Zhou arrest forces investors to take a closer look at red chips' record

INVESTORS will become 'realistic and cautious' towards red chips in the aftermath of the Shougang affair, analysts say.

Attempts have been made to portray the arrest of Zhou Beifang, the former Hong Kong head of Shougang operations, for unspecific economic crimes as a personal matter, but analysts believed investors would now look differently at enterprises famous for their relationships with Chinese leaders.

They would not assume these companies would automatically thrive because of strong ties with high-ranking officials, but instead would look at assets and track records.

And while analysts are still speculating about the motives behind Zhou's arrest, they believe the episode will help in the market in the long term.

'If the Chinese are doing it to crack down on corruption, investors will be more confident in red chips in the future, and obviously there is a clear signal that more transparency is needed over back-door listing,' Larry Wang, China analyst with Morgan Grenfell Asia Securities, said.

He suggested that investment in red chips solely on the grounds that they would make profits from political connections will be something of the past.

'Investors are bound to be more realistic now. In fact, companies that grow only due to their influential friends could be unreliable, because political environment changes all the time.' Nick Ni, Nomura International (HK)'s associate director (corporate finance), said investors had realised that companies with mainland backing were not necessarily 'a safe boat to sail across 1997'.

He commented: 'Being well-connected has its problems.

'Some of those companies do not follow rules of the games in the market and as a result certain people can take advantage to commit some sort of crime.' The market is still awaiting details of the 'economic crimes' Zhou Beifang has allegedly committed.

Just a day before news of Zhou's detention came, his father, Zhou Guanwu, who fought with Deng Xiaoping against the Japanese, announced his retirement from the parent company, Beijing Shougang Corp.

The dramatic arrest caught everyone by surprise and the Hang Sang China Index, which tracks shares of mainland companies traded in Hong Kong, fell 4.8 per cent on the Monday after the weekend news broke last month.

Although it climbed 3.1 per cent on the Tuesday to close at 1,024.60, this does not mean that market confidence was unharmed.

'The recovery showed only that some red chips are actually not bad performers. Therefore, when their stock became cheaper after the sell-off on Monday, they attracted buyers the following days,' an analyst said.

'However, investors may think again about the future of red chips and become more cautious now.' Ever since Shougang Corp entered the financial scene through a so-called 'back-door listing' in 1992, the steel giant has turned declining operations it took over into profit-making vehicles.

It achieved total earnings of US$670 million from exports and overseas business in the first 10 months of last year.

According to Xinhua (the New China News Agency), the corporation now has 262,000 employees, 157 factories, and mills with fixed assets valued at 88 billion yuan (about HK$79.8 billion).

Market analysts commented that Shougang's 'unique selling point' was its relationship with the Deng family.

Deng Xiaoping's second son is the chief executive of Shougang Grand. The patriarch paid a visit to the corporation in 1992 and boosted confidence among investors.

Despite the latest events, some analysts still think that business survival in China is impossible without a special relationship - or guanxi .

'Investors will still look at who in the Chinese government the company is related to, although they would also look more carefully into the company's real ability,' said a legal practitioner who has helped a number of Chinese companies to float on the Stock Exchange of Hong Kong.

'There are thousands of companies in China waiting to be listed in overseas markets, but only a handful could be approved by the Security Commission.

'Some of the selected enterprises are actually losing money, but got through with help from friends in the government. So how can one say guanxi is not important?' Bankers' Trust vice-president Lily Wu played down the effect Shougang would have on red chips. 'It is a fairly special case and not necessarily applicable to all mainland companies, certainly not to H shares.' She said investors should still examine a company's 'network' in China but be more careful about its business background.

'They have to find out more about the track record, proved profits and the operations of the company,' she said.