RED-CHIP CONGLOMERATES, the forgotten darlings of Hong Kong's stock market, are being urged to restructure quickly as China's business landscape changes. Once feted for their superior mainland connections, or guanxi, red chips face mounting questions over their relevance as China prepares to open its economy further to foreigners following its entry into the World Trade Organisation last month. 'The red chip companies were the spoiled kids of investors in the mid-1990s,' said Keith Li, associate director of Daiwa Institute of Research. 'But now interest in the counters is fading.' Red chips are companies incorporated and listed in Hong Kong, but controlled by Chinese state-owned organisations or government bodies. Investors in the 1990s were attracted to these 'window' companies of municipal governments or ministries, figuring their strong relationships with the mainland would translate into lucrative business opportunities. The parents of red chips helped to feed these expectations by injecting assets into the Hong Kong-listed vehicles at supposedly bargain prices, a process that raised red chips' earnings per share and fuelled hopes of further acquisition-driven growth. Asset injections and general investor enthusiasm for China culminated in the red chip boom of 1996-97, during which many red-chip shares were driven to giddy heights. But after the bubble was burst by the onset of the Asian financial crisis, they have failed to regain their lustre and risk being eclipsed by the promised level playing field of WTO. Many red chips now stand accused of being over-diversified, unfocused and unimpressive business performers. So far, more than 50 red chips have been listed on the stock exchange. In terms of market capitalisation, the sector is dominated by telecommunications and oil counters. They include China Mobile and China Unicom, controlled by the Ministry of Information Industry, and CNOOC, controlled by the mainland's third-largest oil company, China National Offshore Oil Corp. Analysts said companies in these two sectors had highly specialised business portfolios and therefore did not fit the traditional mould of the red-chip conglomerate. Stripping out the telecoms and oil counters, eight red-chip conglomerates dominate the sector. They are: Beijing Enterprises Holdings, China Everbright, China Resources Enterprise, Citic Pacific, Cosco Pacific, China Travel International Investment, China Merchants Holdings (International) and Shanghai Industrial Holdings. The companies are either controlled by provincial/municipal governments or ministries. Some are controlled by state-owned enterprises such as Cosco Pacific, which is owned by the mainland's largest shipping company, Cosco Group. During the red-chip euphoria of the mid-1990s, a large number of geographically based conglomerates owned by ministries or municipal governments listed in Hong Kong. The listing of Beijing Enterprises - controlled by the Beijing municipal government - was oversubscribed by a record 1,276 times in 1997. However, slowing organic growth and a seemingly endless appetite for diversification have dulled investor ardour for the company. Beijing Enterprises' maze of business interests stretches from consumer goods, food and beverages, to infrastructure and information technology. In 2000, the company reported a net profit of HK$515.95 million, up about 5 per cent from the previous year, and analysts predicted the company would report limited growth for last year. Beijing Enterprises shares traded at HK$10.25 as of January 29, nearly 85 per cent below their historical high of HK$65 in August 1997. Helping to keep red chips in the investor doghouse has been the suspicion that their much-touted connections are not the business advantage they once promised to be. Those fears received further backing this month when impeccably connected Citic Pacific announced it had failed to obtain a mainland telecoms licence and as a result would sell its fibre-optic network to its parent. Citic Pacific is indirectly owned by the mainland's largest trust company, China International Trust and Investment Corp, which is controlled by the State Council. The company said it was treated as a 'foreign' company under WTO rules and failed to gain any special access to the telecoms sector. 'The traditional advantages of gaining favourable government treatment by red chip conglomerates will disappear as China further opens the market and its economy is going to be increasingly rule-based,' Mr Li said. When the market was liberalised further transactions were based on commercial decisions, even red chip parent companies would find it difficult to get attractive projects. 'Parent companies may be unable to give great help to their listed vehicles,' Mr Li said. The rise of the mainland's private sector - which makes decisions based on profitability rather than relationships - has also helped to sour sentiment towards red chips, which are arms of the state. 'The role of red-chip companies has been changing. The importance of being a window company is fading,' an executive at a major red-chip conglomerate said. 'We always try to distance ourself from our mainland parent. We do not want to play a role as a government agency but prefer to act as a well-managed company which is competitive to foreign rivals through business growth,' he said. Analysts said red-chip companies had to show that they could produce organic growth through their core businesses. Shanghai Industrial and China Everbright, which is indirectly controlled by the State Council, is relatively focused on its core businesses, with the profit of its largest business unit accounting for more than 60 per cent of net profit, according to investment bank Credit Suisse First Boston. By contrast, Beijing Enterprises' largest business segment accounts for less than 30 per cent of profit. Analysts said red-chip conglomerates were under-performing domestic and international competitors in every sector as a result of over-diversification. While some have responded by beginning to restructure their businesses, the changes - held back by political and economic constraints - have been criticised as too slow. For example, China Resources has been trying to transform itself into one of the largest distribution companies in Asia, while Shanghai Industrial is building up its global business portfolio. Liu Yang, director of First State Investments' China investment division, said she welcomed the strategy of Shanghai Industrial which has been investing in foreign firms such as chip-maker Semiconductor Manufacturing International. Ms Liu backed the company's spinning off of subsidiaries domestically to raise funds for expansion. To strengthen their ability to expand, companies such as Shanghai Industrial and Beijing Enterprises are looking to raise money from the mainland's domestic stock markets by issuing China depositary receipts (CDRs). CDRs will allow foreign-incorporated companies, including red chips, to tap the stock markets to finance mainland operations. Shanghai Industrial, Beijing Enterprises and China Mobile are tipped to be among the first batch of companies allowed to launch issues, expected in the first half of this year. Ms Liu said the companies' relationships with local or central governments remained the key to attracting investors. 'Their parents will continue to inject assets into their listed vehicles at low prices,' she said. 'If you are optimistic about Shanghai's economy, you will be interested in Shanghai Industrial. Beijing's economy will be encouraging due to the 2008 Olympic Games - that means the outlook of Beijing Enterprises will be good,' she said. In a nutshell, a repetition of the past decade's red-chip euphoria is unlikely given the changes in China's economy. But companies with sound management and a clear investment strategy will always attract investors. A close relationship with a parent company can be an additional sweetener but is no longer sufficient to attract investors on its own. Graphic: anal31gbz
