Fighting the State

China entrepreneur Li Yonghui has a harrowing tale to tell: He tried to take over a state-owned enterprise--and paid the price

One November day in 1998, Li Yonghui received a surprise visit from a well-connected investment banker. All smiles and professionalism, the banker was offering what seemed like the deal of a lifetime: an opportunity to buy into a state-owned property-development company. The deal would provide Li, a private entrepreneur, access to China's booming stock markets, and it would also afford him connections to the highest officials in Shijiazhuang, Li's gritty hometown in Hebei province, 170 miles southwest of Beijing.

Li liked what he had heard about the company, International Building. It was considered a model state enterprise with real profits and a buoyant stock price. Then again, maybe Li should have smelled trouble: It isn't every day that an entrepreneur is asked to buy into a state-owned company. Still, Li was eager to expand beyond selling trucks. "We were looking for new business opportunities," he recalls. "And this was a chance to enter the stock market." Not long after, Li paid $7.1 million for 18.77% of International Building.

Today, Li, 38, is still battling to recover from the biggest mistake of his life. International Building failed to live up to its billing, but that wasn't the worst of it: In trying to salvage the situation, Li found himself tangling with two of the most powerful men in Shijiazhuang. Hebei Deputy Governor Cong Fukui and Shijiazhuang Mayor Zhang Erchen ran the city like it was their own enterprise--and apparently they felt the same way about International Building. When Li tried to boost his minority share to a controlling one, he found himself in a cramped jail cell--and he stayed there for 100 days, until he agreed to forfeit his stake.

Li walked away a free man, albeit a poorer one, but he got a stern warning from one of the officials who arrested him: "Don't talk about your experience. We can always pick you up again."

For most Chinese, that would be the end of the story. Not so for Li Yonghui. This is one determined--and, some would say, reckless--individual. Despite entreaties from his wife to quit roiling the waters, Li is doing the opposite. Emboldened by the arrest last year of Cong and Zhang on corruption charges, Li has launched a battle for control of International Building in the boardroom and the courts. He is even suing China's securities regulator. "This concerns my dignity and my company's reputation," Li says. "I need an answer." Even though he knows that the rule of law in China is more fantasy than fact, Li seems to believe he'll prevail because his cause is just.

Li's opponents in this struggle--the general manager of International Building and the officials of Shijiazhuang--either refuse to comment on his case or dismiss him as a troublemaker, but that's not how other Chinese see Li. Along the way, he has become something of a standard-bearer for Chinese entrepreneurs: an Everyman willing to stand up to powerful local interests. His ordeal has been covered on national TV, in local newspapers, and in China Securities, a national markets magazine. A Chinese Web site called Golden Net Commentary recently compared him to the title character of the popular movie The Story of Qiu Ju, who refused to give up her struggle for justice against local officials. By telling his story to BusinessWeek, Li hopes--perhaps naively--to win a sympathetic ear from the central authorities. His doggedness both worries and impresses his supporters. "He is an amazing man," says Cherry Li (no relation), an adviser to Goldman, Sachs & Co. in Beijing who knows Li well. "He refuses to give up."

CAUTIONARY TALE. Li Yonghui's story is an inside look at what it means to be an entrepreneur in China: the murky dealmaking, the often dysfunctional marriage of private and state enterprise, the fortunes to be made by anyone with the grit to persevere, and the costly encounters with grasping officials. This is also a cautionary tale: Li's ordeal demonstrates just how far his nation needs to go before private businessmen are accorded the respect and legal protections taken for granted in the West. While President Jiang Zemin recently invited private businessmen to join the Communist Party, the small but growing business class remains an object of suspicion. "We still face discrimination," says Liu Yonghao, chairman of the New Hope Group, one of China's largest private companies, which is involved in everything from food processing to finance. "Local officials usually are lenient with state-owned enterprises, but they're very harsh with private ones."

Nothing in Li Yonghui's childhood pointed to a business career. One of six children born to a poor farmer near Shijiazhuang, Li seemed destined for a life of subsistence agriculture. But, blessed with brains, he managed to win a place at Tianjin University, in the coastal city nearest Beijing, a rare honor for a country lad. After earning a degree in laser technology in 1985, Li returned to Shijiazhuang.

The grimy capital of Hebei was then much the same as it is today: a city of decaying textile factories, crumbling apartment blocks, and army barracks. Jobless residents by the thousands loiter outside the grim apartment houses that once represented the worker's paradise. In recent years, the city has suffered a series of mysterious bomb blasts, while trucks filled with criminals on their way to the execution grounds routinely rumble through the streets. In this hard-luck place, opportunities have always been meager, even for an educated man. For several years, Li worked a series of state jobs, from technician in a locomotive-parts factory to salesman at an electronics-machinery company. "I even sold canned food from a three-wheel cart," says Li.

All the while, Li yearned to go into business for himself. By the late 1980s, Shijiazhuang was starting to open up, and Li began to dabble on the margins. He traded aluminum ingots; he played the stock market; he set up a car-parts business. He made money by purchasing commodities at artificially low state prices and selling them at a premium to partially privatized businesses. By 1991, Li estimates he had an income of $85,000 a year. It was a tough life, though: Li continued to toil at the locomotive factory, often working an 8-hour night shift even as he operated his sideline businesses.

As Li and others like him began to prosper, local authorities began to cash in too, taking bribes and shaking down entrepreneurs for business approvals. Within a few years, they were living the high life--and becoming increasingly obvious about it. In a city where most people still get around on bicycles, officials began tooling about in Audis, Mercedes-Benzes, and China's own luxury vehicles, Red Flag limousines. By the late 1990s, their apartments were filled with the trappings of the bourgeoisie: marble and gold fixtures, big-screen TVs. On any given Friday night, part of Yucai Street turned into party central as local officials descended on state-owned Hebei Hotel, where, it was said, some of Hebei's most beautiful women were available for the right price.

From the beginning, Li watched the shenanigans with distaste. A university-educated man, he considered many local officials country bumpkins. He had no respect for the future mayor. As it happened, Zhang Erchen, then rising rapidly through the ranks, hailed from the same poor county as Li did. Li considered him uneducated, uncouth, a "typical Chinese nouveau riche." Let Zhang wear the ostentatiously expensive clothes, Li told himself. He would stick with casual attire and sandals.

Li's superior attitude didn't prevent him from playing the games one had to play to get ahead in business. In 1994, a local official arrested for corruption fingered Li as one of several people who had paid bribes to win business contracts. Li was not charged, but admits he gave the official gifts and bought him meals. "How could I do business without song li [gift-giving]?" he asks. "This was the system." The experience convinced Li to stop operating in the twilight world between the public and private sectors: Staying in the state sector put him in contact with too many officials with their hands out. He gave up his job and began casting about for new opportunities. It was while visiting a college classmate in Vancouver, Canada, that Li hit on the idea that would make him a millionaire. He would sell trucks on installment to cash-strapped Hebei farmers.

PIONEER SPIRIT. Li called his company, founded in 1994, the Hebei Kaiyuan Group. The name means "beginning" or "first," and was intended to suggest Li's pioneering spirit. Within four years, the firm was selling 170 trucks a month, says Li, and had racked up annual profits of $3 million on revenues of $36 million. Kaiyuan was paying $1 million a year in taxes, making it one of the biggest contributors to local coffers. Li was doing so well he even shipped over a two-story house from Canada and had it erected on a scraggly patch of lawn near Kaiyuan headquarters. By the late 1990s, Kaiyuan had begun to diversify into property development.

The company stood in stark contrast to Shijiazhuang's moribund state-owned sector. "It was one of the best private companies here," says an official who oversees the private sector. "In terms of revenues, profits, and management, it was doing great." It was that high-wattage success that attracted Shijiazhuang International Building. Founded in 1988 by Lu Yihua, a former cook, the company had interests in hotels, restaurants, and office buildings. In 1996, International Building went public with a successful Shenzhen offering. Over the years, General Manager Lu had acquired various useful patrons, including Deputy Governor Cong and Mayor Zhang. It was common knowledge that local potentates frequented Lu's saunas, karaoke bars, and restaurants. And if an official wanted a job for a relative, well, Lu was ready to oblige.

Connections alone, however, would not be enough to take International Building to the next level. Lu wanted to do a stock split, but to win permission from securities regulators in Beijing, she needed to improve the state-owned company's balance sheet. Hooking up with the most profitable private business in Shijiazhuang seemed like the perfect solution. Eager to consummate a deal with Li's Kaiyuan, Lu invited him to dinner at her plush International Hotel in downtown Shijiazhuang. Li recalls a banquet of shrimp, Mandarin fish, and duck's head.

Days later, he signed the deal. In what was effectively an asset swap, International Building paid $3.8 million for a 50.4% stake in Li's company, while over the next few weeks, Kaiyuan bought $7.1 million worth of International Building stock, until it held 18.77% of the company. The deal--typical of the complex transactions in China's semiprivatized economy--would for all practical purposes be a partial merger of the two companies at almost no cost to International Building.

It wasn't long before Li realized he had bought a lemon. Among the many problems afflicting International Building, he says, one investment stood out: a $40 million luxury tower in Shijiazhuang that had been sitting half-built for three years. Li says he also discovered that the listed company had made $35 million in loans to its larger state-run parent, Shijiazhuang International Building Group, as well as to other subsidiaries of the group--which, if true, is a clear violation of Chinese law. Also, says Li, assets had been shifted from the company's parent and affiliates to make International Building's balance sheet appear more robust than it really was.

HONORABLE PLANS. With his company's fortunes now inextricably tied to International Building, Li decided not to back out of the deal. Instead, he would spend another $2.6 million to raise his stake to 25%. That would give Kaiyuan a controlling interest and allow Li to grab management control. He then planned to clean up the company. Having bought up the shares of two of International Building's smaller stakeholders, all Li needed was for the Shenzhen Stock Exchange to issue him the legal title. When that formality was delayed, Li flew to Shenzhen to move things along. Emerging from the exchange shortly after 11 a.m. on May 4, 1999, Li was ebullient. Exchange officials had assured him that he would have the documents that afternoon.

It wasn't to be. Waiting outside were plainclothes officers from Shijiazhuang's Public Security Bureau. They told Li he was under investigation for business violations involving tax evasion and business-registration fraud. "I felt as though I had been pushed off a roof," Li recalls. Still, he wasn't worried, because, he says, he had done nothing wrong. The officers told Li that if he came along quietly, handcuffs wouldn't be necessary.

Soon they were on a plane to Beijing. During the flight, Li and the police drank beer while Li explained that he was simply trying to become the primary shareholder. The cops seemed sympathetic, but when they arrived in Beijing, three police cars and eight more officers were waiting. Li and his escort finally arrived in Shijiazhuang at 5 a.m. Without allowing him to rest, Li says, officers from the Economic Inspection Division began to interrogate him.

Li was taken to the Beijing Military District No. 7 Division Compound, where he was put in a cramped cell with a steel door and wire grating over the window. For the next 100 days, he survived mostly on vegetables, rice, and water. "I would kill time swatting the flies," says Li, who also compulsively swept the floor of his cell. Often, he says, the guards refused to talk to him. "There was always someone awake watching me."

Officials concede that despite his incarceration, Li was never formally charged. "He was suspected of fraud in his business registration and possibly tax evasion," says Luo Beizhong, a Shijiazhuang official. "He was held for some time, but he was not treated as a criminal. He was never put in a prison." His 100 days under round-the-clock guard do not count as imprisonment under Chinese law; such time is considered "living under surveillance."

As Li languished in his cell, local authorities dispatched officials to scour Kaiyuan's headquarters for evidence of financial wrongdoing. After repeated searches yielded no evidence, Li says the officials began to hint at their real goal. Li could walk free, they intimated, if he agreed to buy back International Building's share of his company (at a higher price than before) as well as sell his stake in the state company and abandon efforts to acquire any additional shares. To increase the pressure, the officials began bringing in Li's cowed managers, who begged him to give up his stake.

The pressure took its toll. In Canada, where Li's family had emigrated three years earlier, his wife, Wang Yan, made hundreds of calls to Kaiyuan managers, often collapsing into crying fits. As for Li, he was near the breaking point. Finally, he gave in. In the end, he paid $760,000 more than the original price to buy back the state enterprise's stake in Kaiyuan and agreed to resign from the board. However, Li hung onto his original 18.77% stake in International Building, despite having promised to sell it. He emerged from his cell in August, 1999, to find Kaiyuan on the edge of collapse--and with the warning to keep quiet ringing in his ears. For almost a year, he was too intimidated to seek redress.

Then, last July, Li saw his chance in the social upheaval that had engulfed Shijiazhuang. Resentment against the mayor and deputy governor's high-living clique reached a boiling point. Alarmed, Beijing decided to act. Anticorruption investigators from the feared Central Commission for Discipline Inspection turned their attention to Shijiazhuang. It wasn't long before Cong, Zhang, and scores of other officials were arrested for involvement in graft that may reach into the hundreds of millions of dollars. In May of this year, Cong and Zhang were formally charged and put on trial. If they are found guilty, they could be executed.

With his enemies behind bars, Li decided the time was ripe to go after International Building. Having hung onto his stake, Li redoubled his efforts to become the primary shareholder. In the months since, he has filed more than 130 motions in board and shareholder meetings in an attempt to force management to account for such practices as doling out loans, including some used to build the white-elephant luxury tower in downtown Shijiazhuang. He also accuses management of tax evasion. Asked to comment on Li's allegations, an International Building official told BusinessWeek: "We have not received notice of his suit against us. Whether we have done right or wrong should be decided by the proper government departments."

In only the third case ever in China, Li also is suing the China Securities Regulatory Commission (CSRC) in Beijing's Superior People's Court for dereliction of duty for not stopping International Building from issuing false financial reports and for improperly appointing a new chairman. "My wife has repeatedly told me to give up this struggle. But this is impossible," says Li.

ANOTHER ARREST? Despite the corruption crackdown, Shijiazhuang officials and International Building continue to stymie Kaiyuan. They have blocked Kaiyuan's attempts to become the primary shareholder by transferring all shares held by International Building's parent to a state enterprise called Hebei Construction Investment Co. At the same time, says Li, city officials are increasingly threatening--suggesting that he could be arrested again if he persists.

Nor is Li's legal strategy going far. To date, Beijing courts have not responded to his July suit against Chinese regulators, despite a law that China's courts accept or throw out suits within seven days. "Kaiyuan is being unreasonable," says Zhuang Mu, deputy director at the legal-affairs department of the CSRC. "If they have problems, they should sue the largest shareholder in the appropriate People's Court." Li is doing so in Shijiazhuang, but says: "The courts belong to the local governments. How can we expect to get a fair hearing?"

With no end in sight, Li veers between optimism and despair. "Maybe I should just give up and leave this place," he sighs. That would be China's loss, say Li's supporters. Says Goldman Sachs's Cherry Li: "He's not just fighting for himself. He is fighting for the fair treatment of small shareholders and China's private entrepreneurs. If people like him give up, we'll never see progress."

There is a lesson here for China's leaders: Welcoming entrepreneurs into the Party is meaningless unless the government supports them as they joust with the Establishment. Men and women like Li Yonghui could be the lifeblood of China's new market economy, but they won't prevail if they're ensnared in conflicts with officials too afraid of the future to change their ways.

By Dexter Roberts in Shijiazhuang

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