how to deploy into the mainland some of the $400 million it plans to invest in Asia.

Goldman's global rivals, of course, won't let it harvest huge fees unchallenged. And Beijing will likely ration business among them. It likes to play Goldman against Morgan Stanley Dean Witter in particular, favoring one bank and then the other. Morgan Stanley owns 35% of China's only joint-venture investment bank, China International Capital Corp. And CICC ranks second after Goldman in overseas equity deals completed since 1996. It has potent guanxi, too: Zhu Rongji's son runs its Hong Kong operations.

Merrill Lynch & Co. has also begun to court China again, three years after several of its top Chinese employees left. Merrill may even win the coveted mandate to underwrite a huge initial public offering for Baoshan Iron & Steel Co.

Still, Goldman is pulling in deals at an impressive rate. November's lead position on a $2 billion secondary offering for China Telecom (table) raised Goldman's market share for China equity deals over the last three years to 23%. That compared with 16% for CICC and just 5% each for Morgan Stanley and Credit Suisse First Boston. And the successful execution of offerings such as CNPC could give Goldman's team, led by Asia President Richard Gnodde and managing directors Hsueh-Ming Wang and Zi Wang Xu, an edge in winning more business. Beijing is expected to make more telecom and energy deals as well as offering shares in the Hong Kong operation of state-owned Bank of China, which would be a first for a mainland bank. In addition, China is mulling plans for a vast privatization program of everything from railroads to tobacco companies to heavy industries. None of these deals will be easy, especially if Beijing tries to dictate pricing as it did with electric power company Shandong International Power. It took Goldman seven years to bring Shandong to market.LATE STARTER. Three years ago, Goldman probably wouldn't have been anyone's first pick to win many big deals. In 1996, it earned a measly $107 million in pretax profits from all of its Asian activities. It trailed in share issues and was a distant 17th in merger and acquisitions work. This year, Asian pretax profits, which have doubled annually, could reach $1 billion. In mergers and acquisitions, it ranks first outside Japan, having advised on $17 billion worth of deals.

Goldman's surprising comeback is the result of one of the most focused, relentless campaigns to win business that Asia has ever seen. John L. Thornton, now co-chief operating officer based in London, ruthlessly pruned a long and scattered list of more than 300 clients when he became Asia boss in 1996. These days, Goldman goes after just 100 "Super League" clients in Asia outside Japan, a third of them in Greater China. Call them what you will--the movers and shakers, the heavy hitters--these people make most of the decisions and control most of the money in their countries. The way Thornton figured it: "Do a good deal for one of them, and it's like a positive virus."

Progressively, Goldman is insinuating itself into Asia's economic networks, from its state-owned enterprises to its startups. The bank has won some of the most prized restructuring and privatization assignments in postcrisis Asia. It was the lead manager, along with Salomon Smith Barney, on the first big deal: a landmark $4 billion bond floated by the South Korean government in March, 1998. A year later, it leased Jakarta's port to Li's Hutchison Whampoa in a 20-year, $250 million transaction. Then, in October, Thai Farmers Bank hired Goldman to help it manage $2 billion in bad loans. Even competitors are impressed. "Goldman is very focused," says Julie Craddock, a managing director at CS First Boston (Hong Kong) Ltd. "They have a very high success rate on deals they want."

Successful as Goldman's approach seems, it runs risks and has generated criticism. Most banks look to a steady flow of smaller deals to provide a constant source of income. But Goldman's all-or-nothing emphasis on blockbuster deals makes earnings more volatile if it misses any of them. And though it has raked in fat fees from telecom and banking deals, it has some blind spots. It was late, for example, to see the potential of Asian Internet companies, even though it was a major client of Infosys, the first Indian software firm to list in New York.

A former senior Goldman investment banker derides what he calls the firm's "cash-cow approach" of picking a few big clients. "It's a niche strategy," he contends. "Who knows who the leaders will be 10 years from now? Nobody is smart enough to figure it out," he says. Indeed, Premier Zhu may look strong now. But a shift in power could diminish his standing and send Goldman back to square one.

Goldman's involvement in everything from aggressive trading on its own account to advisory and restructuring work, say some critics, also exposes it to potential conflicts of interest. Others argue that its urge to profit from all aspects of Asia's crisis is unseemly. "The proprietary [trading] guys help wreck economies, the advisory guys help work things out, and the debt guys float the debt," says a senior Hong Kong banker at a rival firm. Goldman, of course, does not see it that way and insists that it maintains good relations with central banks and other authorities around Asia.LOSS LEADERS. The criticism might be sour grapes from rivals pushed aside by Goldman's deal machine. But the bank will face intense scrutiny in China. For starters, Beijing's leaders are hypersensitive to any suggestion that they are being taken for a ride by glib foreigners. That's why Goldman executives spent years cultivating China's mandarins without much hope of immediate reward. They've curried favor by taking on assignments they don't want and donated time and money to pet projects of Beijing's leaders.

Consider what happened last December. The executive vice-governor of the southern province of Guangdong, Wang Qishan, asked Goldman's co-chief operating officer, Hank Paulson, to help restructure Guangdong Enterprises, the big and hugely troubled provincial holding company that Beijing had refused to bail out. Taking on a corrupt, bankrupt business such as this isn't likely to make Goldman any money. In fact, the bank has even promised to invest up to $20 million in the company as a show of good faith. Meanwhile, Goldman has had to contend with disgruntled foreign bankers who won't get back in full their loans to Guangdong Enterprises. Paulson simply says: "If the governor wants to see me, I get on a plane and come."

Then, in September, Premier Zhu asked Goldman to set up a forthcoming high-level management seminar at one of Beijing's elite universities. Paulson and Thornton got General Electric Co.'s John F. Welch and Eastman Kodak Co.'s George M.C. Fischer to promise to attend. On another occasion, Paulson jetted in from the U.S. for a few hours to host a gala fund-raiser for an environmental project in China that took place at Hong Kong Chief Executive Tung Chee-hwa's swank family retreat.

Goldman certainly seems to bend over backward to keep its Super League clients happy. Last year, in the midst of Hong Kong's worst property downturn in 15 years, Goldman signed a 12-year lease for nine full floors in Cheung Kong Center, one of Hong Kong's newest and most expensive office towers. The property is owned by Li Ka-shing, one of Goldman's biggest clients in Asia. Li "jammed it down Goldman's throat," says a source familiar with both companies. "Goldman rented the building when Li was in a tough position." Since then, Goldman has advised Li on the $32 billion sale of Orange PLC, a British mobile phone operator that was a subsidiary of Li's Hutchison Whampoa, to German group Mannesmann. That gave Hutchison a 10% stake in Mannesmann. What seemed a straightforward deal for Goldman turned messy when Vodafone, another client, bid for Mannesmann. Now, the managing director of Hutchison, Canning Fok, says he's against the sale to Vodafone. The spat highlights the conflicts of interest that Goldman faces as it expands--and shows that Goldman can't always count on its favored clients.

However smooth and urbane Goldman's top execs appear to be in public, they have a different persona inside the bank. Thornton, for example, used to hector investment bankers with phone messages, pushing them to move in on clients. New staff, especially the increasing number of non-Americans, are dumbfounded by the bullying, profane messages that colleagues leave on voice mail. The survivors put up with it because the aggression sometimes pays off big, as it did when Japanese telecom giant Nippon Telegraph & Telephone Corp. picked Goldman to do an $18.5 billion spin-off of its cellular phone unit last December.

Apart from generating most of Goldman's profits for the moment, deals outside mainland China are an important test bed for new ideas that may help it with Beijing. Unusually for an investment bank, it is pouring $4 billion from its own account and institutional investors to finance everything from Internet startups in Taiwan to distressed debt in Thailand. Its direct investment funds own part of Ping An Insurance, a Shenzhen-based firm that is one of China's three national insurance companies; Hong Kong's Yue Yuen, a big maker of Nike shoes; and 40% of Bangkok's Regent Hotel. In South Korea, it has scooped up distressed property and bad debts from the Korea Asset Management Corp. In Thailand, meanwhile, it has bought assets from the Financial Restructuring Authority and teamed up with General Electric Capital Corp. to snap up delinquent auto and credit-card loans--and browbeat owners into repaying their debts. At its peak earlier this year, the venture owned nearly one third of the pickup trucks and one of every seven cars in the country.MOD SQUAD. In Japan, Goldman has shed its white-shoe image to pitch for small retail clients. Since June, it has sponsored a popular Saturday morning TV show, Money Angels, featuring a trio of smartly dressed young women dispensing personal financial advice. Goldman sells retail mutual funds through several banks, including Sakura Bank and Sumitomo Bank. Its assets under management are $9 billion.

Gaining such experience could be a big help in China. Beijing's WTO accord with the U.S. foresees more opportunity for foreigners to invest on the mainland--even getting into insurance, banking, and other financial services eventually. Also, Goldman would be able to underwrite mainland stocks on the Shanghai and Shenzhen exchanges as well as trade government securities and some local shares.

Of course, none of Goldman's advantages guarantees success. The reformers, such as Premier Zhu, who it has cultivated, could lose power. And the bank's culture of hustle could turn off some Chinese officials. But for now, it has got an impressive headstart over its rivals in China.By Mark L. Clifford in Hong Kong, with Brian Bremner in TokyoReturn to top

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