China's growing influence is starting to remake the economic balance of power in Asia. It's also redefining corporate strategies and the region's equity research.
"If you don't know what is happening in China," says Hunsoo Kim, head of Asia research for Merrill Lynch, "you don't know anything." Kim may be guilty of hyperbole , after all, the small, often chaotic Chinese equity market is just a decade old and remains largely closed to foreign investors , but he certainly captures the prevailing sentiment in Asia-Pacific research departments these days.
China , or its shadow , is everywhere. Economists in Tokyo, Hong Kong and Singapore spent much of the past year trying to figure out how their local economies can cope with competition from China for export markets and foreign investment. Researchers in New York and London have to gauge China's demand for steel, petrochemicals, oil and natural gas to assess these global markets. Which Taiwanese companies will profit from China's admission to the World Trade Organization? Which Thai manufacturers will get trampled? Does General Motors Corp. have a sound "China strategy" or none at all?
Fielding more of these queries, investment firms are scurrying to offer a compelling Chinese research product for investors. "We want Mandarin to resound in the corridors of Morgan Stanley," says Robert Vaudry, head of Morgan Stanley's Asia research effort. The firm's name, he adds, should be "synonymous with China."
Responding to requests for information about China has become an essential part of an Asia researcher's life. Goldman Sachs (Asia) oil and gas and chemicals analyst and co-head of research Paul Bernard estimates that his China-related research has tripled in three years, to about 70 percent of his total workload. China now exerts such an influence on prices in his sectors that it "feeds into a view on stocks, whether they be in Asia, Europe or the U.S." His team's recent buys on South Korea's LG Chem and Taiwan's Formosa Plastics Corp. were both based in large part on growing Chinese demand for their petrochemicals products.
Consider the experience of J.P. Morgan Securities' Hong Kong,based consumer goods analyst Charles Dutton. The researcher recently had to evaluate the expansion plans of Hong Kong,based clothes retailer Esprit Asia Holdings and South Korean discount chain Shinsegae Co. With most developed Asian markets near saturation, both are looking to China for long-term sustainable growth. Esprit wants to achieve sales of more than $100 million from China in the next few years, while Shinsegae plans to spend $30 million to open two stores in Shanghai as a prelude to creating a 40-outlet Chinese network in the next eight years.
"Exposure to China is regarded as a big positive because it's one of the only countries in Asia recording strong economic growth. Investor demand is huge, but the number of companies with large exposure is very limited," says Dutton. Both stocks surged on news of their China plans, and Esprit's has increased 63 percent since the turn of the year to hit HK$14.70 ($1.88) in mid-April. Shinsegae's has risen more than 40 percent in that time following a huge gain last year.
But do their strategies make any sense? There are few precedents for looking at foreign ventures in China. The legal system offers little guidance to new businesses. And no one is entirely sure what the local demand for a given product or service is. It will be left to pioneering researchers like Dutton and his cohorts to figure out whether these initiatives will work.
Certainly, China presents all analysts with problems as well as opportunities. Local companies' incomplete, inaccurate or nonexistent disclosure about everything from intracompany loans to profits is the bane of every Asia researcher's life. Some Chinese executives, a UBS Warburg study reports, "do not regard a profit warning one day before the official release as being too late."
The consequences of these failures can be devastating to both analysts and investors. Onetime stock market darling Guangdong Kelon Electrical Appliances Co., a Guangzhou-based white goods manufacturer, ran into trouble late last year when the Hong Kong stock exchange suspended it for three months for failing to disclose that it had advanced 1.26 billion renminbi ($152 million) to its parent, Guangdong Kelon (Rongsheng). The stock fell 31 percent as news of the inquiry began to leak out. It later rose when the debt turned out to be smaller than originally anticipated. "There are domestic companies that you can invest in, but they tend to be a little bit suspicious-looking," says consumer analyst Angela Moh (leader of the No. 1 team this year) of Morgan Stanley. "You just have to be very careful."
Not all of this research effort is profitable. Morgan Stanley's Vaudry calls it a "loss-leader" as near-term investments are made, while another research chief more artfully suggests that profits lie "just beyond the horizon." Driving the recent China-mania is a "fear of missing the train," concedes Michael Oertli, head of Asia research at UBS Warburg. Throughout the 1990s, however, repeated flashes of foreign investor interest in the potential of this huge, impoverished country failed to translate into meaningful business opportunities.
Still, research directors and investors believe that China's recent entry into the WTO marks a new chapter in the story. As a result, they're shifting resources to the mainland. Morgan Stanley plans to put four or five analysts in Shanghai this year, and UBS's Oertli has told his Hong Kong,based China analysts that they can move to the firm's Shanghai office any time they want. CLSA Emerging Markets, BNP Paribas Peregrine and HSBC Securities are negotiating to form joint ventures with local firms.
Until they've established better roots, researchers are sponsoring investor tours to visit Chinese companies and meet with government officials. The most common destinations? Shanghai, Beijing, Guangzhou and Shenzhen. As Vaudry says, "Many Asia analysts are in danger of becoming tour guides."
Much of this activity is based on prospective riches that may not materialize. Investment bankers estimate that China-related IPOs and equity issues could raise $200 billion over the next decade. The Shanghai and Shenzhen A-share markets list more than 1,000 companies, with a combined capitalization of $500 billion, versus $494 billion for the Hong Kong exchange. Commission revenue from China's A-share markets now rivals that from Asia's other major brokerage markets: South Korea, Taiwan, Hong Kong and Singapore. "China is probably the largest investment banking story in the world," says CLSA research chief Edmund Bradley. "It's not easy making money, but people have to position for the long haul."
Although the pace of new listings slowed in 2001, the universe of Chinese stocks continues to expand. In November glass manufacturer Zhejiang Glass Co. became one of the first privately owned (with less than 50 percent government ownership) Chinese companies to list on the main board of Hong Kong's stock exchange, when it raised $58 million. That same month Aluminum Corp. of China, the world's third-largest aluminum refiner, was dually listed in Hong Kong and New York, raising $350 million.
As elsewhere, investors remain leery of any potential conflict of interest between research and investment banking. A Singapore-based fund manager says that market conditions have been so unforgiving that brokerages have been looking for every opportunity to squeeze out some revenue. "You see a stock upgraded, and then a month later the same bank tries to place out stock," he says. Toby Hudson, research director at Schroder Investment Management, which oversees $5 billion in Asia equities, says that recent efforts to clear away conflicts are encouraging, but "the litmus test will come when the investment banking deal flow picks up. Then we'll see if action speaks as loud as words."
That test may soon arrive , Asia stocks got off to a fast start in 2002. In South Korea the Kospi surged 32 percent through early April, while Taiwan gained 10 percent. Even devastated markets in Southeast Asia (see Emerging Markets, page 87) rallied in the first quarter. Indonesia was up 31 percent, Thailand 30 percent, Malaysia 18 percent, the Philippines 17 percent and Singapore 10 percent. Says UBS's Oertli, "Asia is one of the few places on earth making more money this year than last, over the same time period."
The turnaround couldn't have come at a better time. A grim final quarter (a 29 percent decline for Asia shares) ruined what would have been a solid year and resulted in a 6 percent loss for 2001. Coupled with a more than 30 percent slide in 2000, the poor markets cost many professionals, including analysts, their jobs. One research head estimates that investment banks sliced their Asia staffs by about 25 percent in 2001. Cutbacks in research departments probably averaged closer to 10 to 15 percent. Says Miel Bakker, co-head of research with Goldman Sachs (Asia). "Nobody made real money, and a lot of people lost money."
The cutbacks no doubt affected the rankings of this year's Asia Research Team. Last year's No. 1 firm, Merrill Lynch, reduced its overall Asia head count by 25 percent and sold its brokerage operation in the Philippines to a management group that renamed it Philippines Equity Partners (which wins a runner-up position in this year's rankings). Following the job cuts, Merrill Lynch slips to fourth this year, with a net reduction of seven positions on the team. Taking the laurels is UBS Warburg, which has been expanding its research coverage worldwide and had already improved its position to No. 2 last year from No. 3 the previous year. In 2002 Credit Suisse First Boston and Morgan Stanley, each of which commands four additional positions on the team, rank second and third, respectively.
Consolidation of investment banking in Asia continues at a rapid pace. Indosuez W.I. Carr Securities withdrew from Asia ex-Japan in November with the loss of 350 jobs. Like Merrill Lynch, HSBC Securities shuttered its operation in the Philippines in November and also departed Indonesia. In August Dresdner Kleinwort Wasserstein abandoned Asia with the loss of 250 jobs; SG Securities cut its research strength by some 60 percent, to 40 analysts.
The prevailing air of caution isn't preventing a vigorous round of job-hopping. Most notably, J.P. Morgan snagged Bhavin Shah, who led CSFB's No. 1, ranked Technology/Semiconductors team until late February. Now heading J.P. Morgan's Asia-Pacific technology research, Shah was "the door-opener for CSFB," says one research head. Although the principals won't comment, Shah is thought to have received an annual compensation package of more than $2 million. His former boss, CSFB research chief Sung June Hwang, believes that CSFB's 18-person tech team, now headed by Ashis Kumar (who leads the firm's No. 2,ranked team for India research and its first-place Technology/IT Services unit), will rise to the occasion. The episode, sighs Hwang, shows "how aggressive this market is becoming."
Few would disagree, as just about everyone is jockeying for position in China and the rest of Asia. In April Citigroup/Salomon Smith Barney hired top-ranked equity strategist Ajay Kapur from Morgan Stanley. Joining Kapur is his two-person team of Narendra Singh and Elaine Chu. UBS Warburg pulled Sharon Su (leader of the No. 1 Taiwan team and the No. 1 Technology/Hardware team) from ABN Amro Asia.
Still, when it came to hiring, no one matched Deutsche Bank. Starting virtually from scratch, it hired more than 60 analysts in 2001, setting off complaints about its impact on salaries and the viability of the operation. Asia-Pacific ex-Japan equities chief Edouard Peter is unapologetic, saying only four of his hires received above-market packages, and he dismisses predictions that the firm will eventually have to cut back. "If people think we are all of a sudden going to fall apart, then they are not looking at what we've just done," Peter says. The firm, he notes, has grown successfully in Europe, the U.S. and Japan and now is aiming for similar results in Asia. That hasn't stopped the carping: "It will all unravel when guarantees paid to new recruits expire in a year or two," scoffs a rival. Clearly, the competition to provide the best research in China , and all of Asia , has only just begun.
Picking the team
To find out whom the largest institutional investors turn to for advice on Asia ex-Japan, Institutional Investor sent a questionnaire covering more than 25 industry categories, investment specialties and countries to the directors of research and heads of investment at approximately 400 institutions and investment counseling firms that are major investors in the region. Included were select money managers in the Asia 100, our ranking of the largest institutional fund managers in Asia; we also tapped directories and industry data sources to ensure the completeness of the survey universe. Well over half of these institutions responded. The sector lineup remains largely unchanged from last year. Modifications include the addition of a Media category, the deletion of the Internet category and the separation of Technology into three sectors: Technology/Hardware, Technology/IT Services and Technology/Semiconductors. In addition, we have recast last year's Oil & Gas category to include Chemicals, which had been a separate category.
Respondents were asked to reply themselves, to survey their money managers or to circulate the questionnaire through their own research departments to poll individual analysts. Those who did not respond were contacted to determine if they would be willing to participate over the telephone. After the questionnaires were returned, our reporters spent weeks interviewing investors to learn more about their choices. In addition, many of the winners were contacted to clarify points that their clients had raised. The names of those surveyed and the institutions they work for are kept confidential to ensure their continuing cooperation.
To rank analysts in Asia ex-Japan, we combined votes for both firms and individuals, because many investors voted for both. A numerical score was produced for each firm by weighting each vote based on the respondent's Asia ex-Japan assets under management and on the rank it awarded to the firm or individual (first, second, third, runner-up). Those scores were used to determine the rankings. Analysts were designated runners-up when their scores fell within close range of the score of the third-teamer.
Determining which analyst should be highlighted in categories where votes are aggregated can be difficult. That task is further complicated in areas, particularly less-developed markets, where sectoral and regional coverage can overlap. In cases where there is a strong favorite or only one analyst tracking a category, that individual is highlighted. But because coverage of many of the categories requires teamwork, our write-ups often contain evaluations of group efforts. In those cases, the head of the squad or the individual analyst receiving the most votes is emphasized. To meet this magazine's production schedule, analysts who switched firms after February 18 are cited at their previous organizations.
The ranking was compiled by Institutional Investor under the direction of Senior Editor Jane B. Kenney and Senior Associate Editor Tucker Ewing. Contributing Editor Kevin Hamlin wrote the overview. Reporter/Researcher Suzanne Lorge and Contributing Editors Andrew Bloomenthal, Jeanne Burke, Mary Dubas, Mark Frankel, Ben Mattlin, Scott McMurray and Mike Sisk wrote or edited the sector reports that follow.