China: A Lesson Learned The Hard Way

This time around, Beijing supports a company in trouble

As a senior Chinese official, Wang Qishan is used to deferential treatment in both Hong Kong and Beijing. But when the executive vice-governor of China's troubled Guangdong province stood before more than 250 foreign bankers at Hong Kong's posh Shangri-La Hotel on Mar. 1, he was greeted with an unusual stony silence. "Even after I said, `Thank you,' there was no applause," says a sober Wang, a close associate of Premier Zhu Rongji and the man charged with cleaning up the financial mess in the once booming showcase province of southern China.

That's because Wang had grim news for the banks, including HSBC, Standard Chartered, Sanwa Bank, and Banque Nationale de Paris, that were already reeling from earlier bad news out of China. One of China's most prominent companies, Guangdong Enterprises (Holdings) Ltd. (GDE) could not make principal repayments on its $3 billion in debts. Wang told bankers that China was prepared to save the conglomerate through a Goldman, Sachs & Co.-led restructuring and asset-building plan. But he warned that banks were nonetheless going to have to share the pain.

Wang's plan has both a carrot and a stick. His offer is to inject profitable state-owned assets into the group to shore up the balance sheet, provide a source of cash flow, and give the company a shot at survival. In return, sources close to the negotiations say, banks will have to accept some sort of haircut. When the formal restructuring proposal is put forward in April, bankers likely will be asked to swap some of their loans for "hope notes," or junk-grade securities. Remaining loans would be stretched out over a longer period. If the bankers balk, Wang could put the company into formal bankruptcy, where creditors would get only about 60 cents on the dollar, according to financial statements.

It's another shock for the banks, but it could be worse. While Wang's announcement adds to the evidence of just how badly the troubles in southern China are threatening Hong Kong, it stands in sharp contrast to China's actions following the chaotic collapse of Guangdong International Trust & Investment Corp., or GITIC, late last year. Bankers, owed $4.3 billion, were told in January they had to fend for themselves in order to collect on their loans, despite earlier promises that the Chinese government would honor debts. They responded by cutting credit lines and recalling loans to China. Chinese leaders were stunned by the liquidity crunch.

CONSEQUENCE. This time, Beijing may have learned its lesson. Bankers familiar with GDE say Chinese officials were worried how international financial markets would react to getting stiffed again. "They knew if they did this twice, the window was going to close," says a banker involved in the negotiations. Adds another banker: "The consequences [of GITIC] went far beyond what the central government had expected--that's why they can't afford to let [GDE] go bankrupt." Even Wang admits to taking "the stability of the Hong Kong market" into account, noting that GDE subsidiary Guangdong Investment is part of the Hang Seng index.

Wang's restructuring plan may become a model for how China will handle bankruptcies in the future. The idea is to bring order to the GDE group, which currently has 299 separate companies, by selling peripheral companies and merging core ones. State-owned assets that could be transferred to GDE balance sheets if bankers agree to the haircut range from a water supply and treatment plant that supplies 80% of Hong Kong's water to bridges and toll roads.

It's clear things are different this time around. Wang gets high marks for the most open workout program China has ever seen. In the case of GITIC, even bankers got only the most perfunctory information. This time, in addition to hiring Goldman, he brought aggressive auditors into the group and then released the results of even the privately held parent company.

Yet what the auditors are reporting is not pretty. GDE bet heavily on Hong Kong stocks and property at the wrong time, so the company had to take a massive $2.1 billion write-off for the nine months ended Sept. 30. That left it with a negative net worth of $1.7 billion. Guangdong Investment Ltd, a utility, hotel, and infrastructure company, also took a $240 million write-off. Worse news came from another subsidiary, Guangnan (Holdings) Ltd. It was running supermarkets and supplying pigs and chickens to Hong Kong--before getting into Hong Kong's inflated stock and property markets. Guangnan took a $440 million write-down and said that it, like its parent, was also insolvent.

The size of the losses at what were supposed to be among some of China's most international and market-savvy companies is yet another reminder of how large China's problems loom and how weak its internal controls remain. The same day as Wang's announcement, Standard & Poor's, like BUSINESS WEEK owned by The McGraw-Hill Companies, downgraded China International Trust & Investment Corp., one of Beijing's most prominent financial institutions, and one other Chinese bank, to junk status. Ratings on three of the country's largest banks, including the Bank of China, were cut to the lowest investment grade.

Wang is betting his credibility on the workout. He previously headed China Construction Bank, where he set up an unprecedented joint venture investment bank with Morgan Stanley. Zhu sent him to Guangdong following a central government decision in late 1997 to rein in China's free-wheeling financial institutions, especially in the south. Wang's decision to hire Goldman is the first time a foreign investment bank has been brought in to help a troubled Chinese company.

Goldman has its work cut out. It has promised to invest $20 million in the group once the restructuring plan is completed in six months to a year. With 250 banks involved in arduous negotiations, there's plenty of room for things to go wrong. Many Asian banks have real disdain for write-downs, though they may be willing to take a disguised write-off in the form of junk debt.

Wang and the Chinese have even more at stake. If restructuring doesn't work, China's already perilous standing in the international financial markets will be jeopardized. "China is trying to do the right thing," says John Godfray, a director at Dresdner Kleinwort Benson who follows Chinese conglomerates from Hong Kong, "but we've got a long way to go." Plenty of investors agree.

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