WSJ article about China inflating "stock bubble."
July 31, 2000
China Milks a Cash Cow
By Inflating a Stock Bubble
By KARBY LEGGETT
Staff Reporter of THE WALL STREET JOURNAL
ZHENGZHOU, China -- As Lu Yide takes a break between meetings with a
bankrupt subsidiary and angry securities regulators, one of his assistants
nudges him and delivers some perplexing news: His company's stock is
surging.
Slumped in the corner seat at a coffee shop, the balding 46-year-old executive
shakes his head and mutters, "There's a lot of confusion in the market."
That's quite an understatement. Mr. Lu's Zhengzhou Baiwen Co., a
government-controlled department-store operator and household-goods
wholesaler, is on the brink of failure. Its debts are almost double the value of
its assets, creditors are trying to liquidate it, and Baiwen's once-vaunted
distribution network is shrinking by the day.
A Lesson Learned
Even so, the company's shares have enjoyed a monumental run-up. Part of the
reason: A decade of stock trading has taught China's investors that their
government has a powerful incentive to do whatever it takes to make every
stock a winner -- and that listed companies never go under. Thus, Baiwen has
become part of the country's government-primed investment bubble, a boom
even more divorced from economic reality than the ebbing Internet frenzy in
the U.S.
Founded a decade ago, China's two home-grown stock markets, in Shanghai
and Shenzhen, are symbols of the country's embrace of market-oriented
economic reform. And, by some measures, they have been a dazzling success.
More than 45 million Chinese now have their own trading accounts, giving
China the world's second-largest shareholding population, after the U.S. Nearly
1,000 companies have listed on one of the country's two exchanges, and their
total market capitalization is the third-highest in Asia, behind Hong Kong and
Japan. Their combined daily volume often more than doubles the Hong Kong
stock market's.
Power to Choose
But despite their popularity, China's stock markets have become more of a
hindrance than a help in improving the efficiency of China's largely state-run
economy. That's because the Beijing government generally uses the stock
market to funnel money into ailing government enterprises, rather than the
country's most promising businesses, by exercising its power to decide which
companies are allowed to list their shares and which aren't.
So far it has excluded all but a handful of the growing number of privately
owned companies who need capital to expand and which could help absorb
some of China's millions of newly unemployed workers. As a result, local
Chinese investors over the past 10 years have been pouring their life savings
into some of the country's worst companies.
Few of these investors realize the scope of the problem. The markets were
supposed to create a modern equity culture, but the tight rein Beijing keeps on
corporate information stands in the way. The government regularly bans news
coverage of companies such as Baiwen, leaving ordinary investors to feed on
rumors while in-the-know traders and bureaucrats manipulate stock prices or
use the government-run media to talk up the market.
An Uphill Battle
Beijing says it wants to fix some of these problems, which affect foreign
investors, too, though to a far lesser extent, since most of China's
government-controlled companies are listed only in China and can be traded
only by Chinese nationals. Earlier this year the central government brought in a
new reform-minded securities chief, Zhou Xiaochuan, who is pushing to
tighten accounting and disclosure rules and trying to launch a Nasdaq-style
second board where higher-quality private firms could list. But implementing
these reforms will be an uphill battle.
For one thing, analysts say as many as 20% of China's listed companies are
money losers such as Baiwen, and the number is growing as competition and
poor management pushes many state enterprises into deeper trouble. That
means the proposed reforms could jeopardize hundreds of listings at a time
when Beijing, with its state banking system technically bankrupt and its budget
deficit widening, needs the markets in their current form to help more
state-owned companies raise capital. Because it wants to sell a mountain of
government assets through the markets in the next decade -- more than $500
billion, according to Hong Kong-based Morgan Stanley economist Andy Xie --
it can ill-afford to damp investor enthusiasm by letting businesses such as
Baiwen fail.
Few companies are as emblematic of China's dysfunctional stock exchanges.
Last year, Baiwen posted a loss of $115 million, the steepest ever for a listed
company in China's brief stock-market history. That has prompted a debate
among regulators, some of whom would like to delist Baiwen but fear that
doing so would create an even bigger problem. "The government is worried
that if it doesn't save Baiwen and other companies like it, investors will take to
the streets and cause social unrest," says a senior securities-market regulator.
Zhengzhou Baiwen, whose original name meant Zhengzhou's Hundred Goods
Supply Station, was set up in 1948. Its task was to distribute household goods
such as soap and pencils at fixed prices and under strict quotas, as part of
Communist Party Chairman Mao Tse-tung's rush to turn China into a giant
commune. When Mr. Lu joined Baiwen nearly 30 years ago, the company was
a fixture of daily life in this central Chinese city with a population of three
million people. "Everything we bought and sold, our prices, even our clients,
they were all decided by the government," he says.
Studying Capitalism
That started to change in 1978 as China embarked on a more market-oriented
economic policy. Like the other state-owned enterprises that now make up
95% of China's listed companies, Baiwen had to learn capitalism. Managers
such as Mr. Lu started to transform the company from a state-run supply
agency to a modern distribution operation, hoping to buy in bulk from
manufacturers and sell to department stores, pocketing the difference as profit.
They also set up an imposing department store in downtown Zhengzhou,
which for a time was the city's largest retail center.
In 1988, Zhengzhou local government gave Baiwen, which was owned by the
local branch of the Communist Party, permission to sell nearly $5 million of
shares. China didn't have any stock exchanges back then, but the offering
attracted local-government companies and other investors excited by the new
prospect of owning stocks. Baiwen used the money it raised to set up branch
stores around the city. Mr. Lu, who by that time had worked his way into
senior management, was put in charge of Baiwen's home-appliance division, its
most promising business.
But Baiwen's rapid expansion exhausted its proceeds from the stock sale. In
1993, still without a formal stock-market listing, Baiwen turned again to the
Zhengzhou government, which gave the company approval to sell another $23
million in shares. Flush again, Baiwen used the money to pay off bank loans,
buy new land and build a spacious warehouse.
By 1995, the company's investments appeared to be paying off. China's
economy was booming and consumers were spending. In 1996, after years of
lobbying, the company finally won approval to list its shares on the Shanghai
Stock Exchange, where they debuted at 82 cents, more than double their
31-cents-a-share value before the listing. About two years later, Baiwen sold
more stock, raising nearly $20 million. By that time, its share price had doubled
again, to $1.68. The company went national, setting up branches throughout
China and expanding its product line to nearly 30,000 consumer products,
ranging from television sets and cosmetics to cigarettes and bicycles.
So successful was Baiwen that in mid-1997, with the company's shares trading
at around $1.11, the Zhengzhou Communist Party named it the city's model
company. And as Baiwen's reputation soared, so did the fortunes of Mr. Lu, an
energetic man born to Japanese and Taiwanese parents who moved to China in
1954. Shortly after Baiwen's debut on the Shanghai exchange, Mr. Lu was
promoted to general manager. He later earned the nickname "Boss Lu" for
tirelessly promoting his plan to make Baiwen China's largest household-goods
wholesaler.
Bad Timing
Mr. Lu approached the China Construction Bank, one of China's Big Four
state-owned banks, and secured a revolving credit line valued at nearly $200
million. Then, he signed a deal to become the top distributor for China's largest
TV-set maker, Sichuan Changhong Electric Co., and a few other
home-appliance manufacturers. He loaded up on TVs, washing machines and
air conditioners and began selling them through Baiwen's sales network to
retailers around the country. By early 1998, when its borrowings peaked,
Baiwen's shares were still strong, trading at around $1.53.
But Mr. Lu quickly realized that he had filled his warehouses just as China's
economy was going into a tailspin. Deflation set in, and consumer spending
shriveled. TV prices fell by more than half, forcing Mr. Lu to sell them at a
loss. "The market collapsed on us," Mr. Lu says.
Mr. Lu says that by mid-1998 it had become clear that his company was losing
money, but no one had a clear idea how much. Baiwen hadn't invested any of
its $48 million in stock-sale proceeds to set up a computer database or retrain
its lackadaisical sales force. Indeed, while neglecting its core businesses,
Baiwen poured money into an array of speculative deals. In one, it lost more
than $8 million on a residential and office complex in Beijing. In another, it
acquired two cash-strapped state enterprises from the Zhengzhou government.
The Truth Delayed
Investors, however, knew nothing of the gathering debacle. In fact, in early
1998, Baiwen told them that it expected to record a profit of nearly $10 million
for the year, even though its losses were already mounting. A year later,
Baiwen admitted the truth: It had a 1998 loss of more than $60 million. Its
shares imploded, hitting a low of 48 cents.
Zhou Lan, a retired teacher in Shanghai, was devastated by the belated
disclosure. In 1998, when Baiwen was predicting a profit, she bought 2,500
shares of the company. In 1999, she sold at a loss of $2,500, or more than
two years' salary. "I would never have purchased Baiwen's shares if I had been
told the truth about the company's performance," she says.
Sitting in front of a multicolored trading screen at a brokerage outlet in
downtown Shanghai, Ms. Zhou says she no longer trusts China's listed
companies. But with interest rates low and foreign stocks taboo, she says she
has no other investment choice. After losing on Baiwen, she says she has
figured out a new strategy: buy companies that insiders seem to be bidding up
-- and then bail out before they do. "It's all about luck," she says.
Bankruptcy Claim
Late last year, Baiwen fell apart. Unable to pay off its loans, it defaulted on
almost $250 million in debt owed to the Construction Bank, which then
transferred Baiwen's debt to Cinda Asset Management Co. Cinda combed
through Baiwen's accounts, found little of value and filed a bankruptcy claim
against it in a local court in March, the first time such action has been taken
against a company listed on China's exchanges.
These days, Baiwen's flagship investment, its giant department store in
downtown Zhengzhou, reflects the company's decline. A rambling series of
dank rooms, it is empty of customers on a recent afternoon, even as dozens of
sales clerks play cards, drink tea and chat. Instead of a computer, an abacus --
still the company's main accounting tool -- gathers dust on a checkout counter.
Meanwhile, Mr. Lu, a short, heavyset man with a round face, has been
spending his days crisscrossing China to close down parts of the company,
meet with creditors and petition his government backers to fund a bailout.
Baiwen, Mr. Lu says, "is a lesson in the problems facing all of China."
That may be, but investors continue to be mostly in the dark about the
company, whose shares finished Friday at 76 cents, up 31% from a month ago
and up 56% from a year ago. Securities regulators say that with a dozen listed
companies teetering on the edge of bankruptcy, news of Baiwen's woes could
lead to a selling binge, undermining the government's plan to bail out its
money-losing state sector by listing even more of it on domestic stock
markets.
They have imposed a news blackout on Baiwen in the Chinese press, even as
the company's stock surges and its market capitalization approaches $140
million.
Sipping beer in a dark restaurant, Mr. Lu ponders Baiwen's future. He looks the
model of a successful executive, wearing an expensive Yves Saint Laurent
dress shirt, but his mood reflects the fatalism of a state-enterprise manager.
"We failed to make the transition to the market economy," he says, bracing for
another round of late-night appointments with government officials. "But we
still hope we can get another chance."
Write to Karby Leggett at karby.leggett@wsj.com
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