A crop of star investment bankers is fighting for the next batch of big deals.
By Brad Martin
January 2002
Institutional Investor Magazine
In the West throwing money at star investment bankers with the idea that they’ll bring in big deals is fast becoming passé. But in China it’s still in style.
After a quiet spell, Beijing is getting ready to resume rolling out privatizations and equity issues - up to $200 billion worth over the next decade, by some estimates - that spell fat times for firms in a position to get in on the action. In addition, China’s entry into the World Trade Organization and ongoing regulatory reforms are leveling the investment banking field, long dominated by Morgan Stanley and Goldman, Sachs & Co. So even as they pare down elsewhere, major investment houses have been scrambling to hire bankers who can bring in China business.
The loudest salvo in the people wars came in mid-2001, when legendary deal maker Francis Leung (known as the King of the Red Chips) was named chairman of Salomon Smith Barney Asia. A few months later Salomon lured the well-connectedMargaret Ren from Bear, Stearns & Co. to work as Leung’s sidekick. Leung’s annual compensation is rumored to be upwards of $8 million and Ren’s between $5.25 million and $5.5 million, both with multiyear guarantees.
Non-U.S. companies are equally keen to jump on the gravy train. In a reorganization aimed at putting more emphasis on China, HSBC Holdings in December promoted Guocang Huan, whom it had hired away from Salomon last March to head its China team, to co-head of investment banking for Asia-Pacific. And Deutsche Bank last spring hired 36-year-old Lee Zhang away from Goldman, where he had been an executive director since 1998. “The tone in the market now is that people will be able to get deals in China in 2002 that maybe you wouldn’t see in other, developed markets,” says Frank Nash, Deutsche’s head of global corporate finance for the Asia-Pacific region.
China has come a long way since its first cautious forays into global capital markets in the late 1980s. Having the right guanxi, or connections, has declined in importance over the years. Nevertheless, whom you know remains an important part of doing business. Officially, investment bankers insist that they compete in China the same way they would in any other market, by leveraging their international reputations and backing them up with local due diligence and teamwork. But the most sought-after bankers remain those with access to government and industry officials and a strong track record of delivering deals.
The prizes they’re jousting for are the richest in Asia. Total volume of China equity raised in 2000 was $21.8 billion, more than double the $10.2 billion in 1997 - the previous best year. Last year saw a steep falloff in deals, owing to a combination of global financial volatility and internal problems in Beijing with streamlining huge, state-owned enterprises for listing. Signs of a comeback appeared in December, when Aluminum Corp. of China’s $400 million IPO in Hong Kong and New York was several times oversubscribed - suggesting that the market was looking favorably on China as a possible bright spot in an otherwise forbidding global investment environment.
Industry insiders expect 2002 to be busy, with Bank of China, China Telecom (South) and mobile phone companies China Unicom and China Mobile all coming up for major restructuring or market financing. The telecommunications sector alone could produce more than $10 billion worth of new equity, although a big chunk of that could be floated domestically rather than on the international markets. Mandates for future listings that could be announced in 2002 include China Netcom, the company that will take over fixed lines in ten northern provinces while China Telecom (South) keeps the other 21, Air China and SinoTrans, the giant state-owned transportation and logistics enterprise. “The biggest deals are not all done,” says Morgan Stanley’s Jonathan Zhu, who heads the firm’s China team.
Does hiring a rainmaker really help? It’s hard to ignore the success that market leaders have won by establishing strong personal connections with the Chinese entities whose business they crave. Goldman’s China banking co-head, Ziwang Xu, is a mainland-born industry veteran who reportedly maintains excellent relationships with leading officials in China. Some credit him with securing the 1997 mandate for China Mobile ($4.2 billion), whose successful execution secured Goldman’s place at the top of that year’s China international equity league tables. Goldman is considered a front-runner in the race to manage a Hong Kong and New York listing of China Netcom.
“We have never relied on connections to get business, and the Chinese have never given out business on that basis,” insists Richard Gnodde, president of Goldman Sachs (Asia). Nevertheless, the two reigning industry champions have benefited enormously from guanxi. Perhaps the most significant reason for their head start in the market was something few competitors could dream of until recently: close relations with the powerful China International Capital Corp. Started in 1995 as a Beijing-based joint venture between Morgan Stanley and China Construction Bank, with three other minority partners, CICC possesses impeccable political connections. One of its officials, Levin Zhu Yunlai, is the son of Prime Minister Zhu Rongji.
Shawn Xu, CICC’s research director, denies that his company has ever been in a position to hand out business. “This is completely up to the issuer,” he says. But there is no disputing that the big winners, once the jumbo deals started coming in 1997, have been CICC and firms close to it - a club that started out with just one member, Morgan Stanley, and expanded to include Goldman.
The proof is in the league tables. In 2000 CICC ranked No. 1 in the $21.8 billion market for China international equities and equity-linked offerings. It handled IPOs for oil companies Sinopec ($3.5 billion) and PetroChina ($3 billion) and China Unicom ($5.6 billion), along with a follow-on offering in which China Mobile brought in new assets from its parent firm ($7.6 billion, the biggest China stock deal of all time). Morgan Stanley, joint global coordinator with CICC of the Sinopec and China Unicom deals, ranked second. After being first in 1997 and 1999, Goldman came in third in 2000; it co-lead managed with CICC and Merrill Lynch & Co. the PetroChina launch and the China Mobile follow-on. Merrill came in fourth. Altogether CICC and those three Wall Street colleagues accounted for a more than 92 percent share of the market in 2000.
But a couple of competitors have started to chip away at CICC’s domestic monopoly. For example, Air China has chosen Citic Securities Co., the investment banking arm of state-owned China International Trust and Investment Corp., to be its domestic adviser on restructuring. “The market is just that much bigger than what CICC can do single-handedly,” says Michael Chang, head of investment banking at Bank of China International, another CICC rival.
Today’s increased competition also reflects something of an unwritten quota system to spread the wealth. Splitting up lead manager duties for a single deal among two or three firms, usually including one Chinese firm, has become the rule rather than the exception, and that helps Wall Street and off-Wall Street contenders alike get pieces of the action. In addition, bankers believe that the Chinese are seeking more geographical balance among leading international firms. UBS Warburg and Deutsche Bank, among others, have argued mightily that the Chinese should not confine their favor to Americans.
China’s inclusion in the WTO opens the market to further competition. On December 12 the government announced it will permit foreigners to take up to 33 percent stakes in Chinese banks that manage domestic stock and bond sales. All the top firms want to be in the running for such partnerships. Most of the discussions are in very early stages, but one exception may produce an early announcement: HSBC Holdings, J.P. Morgan Chase & Co. and Société Générale are said to be competing for the chance to buy into Hong Kong-based ICEA Finance Holdings, the brokerage arm of Industrial and Commercial Bank of China.
To challenge the institutional clout of Morgan and Goldman, rivals are emulating their tactics. Both have mainland-born Chinese bankers commanding the front lines. Both dispatch their chairmen and other top executives on frequent trips to schmooze with high-level officials in China. So when UBS Warburg was angling for a role in the Bank of China deal, global vice chairman Lord Leon Brittan, a former European Commission vice president and U.K. cabinet member who had helped negotiate China’s WTO entry, hopped on a plane to Beijing.
Similarly, Credit Suisse First Boston sent over former U.S. Treasury under secretary David Mulford, now CSFB’s chairman for international operations, to help get in on China National Offshore Oil Co.'s second attempt at an IPO, which succeeded last February. Salomon had tried to take the oil giant public for $2.5 billion in 1999 but had to pull the IPO just 36 hours before takeoff. (A 700-point drop in the Dow Jones industrial average and a 25 percent plunge in oil prices made the issue price of 18 to 20 times earnings seem wildly unrealistic.)
CNOOC hedged its bets the second time around, naming Merrill Lynch and CSFB to be foreign co-lead managers along with BOCI. In a weak market CNOOC shares went for only 5.8 times earnings, and the total take was just over $1 billion. Nevertheless, succeeding where Salomon had failed was a coup, and there’s little doubt that flying in Mulford helped CSFB.
Whether or not they have turned to luminaries to help bag deals, most investment banks are placing well-connected mainlanders in direct charge of their China business. For example, Deutsche’s new hire, former Goldman banker Lee Zhang, belongs to an elite group of financially influential Chinese known as the “tea party circle” and is known for his sterling portfolio of contacts. He’s already bringing home the bacon. Industry sources say Deutsche has been appointed sole bookrunner for this year’s IPO of Datang Telecom, China’s second-largest telecom equipment maker. And the bank is slated to be joint lead manager for Europe, with Morgan Stanley and CICC, when China Unicom’s mainland parent raises capital to transfer more assets into its foreign-listed subsidiary.
Under mainland-born president Charles Li, president of its China unit, Merrill Lynch was one of the first non-Chinese firms besides Goldman and Morgan to get in on a jumbo deal. In 2000 Merrill was tapped to work on a $7.6 billion secondary offering by China Mobile. (Goldman and CICC were also involved.) That helped place the firm at No. 4 in China international equity issues, up from eighth place in 1999. Another bank that earned a moment in the limelight was Bear Stearns, before its mainland-born China head, Margaret Ren, moved to Salomon to join Leung. A relative of Zhao Ziyang, the former Communist Party secretary-general, Ren helped Bear Stearns win its co-lead manager role for China Mobile’s combined $2.6 billion debt and equity financing in 1999. The deal earned the relatively small company second place in the China bookrunner league tables for the year - just behind Goldman, which had a bigger chunk of the same China Mobile follow-on.
Leung is by far the most famous of the Chinese investment bankers, with a career that virtually parallels China’s entry into the capital markets. He launched the first red-chip stock in 1990, co-founded investment banking boutique Peregrine Investment Holdings with emerging-markets bond maven Philip Tose and lead-managed more than a third of the $8.2 billion worth of equity deals that Chinese companies raised abroad from 1994 to 1997. He required just one morning in 1999 to raise $1 billion for Richard Li’s Pacific Century Cyberworks, the telecom giant. When Li’s father, Li Ka-shing, launched Internet portal Tom.com that same year, Leung managed the IPO.
The son of poor immigrants from the mainland, Leung grew up in Hong Kong in a mountainside hut, working part-time as a restaurant busboy. A so-so student while in high school, he began to apply himself more rigorously only when he went to Canada for college. After earning bachelor of commerce and MBA degrees at the University of Toronto, he joined Wardley (later to become HSBC Investment Banking) in Hong Kong in 1980 - long before Goldman Sachs and Morgan Stanley had even stuck pins in their maps of China.
In 1985 Leung moved to Citicorp Scrimgeour Vickers, and in 1987, in the midst of a bull market, he attracted attention with the public issue of Oriental Press, a Hong Kong company that set a local record for oversubscription. That same year, he began to target mainland enterprises for what he calls “education.” China Travel, one of the Big Four mainland enterprises with a monopoly on railway freight hauling between Guangzhou and Hong Kong, noticed his success and invited him to lecture on the capital markets and the benefits of being a public company. The worldwide crash of October 1987 intervened before any mainland deals could get off the ground. But, Leung recalls, “they wanted to learn.”
In late 1988 Leung co-launched Peregrine and took charge of the group’s Greater China equities and corporate finance activities. A couple of years later, he invented the red-chip stock. He helped state-owned China International Trust and Investment Corp. buy a Hong Kong property company - a “window company” - that it could use to acquire a backdoor Hong Kong listing. Citic infused its window company, renamed Citic Pacific, with some of its Hong Kong real estate holdings and with such other assets as its 20 percent share in Dragonair, Hong Kong’s No. 2 airline. Many overseas institutional investors now own the stock, which has been selling lately at about four times its listing price.
A wave of additional red chips followed Citic Pacific - including China Travel. Leung launched Guangdong Investment, the Hong Kong window company for Guangdong Province, and listed it in Hong Kong. The first actual IPO of a red chip came in 1992 with Hai Hong, a subsidiary of China Merchants Group, the Hong Kong window firm of China’s Ministry of Communication. In 1993 Leung teamed up with Merrill Lynch to launch Shanghai Petrochemical, the first-ever offering of H-shares - stocks issued in Hong Kong by companies incorporated in China and governed by Chinese company law.
Zhu Rongji, then vice premier, introduced austerity measures in 1993 to lower Chinese inflation, and China fever waned on the Hong Kong market. The adjustment period lasted until 1996, when the relative health of the mainland economy renewed investor confidence. Leung helped the Shanghai and Beijing municipalities launch their own Hong Kong window companies, Shanghai Industrial and Beijing Enterprises, as red chips. The latter, in 1997, caused an investor frenzy.
Indeed, critics complained that some of Leung’s red chips were badly managed companies whose prices he was helping to jack up unrealistically with aggressive presentations to investors. In June 1997 Beijing took measures to cool down the red-chip market, ordering a slowdown in the injection of mainland companies’ assets into the Hong Kong firms. Combined with the onset of the Asian financial crisis, that proved enough to prick the red-chip bubble. But the bulge-bracket banks, smelling profits in the early H-share listings, had begun to descend on China. As Leung recalls, “Many of these companies employed Chinese nationals with good connections.” Relationships were key in this phase, he says. “That’s how deals or mandates were obtained.”
Changes around this time in the scale and quality of enterprises seeking listings affected the competitive environment for investment banks. Earlier, their problem was not so much getting business - there’d been plenty to go around - as making sure their potential clients were worthy. The Chinese government had so rushed the approval process for enterprises seeking listing that bankers hardly had time for due diligence on the companies whose mandates they sought. “It was like a blind date,” says HSBC’s Huan. “You didn’t know what you’d get.”
But new rules improved the process of government approval for privatizations, and banks focused on taking the largest telecom and energy firms to market. A firm would hear rumors about which enterprise might go next and throw its resources into the battle for that deal. “This is when I think it became more effective to have a mainland-born guy,” says Zhi Zhong Qiu, chairman of the greater China region for CSFB. “In the early days it was very important to know what channels to go through.”
Although Leung is not technically a mainlander, his access to those channels meant that even the collapse of Peregrine in 1998, in the wake of some bad Indonesian bond deals, didn’t dim his star. The investment banking arm of Banque Nationale de Paris bought Peregrine’s Greater China equities operation, taking in Leung and his team, and created BNP Paribas Peregrine. When the Hong Kong market recovered in late 1999, Leung cranked out dot-coms and other high-tech IPOs, promoting them to Hong Kong investors who typically took a short-term view of the market.
The most controversial of those issues was his friend Li Ka-shing’s Tom.com; police were called to control crowds of speculators crazed by the prospect of a quick profit. The Securities and Futures Commission reprimanded Peregrine following accusations that the bank had intentionally limited the outlets collecting applications for share purchases, with the intent of firing investors’ lust. The SFC rejected Leung’s excuse that demand had been greater than anticipated. At any rate, Tom.com is one of the few Hong Kong dot-coms still above water. In December it was trading at almost twice its IPO price.
There’s been some industry speculation that Wall Street compliance standards may clip the wings of the high-flying Leung, but he says he’s not worried. “Citigroup is a much larger organization and has a very powerful platform, but I don’t think any of the things we do under American firms are that different from Peregrine or BNP Paribas,” he says.
Leung’s focus at Salomon will be getting the firm back on the map. When its attempt to take CNOOC public bombed, the bank vanished from the league tables in 2000 after taking ninth place in 1998 and fifth in 1999. But Leung appears confident. This year Salomon Smith Barney is to be renamed Citigroup Corporate and Investment Bank. “The Citigroup platform will be a very powerful one to launch products into China,” Leung says.
Domestic placement is likely to be critical to the next phase of China deals. The biggest enterprises will soon have done their IPOs, and business will shift to refinancing already listed companies. Initial public floats have been only in the 10 to 25 percent range. And as the refinancing trend kicks in, it’s by no means certain that companies will choose to go to the overseas markets. They have an attractive alternative at home. As Leung explains, “For China we see fewer and fewer companies going overseas now because the domestic market is very liquid at the moment and offers high valuations.” Indeed, hunger on the mainland for investment vehicles has driven the market in A shares, which are available only to Chinese citizens, to price-earnings levels typically reaching 50 or 60 times earnings.
Only domestic investment banks are permitted to manage domestic offerings. So a logical move for Citigroup/Salomon would be to form an investment bank on the mainland, as Morgan Stanley did with CICC. “We are considering it,” says Leung, adding that Salomon’s ability to contemplate such a move is “one of the reasons” he wanted to move there from BNP. If Citibank’s proposed investment in the Bank of Communication goes through, China’s No. 5 commercial bank could be one choice as an investment banking partner. Leung will say only that Salomon is “still in the process of discussing it with a number of potential partners.”
China’s fundamentals appear to justify the conviction among investment bankers there that they are in the right place at the right time. The country’s middle-class population is expected to rise to 400 million by 2010, as the coastal provinces increasingly shift into capital- and knowledge-intensive industries. Beijing is keen to develop the rural western provinces. The nation’s inclusion in the WTO is likely to pave the way toward unprecedented cooperation with foreign businesses. No wonder investment banks are willing to spend big to put their markers on the board.
China’s Gang of Three
China’s Cultural Revolution was at fever pitch in 1969, when Guocang Huan graduated from high school in his native Shanghai. Like most of his classmates, he was sent off to the boondocks for a few years of “reeducation.” But Huan’s toil among farmers in hardscrabble northern Anhui Province taught him a different lesson from what the authorities intended. The city boy noticed that peasants working their kitchen gardens at home outproduced the collectively worked farmland by a factor of eight.
A drive to learn more than what the government encouraged has shaped the lives of three of the most prominent men who pursue China business for international investment banks. Huan, HSBC Holdings’ co-head of investment banking for Asia-Pacific, studied in his spare time while working as a furniture mover and construction laborer after his farm tour ended. Credit Suisse First Boston’s regional chairman, Zhi Zhong Qiu (known to Westerners as Z.Z.), spent six years on a rice farm and studied at night from books provided by his parents, who had been high school teachers. Merrill Lynch & Co.'s Charles Li avoided reeducation by skipping high school and signing on as an offshore driller, teaching himself English after hours by listening to the radio.
“In China you need to have somebody who knows about the country and the culture and knows how to have chemistry,” says Qiu. “Being a Shanghai-born Chinese helps. I can read people.”
If the three bankers have similar personal backgrounds, the teams that they lead confront different challenges. CSFB’s situation is the most sensitive. Last summer Qiu and company expected that CSFB would be appointed financial adviser and lead underwriter for the U.S. in a multibillion-dollar share offering by mobile phone giant China Unicom. Then came a news report that China had blacklisted CSFB, as punishment for giving Taiwan too high a profile in a planned road show to promote the breakaway island province. But the events of September 11 quickly pushed the flap out of the news. In the fall CSFB’s new chairman, John Mack, went to Beijing for some fence-mending. China now says there’s no blacklist - but Unicom hasn’t restored CSFB to the syndicate for its offering.
It’s largely up to the Shanghai-born Qiu, 46, to fix his firm’s reputation. A fifth grader in 1966, when the Cultural Revolution brought the old school system to a halt, he recalls years of chanting quotations and singing revolutionary songs. But thanks to his late-night diligence on the rice farm, Qiu was able to sit for the revived university entrance examination in 1978 and studied electrical engineering at Tongji University in Shanghai. After two years there he moved to New York and got simultaneous degrees from New York University and Cooper Union in 1983. He earned a master’s in power engineering from Ohio State University and started a Ph.D. program at the Massachusetts Institute of Technology. After a move back to Hong Kong to work in a family business, he returned to the U.S. in 1988 and got a Harvard Business School MBA. Following a stint at consulting firm Booz Allen & Hamilton, he joined CSFB.
At first, Qiu worked in risk management, pioneering derivatives transactions in China. Recognizing his mainland contacts, senior investment banking managers in Hong Kong borrowed him to win Credit Suisse a $75 million mandate from Brilliance China Automotive, which in 1992 became the first Chinese company listed on the New York Stock Exchange. Qiu didn’t return to investment banking until a promotion in 1999 made it part of his responsibility.
CSFB had been out of China’s big leagues during the early megadeal period after 1997. Qiu set out to correct that. His most notable success was getting a joint mandate with Merrill Lynch in 2000, when they pulled off China National Offshore Oil Co.'s listing, a billion-dollar-plus deal. A $325 million private placement for China Netcom around the same time solidified relationships that could prove useful now that Netcom is to take over fixed-line phone operations from China Telecom (South) in the north.
Huan, for his part, has a well-known brand to work with. But before his arrival last spring, HSBC had failed to parlay its commercial banking clout and Shanghai roots into a place among the big boys in China investment banking. The buzz is that Huan is about to change that. Along with Merrill and UBS Warburg, HSBC is on the short list for a deal to restructure several state-owned airlines, including Air China, with assets worth an estimated $6.7 billion, into a Beijing-based conglomerate. The restructuring adviser could be announced as early as February.
Huan certainly knows the territory. In 1996-'97, while with Barclays de Zoete Wedd, he worked on the acquisition of a large stake in Hong Kong-based Dragonair by the Hong Kong-listed holding company of China National Aviation Corp. CNAC will be part of the new conglomerate.
After the Cultural Revolution ended and China resumed holding entrance exams for college and graduate school, Huan’s after-work study paid off. He won a place at the China Academy of Social Sciences, where he earned a master’s in international economics. From there he went to the U.S., getting degrees from Princeton and Harvard Universities. He taught at Columbia University and worked as an economist for Deutsche Bank and J.P. Morgan; the latter transferred him from New York to Hong Kong.
Huan became an investment banker in 1995, running China business for BZW. Two years later, when BZW sold its equity business, he joined Salomon Brothers, where he became regional vice chairman and co-head of investment banking, focusing on North Asia and especially China.
Merrill’s Li, now 40, grew up in the northwestern desert province of Gansu, to which his family had been banished from Beijing in the late 1950s, during China’s Anti-Rightist Movement. By the time his parents were pronounced rehabilitated and allowed to return to Beijing, Li had finished the second year of middle school. After working in the oil fields, he enrolled in Xiamen University as an English literature major.
In 1984 Li became a reporter for the Beijing-based, English-language China Daily. From there he managed to get to the U.S., earning a master’s in journalism at the University of Alabama. Switching careers again, he then won a scholarship to Columbia University’s law school, before joining the law firm Davis Polk & Wardwell, where he worked in securities law and mergers and acquisitions. “Merrill was a client,” he says. “They recruited me, telling me, ‘You can earn a lot more than you’re making now, for doing the same thing.’” That was 1993.
Since then Merrill has landed a number of deals that were big by the standards of the day. But the firm was slow to catch up with Goldman and Morgan Stanley - until China Mobile in 2000 and CNOOC in 2001. It is expected to retain its joint mandate with Morgan Stanley to restructure China Telecom (South), which could be listed as early as September.
Some people think Merrill and HSBC may end up sharing an Air China mandate. And like most of his industry colleagues, Li is looking for mainland joint venture partners that could help his firm get in on some of the tens of billions of dollars in equity that are likely to be raised domestically in the next few years. “We obviously are right in the middle of all the discussion, and we will be right in the middle of whatever opportunities come out,” he says.
