New World Takes A Great Leap Back

Henry Cheng's empire is forced to regroup

Henry Cheng has long had to live in the shadow of Hong Kong's premier tycoon, Li Ka-shing. So in the mid-1990s, the scion of the New World real estate and infrastructure empire decided to try to outshine Li in the giant untapped market of China. Cheng also poured hundreds of millions of dollars into developing a fixed-line and mobile operation in Hong Kong on a similar scale to Li's Hutchison Telecom. The competition moved to the dot-com realm: Cheng arranged a back-door listing for his Internet company, New World CyberBase, soon after Li's son Richard engineered a similar deal for his Pacific Century CyberWorks.

But there is a big problem with Cheng's keep-up-with-the-Lis strategy: Dismayed by the group's soaring debts, investors have abandoned New World companies. Instead they have favored livelier and more profitable ones run by the Li family and other tycoons. The stock price of flagship New World Development, which has interests in property, telecom, transportation, and services, is down 39% this year, against a 1% rise for the benchmark Hang Seng index. Suffering from a depressed Chinese property market and continued losses at its telecom operation, the company recorded a loss of $117 million on sales of $1.2 billion for the six months ended Dec. 31. That was its first red ink since going public in 1972. Other New World companies have taken a hit, too. For instance, New World CyberBase's stock has plunged 85% in the past 12 months.

If there's a moral to this tale, it's that tycoons who relied largely on guanxi, or connections, to succeed in old-line businesses need a lot more if they hope to succeed in the New Economy. Sure, guanxi still matters, and both the Li family and the Cheng family have used their valuable connections with top Chinese and Hong Kong officials to further their diversification into telecom and Internet businesses.

But unlike the Chengs, the Li family businesses have long looked beyond the confines of Greater China for their growth with big, expertly timed investments in European telecom operations like Britain's Orange PLC. That's given Li Ka-shing's Hutchison Whampoa the international experience and management savvy to become a vital global player. Companies such as New World that didn't stray much beyond their backyards can't boast that kind of management depth.

A somewhat contrite Cheng is willing to admit to some mistakes. "We invested in China at least four or five years earlier than we should have," he says. "We lost a golden opportunity" in the Hong Kong property market as a result. Now, he's pushing an ambitious plan to reduce New World Development's debt load from $3.8 billion to $2.5 billion. That would take the company's debt-to-equity ratio from 52% to a more manageable 35% in 2001. To do that, he's selling off portions of a range of New World businesses. On the auction block: stakes in New World's telecom operations, its Internet investments, and some Hong Kong properties (table).

By bringing down his debt burden, Cheng figures that he can prop up his lagging stock price and have more resources to pay renewed attention to Hong Kong real estate. And bringing in partners to help run the telecom businesses will protect New World's balance sheet from the costs of developing third-generation mobile services. Cheng insists that he is not redrawing his game plan. Rather, Cheng says that sticking to the diversification strategy will pay off.

FALSE START. But Cheng's plans have already run into problems. A deal to sell a majority stake of the group's fixed-line telecom operation to Australian company Davnet collapsed in June. New World was keen to reduce its stake because it lags far behind powerful rivals like Hutchison Telecom--controlled by Li Ka-shing--and Cable & Wireless HKT, which is in the process of being acquired by Richard Li.

But Davnet walked away from the deal, saying the operation was losing market share and staff members; within days, Davnet retracted its comments after New World threatened legal action. Now, Cheng is shopping the subsidiary around again. Industry sources say Singapore Telecommunications may be interested, since a stake in New World would give the Singapore company the foothold in Hong Kong it lost to Richard Li in its bid to take over HKT. In the meantime, to lure new customers, New World recently slashed rates for calls to China.

Cheng knows that he needs to reduce his exposure to New World's mobile operation, too, so he's looking for outside investors and local deals. He wants to sell a minority stake, with Chase Capital the likely buyer. New World is also interested in merging New World Mobility with Peoples Telephone Co., the smallest of Hong Kong's mobile operators. The combined entity would become a market leader. Equally important, with New World Mobility facing the prospect of the expensive transition to third-generation mobile service, the change to a minority stake in New World Mobility would minimize the impact of the investments on New World Development's debt levels.

However, some industry officials aren't convinced that a tiny New World cellular company will be able to survive the city's brutal competition. The deals "offer very little in the way of solution for New World's problem," says a rival. He believes that the overcrowded industry faces further consolidation, possibly leaving New World/Peoples as fodder for future mergers. "Members of the Cheng family don't believe in the telecom business," the competitor says. Cheng dismisses such charges as "nonsense," adding that "definitely we can survive."

"NOT PRETENTIOUS." Some skeptical investors wonder whether New World can recover with Cheng at the helm. They blame his strategy for the group's poor earnings. New World Development trades at about a 50% discount to its net asset value, says Raymond Ngai, a property analyst at Prudential-Bache Securities in Hong Kong. "The market perceives the management as not good," says Ngai.

Cheng does have his fans. New World "is not a pretentious company at all," says Michael Green, an analyst with Donaldson, Lufkin & Jenrette in Hong Kong who rates New World Development as a "buy," ahead of blue chips like Li's Cheung Kong. "It simply gets on with the business." The company has bolstered its cash flow by taking full control of its local bus and ferry service, which Cheng entered in the late 1990s, from Britain's FirstGroup in May. The business may become more lucrative, especially with routes that could carry tourists to the Disney theme park that is to be built on one of Hong Kong's outlying islands.

But that may not help New World avoid a loss for the fiscal year ended in June. A big reason for the plunge in earnings: a $167 million write-off for the disappointing initial public offering of subsidiary New World China Land, which is trading at 70% below its IPO price of a year ago.

With the Chinese economy picking up and foreigners on the prowl for opportunities after Beijing joins the World Trade Organization, Cheng says that his bet on China will still pay off for New World. As foreign investment increases, he notes, more companies will be looking for office space. "It is just a matter of time," he says. Having waited so long, Cheng hopes others will be just as patient.

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