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The End of Guanxi Capitalism?


In the mid-1990s, Larry Yung was Hong Kong's preeminent "red capitalist." The son of China's then Vice-President, Rong Yiren, Yung was the high-flying chairman of Citic Pacific Ltd., a Hong Kong company partly owned by China International Trust & Investment Corp. (Citic), the mainland's biggest holding company. Because Yung was a "princeling," with impeccable connections, investors considered Citic Pacific a sure bet and sent its stock skyrocketing.

The runup in its share price helped Citic Pacific build a war chest that it used to take stakes in some of Hong Kong's best-known companies. Among them: flag carrier Cathay Pacific Airways, Hong Kong Telecom, and Hong Kong's No. 1 electricity provider, CLP Holdings Ltd. Yung was one of the first mainlanders to join the Hong Kong establishment, buying a mansion in the tony Peak district, accepting a stewardship at the Hong Kong Jockey Club, and avidly courting the Hong Kong media.

These days, Yung is a princeling without a crown. That's because the 59-year-old tycoon seems to have lost some of his guanxi, or connections, in Beijing. In mid-January, Citic Pacific announced it was abandoning efforts to get mainland approval to operate a fiber-optic network it bought in 2000 from the People's Liberation Army. Instead, it was selling the network to Beijing-controlled Citic.

What happened? Analysts say Beijing may be telegraphing a message that guanxi capitalism is dead. That has a lot to do with China's new membership in the World Trade Organization, requiring it to lower trade barriers and lay the foundation for a system where competence counts more than connections, and where business is done by the book. "The government," says Lan Xue, head of China research at Merrill Lynch in Hong Kong, "is sending the signal that if you aren't following the rules, you have to eat your investment."

The rule in this case was that foreign companies, including Citic Pacific, are barred from getting telecom licenses to operate on the mainland. When Yung announced his intention to seek a license in China two years ago, investors figured if anyone could get around the rule, it would be him. Indeed, Citic Pacific assured investors it was making good progress in its efforts to get a license.

So when Citic Pacific Managing Director Henry Fan informed investors of the bad news on Jan. 14, the company's stock promptly plunged 9.4%, and now trades at $1.90 (chart). Citic Pacific's telecom fiasco "shows that guanxi can only take you so far," says Robert Sassoon, an analyst at SG Securities in Hong Kong. "In the mid 1990s, everything they touched turned to gold, but now China is different and doesn't need to rely on the likes of Citic Pacific."

In fact, Yung's connections have been failing him for some time. Before the 1997 return of Hong Kong to Chinese rule, Yung bought into CLP, hoping to use its expertise and his connections to become a player in China's power-generation business. By 1999, that plan had fizzled, and Yung sold the stake. "Companies like Citic Pacific were beneficiaries of China's opaque environment," says a European investment banker. "What's its raison d'etre now?"

Good question. All agree Citic Pacific needs to find a focus. Its portfolio includes such disparate businesses as bridges and tunnels, motor manufacturing, and residential property. Two-thirds of its assets are minority stakes in companies in which it plays no management role. In 2000, Citic Pacific made $454 million on revenue of $2 billion, about half what it earned in 1997. Merrill Lynch expects the company's 2001 profit to fall 29%, largely due to a terror-related plunge in Cathay's earnings.

Citic Pacific's woes mark the end of an era. So-called red chips have become increasingly irrelevant. Now that Chinese capital markets are maturing, mainland companies find it easier to raise funds at home. Those seeking international credibility can list directly in Hong Kong or New York, without the bother of setting up a separate public subsidiary. Besides, foreign investors looking for pure China plays prefer these stocks--Hong Kong Telecom and China National Offshore Oil Corp. are favorites--because they must adhere to the U.S.'s tough securities regulations.

Where that leaves Citic Pacific and Yung--who declined a request for an interview--is hard to say. The company has announced only that it plans to focus on infrastructure development and property management. But Citic Pacific has tried to reinvent itself before. "They have now been consigned by the market as a passive holding company with no unique franchise," says Sassoon. "Their strategy is not very focused." With its stock down more than 40% in the past 12 months, compared with a 25% skid for the Hang Seng Index, Yung & Co. need to show they can deliver more than good guanxi. By Frederik Balfour and Bruce Einhorn in Hong Kong


Later, Baby
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