Investors To China: Open Those Books

WTO entry will bring investors looking for accountability

China's top proto-capitalists are going back to school. Starting Oct. 16, 160 senior execs from the country's biggest state-owned companies will spend three weeks at the spanking new campus of the National School of Administration in western Beijing, studying international capital markets, privatization, and the impact of foreign competition on China's closed markets. The course, given on government orders, is all part of Beijing's ambitious effort to whip management into shape at state-owned enterprises.

Those managers aren't just worried about term papers. As the year winds to a close, many face two enormous sources of pressure. One is China's imminent entry into the World Trade Organization. WTO entry will eliminate trade barriers and expose state companies to competition for the first time. The other source of pressure will be shareholders. And they will be of the most demanding variety--multinationals and big Western funds looking for the next great China play. These investors will want results, and the state companies' executives are being told they must deliver.

LONG LINE. Premier Zhu Rongji and other reformers in Beijing want investors' money badly. And they've been dispatching the nation's model companies to international capital markets to raise money for the changes they must make to become competitive. State-run companies have raised $18 billion on foreign exchanges so far this year; they hope to raise an additional $50 billion by 2003. "Companies are saying `Let's do an IPO and expose ourselves to the market,"' says Lee H. Zhang, executive director of Goldman, Sachs & Co.'s Beijing office. "Then the discipline of being public will force them to cut costs."

The queue of those lining up for listings represents a who's who of corporate China. The country's largest oil refiner, China Petroleum & Chemical Corp. (Sinopec), expects to raise $4.2 billion in October. ExxonMobil, BP Amoco, and Royal Dutch/Shell Group have agreed to take $1.2 billion worth of shares. Next up: China Mobile (Hong Kong), which first went public in 1997, will kick off a $6.5 billion secondary offering, also in October. It used its IPO money to build the world's second-largest mobile-phone network, with 40 million subscribers.

Unlike China's "red-chip" companies of the 1990s, small and often mediocre firms that listed on the Hong Kong Stock Exchange, these companies are big and have already embarked on major reforms. Chinese leaders are betting that the presence of outside shareholders and independent directors on the companies' boards will accelerate the streamlining and modernizing processes they need to undertake. Public listings "are good for the companies," says Adaline Ko, a director at fund manager Lloyd George Management (Hong Kong) Ltd. "If you have people scrutinizing, at least you have to answer to somebody."

It's happening already: PetroChina is cutting 50,000 workers. It has pledged to slash the cost of each barrel of oil it drills from just over $5 in 1998 to $4 in 2002, closer to the global average of $3.64. That should save $710 million over four years. The company, which has adopted U.S. accounting standards, went through a rigorous two-month review by the U.S. Securities & Exchange Commission this year in preparation for listing. With international investors watching, it will be harder to fall short of targets.

Sinopec also is an example. Besides adopting U.S. accounting standards, it is spinning off ancillary operations, including a college and hospitals. It has promised to cut 100,000 workers, from the current 510,000, and targeted $1.6 billion in cost savings. It will spend $120 million on information technology and e-commerce initiatives. "WTO's role is to speed up the reform in China," says Chen Ge, a deputy director at Sinopec. "The purpose of the listing is to reform the management of state-owned enterprises."

In a significant break from the state-dominated ways of old, Beijing looks ready even to list its banks. In the past, officials declared that shares in anything but banks could be sold because of their critical role in the economy. Now, financial industry sources say China's State Council has given preliminary approval for an IPO by the Bank of China, the country's third-largest. The Industrial & Commercial Bank of China may follow with its own IPO.

Independent boards are also on the way. Thanks to an introduction from underwriter Morgan Stanley Dean Witter, telecom heavyweight Craig O. McCaw has joined the board of mobile operator China Unicom. All three of the red chips listing this year have independent directors--some of them, like McCaw, based outside China. PetroChina, whose outside directors include Italian oil executive Franco Bernabe, has emulated Western boards and is the first in China to boast a compensation committee, an audit committee, and an environment and safety committee.

Huang Yan, president of PetroChina, is one of 363 managers there who had most of his pay tied to a stock incentive program when the company listed in April. His base salary, plus bonus, is $19,300 this year. But he has options on 1.82 million shares. Although the options don't vest for three years, on paper he has made $84,000 since the listing, equivalent to seven years' base salary. But nothing is guaranteed. "If there is no appreciation, I get nothing," says Huang, who is extending the plan to cover middle managers as well.

OLD HABITS. Of course, there's still a long way to go before China's companies are truly accountable and transparent. Only China Mobile has a track record of any length with investors. "[Despite] commitments to shareholders, at the end of the day, they are state-owned and controlled, and there's no getting away from that," says Franklin Templeton fund manager Mark Mobius. Mobius bought PetroChina in the IPO but sold the shares in September. Many companies remain stingy about releasing even public information. In a typical case, a China Unicom Ltd. official flatly refuses to discuss the company's stock incentive plan, although it is detailed in a prospectus issued as part of its June IPO in New York and Hong Kong.

Notwithstanding the lack of disclosure, Chinese companies are having no trouble floating stock. But as China enters the WTO, openness and honest accounting will become critical to reform. Managers who have gone back to school had better be ready for the test.

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