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Sweet and Sour

The trade-off between risk and reward can't get much bigger than in China, as these companies found.

1Mar

Determined to exploit lucrative opportunities in China? Then prepare for some wild ups and downs along the way. Just ask Douglas MacLellan, chairman of WelCom Corp. The Playa del Rey, California-based company, which represents some 30 U.S. and Taiwanese investors, is part of a group of 25 foreign joint- venture partners that struck deals during the past few years with China Unicom, the country's second-largest telecommunications group, to help develop regional cellular and wire-line networks throughout China.


As foreigners, they were prevented by Chinese law from owning equity in the business, exerting managerial control, or sitting on the boards of directors of Unicom's regional subsidiaries. But in return for providing construction, financing, and other services to the Unicom subsidiaries, the partners were granted a majority percentage of their net cash flow over an average of 15 years.


Today, the members of the foreign investor group, including such industry giants as Sprint (now being acquired by MCI WorldCom), Germany's Siemens, France Telecom, and NTT of Japan, as well as smaller companies such as Metromedia, McCaw International, and WelCom, are essentially being forced out of the market by Beijing regulators with the assistance of China Unicom's management.


Granted, they're getting their original investment back, plus a percentage that varies from company to company. But they were expecting much more, and soon. In fact, the market was just getting off to a flying start late last year, thanks to the $1.4 billion that the partners invested, when China pulled the plug.


On WelCom's initial investment of $25 million, MacLellan figures the total value due the company is close to $500 million. He further estimates the initial investment by all the foreign investors to now be worth up to $8 billion.


Unlike others in the group, WelCom plans to fight rather than take its money and run. For starters, MacLellan plans to seek international arbitration at the Court of The Hague and/or to sue in U.S. federal court. MacLellan will also seek to have information about his dispute included in the prospectus for Unicom's upcoming initial public offering, which is planned for either Hong Kong or the United States, and he has informed Morgan Stanley, Unicom's lead underwriter, of his intentions. WelCom's suit will seek damages of up to $500 million, an appreciable portion of the up to $7 billion that Unicom expects to raise through the offering.


"We will ask for the inclusion of our complaint no matter which market is used," MacLellan says, "and if it is in the U.S., we will ask the [Securities and Exchange Commission] to investigate and hold up the offering pending the resolution of our commercial negotiations."


In addition, he may demand trade sanctions from the office of Charlene Barshefsky, the United States Trade Representative. "We were intentionally defrauded," MacLellan insists. "As far as we're concerned, they owe us the balance of the contract."


That is not the view, however, of the Chinese government. Once regulators announced that the contract had "irregularities" and must be "revised," the government placed an offer on the table that was essentially a directive to quit the industry.


Because of WelCom's call for arbitration and legal proceedings and the threat it poses for marketing Unicom's IPO, however, MacLellan says he has received indications that the Chinese government may try to settle the dispute. He says the talk is of more-generous terms, or even reinstating WelCom's part of the joint venture. The Chinese government failed to respond to repeated requests for comment.


WelCom is clearly in a different position than the other foreign partners. As MacLellan puts it, "We formed WelCom for these particular joint ventures."


For the other participants, the deal represented one of many ventures abroad, so they walked away from this one relatively unfazed. "We're disappointed," admits Mark Hauf, president and CEO of the Chinese subsidiary of Metromedia, a closely held telecom firm based in East Rutherford, New Jersey. "But the situation is reflective of much more than simply reneging on the deal."


How so? "We reached an agreement to bring the deal to an end," Hauf says. "We got less than we wanted, they paid more than they wanted. But we walked away friends." Metromedia has yet another deal in the works with China and expects to have others going by June, primarily in internal corporate networks. And Hauf is confident of success, because he believes the country's embrace of Western capitalism will only strengthen. "It would be a mistake to infer that China is likely to do this in general," he says.


Companies outside the partnership agree. "There are regions of the world, emerging markets, where we won't play," says Tom Morris, CFO of Phillips Petroleum, which recently signed a deal with China to develop an oil find off its coast. Morris declines to name those regions. "But when it comes to the Chinese," he says, "they've always been straightforward with us. They've never broken their word."


These executives place great faith in China's ongoing, albeit gradual, integration into the global economy, and cite the eagerness with which the government has pursued membership in the World Trade Organization (WTO).



Pressure To Compete

With entry into the WTO, China will have to allow foreign-owned and -operated companies, the kind the telecommunications industry is not ready to compete with yet. "That's why the government did this," says Hauf. "The pressure to compete made it necessary to abandon this approach."


Yet Hauf cautions investors in other Chinese industries against expecting too much too soon. "There are unusual rules, there is an underdeveloped infrastructure, and there's not a lot of experience," he says. "It won't turn into an ideal environment instantly for foreign investment."


Still, Hauf adds, the experience with Unicom isn't all that different from risky investments in developed markets. "We entered into a venture-capital deal without an exit path," he says. "We expected to develop the business indefinitely for a period of 12 or more years. We never anticipated this kind of development. And to be fair to us, 3 or 4 years ago, no one could have anticipated these policy changes."


And Hauf contends that is especially difficult to do from abroad. "The biggest mistake in business with China is doing it from America," he says. "You have to be engaged in an active way. A quarterly look or visit is not sufficient to convey the likely risks. It's a mistake to make a deal with a Chinese party and manage factors or act as financiers as though you're an outside party." Of course, being in Beijing didn't help Metromedia in this case.



Forget GAAP

What's more, unlike with risky deals at home, investors should forget about getting a close look at a local partner's books. And if they do get a look, they can't expect to find the accounts prepared in anything close to generally accepted accounting principles.


"Western businesspeople are so used to the availability of coherent financial information," says Hauf. "Not so in China. And you don't realize how dependent you are on that until it's not there. Everything is done with a very secretive character. Not just to Western eyes, but to all eyes."


Yet even MacLellan fully expects to do more business in China. "I am spiritually and intellectually committed to China in the long term," he says. He is encouraged, moreover, by the new body of commercial laws that took effect last fall. And like Hauf, he thinks joining the WTO will make China more accountable to Western investors. That's possible as early as this May. "While I'm sure you could still have problems," he says, "both these things will do a lot to create an environment for Western-style settlement of issues."


Meanwhile, he's counting on China's interest in WTO membership to help WelCom win more-favorable treatment by Beijing. "They will want to resolve this with us prior to joining the WTO. Because once they're in the WTO, the next day we will have the ability to utilize the full force of the U.S. Trade Representative's office to compel them on a contractual basis. If they still resist, it could even lead to sanctions."


For that reason, McLellan insists, "we're going to win. There's no way we're not." But not without a fight.

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