by CBfeature
On March 20, 2006, China GrenTech Corp. Ltd. (NASDAQ:GRRF) got listed on the NASDAQ stock exchange with a P/E of 380. Its stock price closed at US$19 the first day, helping GRRF raise US$112.5 million.
But the day was not as inspiring for some domestically listed companies. Two of GrenTech's former shareholders, Shenzhen Universe (Public, SHE:000023) and Nanning Chemical (Public, SHA:600301), excluded themselves from sharing GrenTech's profits after selling their combined 42.69% stake in the company years earlier.
Last year's NYSE listing of Wuxi-based Suntech (NYSE:STP) followed a similar trajectory. Its former major shareholder, Jiangsu-based Little Swan Group (Public, SHE:000418), was tired of the solar energy company and transferred all of its shares long before its bright overseas listing.
For Shenzhen Universe, Nanning Chemical and Little Swan, continued investment in GrenTech and Suntech could have been no less than an illuminating experience. But there is more to their hasty sell-offs than meets the eye. Many more domestic investors will be excluded from sharing the benefits of listing in overseas markets if proper rules aren't worked out soon.
Par Value Deal
China GrenTech Corporation was jointly founded by Gao Yingjie and Zhuang Kunjie in 1999. It specializes in the development, production and marketing of radio frequency (RF) products and wireless communication systems. Since starting, it has become China Unicom's largest network optimization equipment supplier and the leader of China's RF technology market.
GrenTech got off to a rough start. By the beginning of 2000, the company was badly in need of more startup funds. But in December of the same year, Shenzhen Universe and Nanning Chemical respectively announced plans to buy large stakes in the struggling startup. In mid December, Shenzhen Universe bought 28.169% of GRRF from its shareholders for RMB60.37 million (US$7.56million). Meanwhile, Nanning Chemical spent RMB36 million (US$4.5 million) purchasing a 14.52% stake in the company, making it the third largest shareholder. GrenTech's registered capital swelled from RMB10 million (US$1.25 million) to RMB112 million (US$14 million) after the deal.
Shenzhen Universe and Nanning Chemical were initially optimistic about their investments. Universe estimated that prospective annual returns would exceed 20% of their original purchase price, making GrenTech a new source of profit. The company's market prospects surfaced again in a 2000 annual report, which specified that GrenTech network optimization products had done well across China.
Holding up its end of the bargain, GrenTech did not disappoint its domestic shareholders. The company's net profit reached RMB43.21 million (US$5.4million) in 2001. The following year, Shenzhen Universe received dividends totaling more than RMB3.56 million (US$446,000) from GrenTech, while Nanning Chemical received RMB3.6 million (US$451,000).
The returns for all companies were, without a doubt, fat: before investing in the wireless and RF provider, its annual profits amounted to little more than RMB8 million (US$1 million).
But this was the first and the last time the two investors enjoyed such returns. From 2002 to 2003, Shenzhen Universe sold its GrenTech holdings in two lots, with a 14.013% stake first going to Shenzhen Hengxingyue Industry Co., Ltd for RMB30 million (US$3.76 million) in May. Another 14.156% share was offloaded to Shenzhen Lingxian Network Optimization Equipment Co., Ltd for RMB30.3 million (US$3.8 million). Also catching the wind of change, Nanning Chemical transferred its 14.156% share to Lingxian in October, 2003, for RMB36 million (US$4.5 million).
The transactions, however, are much more interesting after reading the fine print. Hengxingyue is GrenTech's original shareholder, while 90% of Lingxian's equity already belonged to GrenTech. The transactions were actually a share repurchase maneuver two or three years after the dividends were sold.
Strange as it may seem, the two investors did not gain from their partnership with GrenTech. Shenzhen Universe sold their shares for RMB70,000 less than their original purchase price, while Nanning Chemical just managed to break even.
The legal procedures governing listed companies were followed when GrenTech's shares were sold. Both companies issued announcements as stipulated by the exchange, and Shenzhen Universe's board of directors even released GrenTech's impressive financial statements for Lingxian to peruse.
Listing Matters
Was GrenTech past its prime? Or did internal problems affect decision making at Shenzhen Universe and Nanning Chemical? The latter clearly seems to be the case given the strategic importance of the GrenTech investment for both companies.
Around the time that Shenzhen Universe and Nanning Chemical were offloading their stocks, GrenTech was quickly becoming the second largest wireless equipment supplier in China. Odd, then, that both companies would sell their shares when profits were clearly rising. A brief look at GRRF's reported sales revenues shows fantastic growth: in 2002, when the sell-offs first started, revenue stood at RMB350 million (US$43.8 million). A year later, after both companies had washed their hands of GrenTech, revenue rose to RMB360 million (US$45 million). But the years that followed saw more dramatic growth, with revenues reaching RMB560 million (US$70.1 million) in 2004 and RMB716 million (US$90 million) in 2005. It is safe to say that the sell-off was hasty at best; larger profits were clearly there for the taking.
A flurry of questions surrounding the early retreat lingered for a time, but for Shenzhen Universe and Nanning Chemical there was only one answer: GrenTech was planning to get listed in the overseas market. To achieve this, GrenTech tried its best to encouraged Universe and Nanning Chemichal to withdraw.
Shenzhen Universe and Nanning Chemical's departure from GRRF made it easier for other institutional investors to enter into the mix. Just two months after their withdrawal, led by the leading private equity investor Acris Capital and Standard Chartered Bank, GrenTech received US$26 million from the overseas investors. The company also stated that its transformation into a foreign-invested company was prompted by lower taxes and other incentives offered by the Chinese government to firms using overseas capital.
After helping GrenTech through its growing pains, Shenzhen Universe and Nanning Chemical became an obstacle to its overseas listing and chose to withdraw. The two original investors did not reap the gains that their later arriving foreign counterparts did, and also did not receive any compensation for their losses.
Chinese companies controlled by domestic investors usually face more complications than Sino-foreign joint ventures when applying for overseas listings. But this does not mean domestic-investor-controlled companies stand no chance of listing on US capital markets. Operations like Brilliance Auto, China National Petroleum Corporation (CNPC) and China Petroleum & Chemical Corporation (Sinopec) have already proven this isn't the case. Then why do domestic investors opt out of working with Chinese companies when they list overseas?
Shenzhen Universe and Nanning Chemical are not the only domestic investors that have chosen to withdraw. When SunTech listed on the NYSE in December 2005, its US$15 issuing price rocketed and closed at US$23. All of SunTech's domestic investors sold their shares overnight in early 2005, which was said to have been done under local government pressure.
Why, then, are investors from state-onwed enterprises bumped out of overseas listings? Sun Li, the senior partner of Syno Capital Inc. believes the problem has a lot to do with the complicated investment control mechanisms the government places on state-owned enterprises.
That's not to say success is impossible to come by. Chinese companies have, in fact, been very successful in overseas stock markets. The Bank of China's US$11.2 billion IPO is one of the most recent examples, and is preceded by a long list of other bank and natural resource listings. The gap, however, between the high-risk modern market and the state-owned model is huge, and by no means complimentary. Sun Li echoes this statement with his belief that a marketplace dominated by state-owned companies can not meet the high demands of a market economy. Or even contend, for that matter: with state control over assets, politics more often than not play a strong roll over where funds are allocated and who allocates them, reducing efficiency and creativity.
In addition, the government requests that 10% of funds raised by domestic stock market listings be handed over to China's social security system. And further complications may arise if a business lists abroad. Risk accountability for selling shares, what price to sell shares while securing state-owned assets and how to transfer hard currency back to China are only some of the problems left unresolved. Instead of developing proper solutions to the problems, the government has created rules that restrict domestic venture capital from enjoying big returns from overseas markets.
Sun Li also recognizes that an effective IPR protection system needs to be established. But there are some barriers. "The complicated system and human factors have made it difficult for China to build a comprehensive IPR system," Sun Li notes. "This, of course, makes it much easier for overseas venture capital investors to acquire state-owned businesses, pushing domestic investors out of the overseas capital market."