China Netcom's IPO Shows the Thrill Is Gone
The Wall Street Journal
2004-06-07

Hong Kong - THINGS AREN'T GOING exactly as planned for the initial public offering of China Netcom Corp. stock, one of the biggest overseas IPOs of the year.

It highlights the recent difficulties of Chinese companies seeking public listings abroad. "The euphoria for all things China is gone," says Frank Au, managing director of Latitude Capital Group, a Hong Kong-based merchant bank focused on China. Investors may be more skeptical about buying shares of formerly state-run Chinese enterprises still grappling with how to run profit-making businesses, he says.

China Netcom recently pushed its IPO back to September from July and downgraded the deal's size to $1.5 billion. Beijing has announced that China's National Audit Office will conduct an audit of China Netcom's 2003 finances this summer. "This audit will not be a routine one," the audit office said, stressing it would be one of the most stringent financial reviews ever carried out by its accountants.

Originally, the company was expected to raise $2.5 billion in an offering in Hong Kong and New York. Investors saw China Netcom as a chance to grab a piece of the last of China's Big Four phone companies to go public and get in on the ground floor of China's huge telecom market. There are nearly 300 million mobile-phone subscriptions in China, which is home to about 1.3 billion people, many of whom subscribe to more than one mobile service.

China Netcom had the added cachet of a fledgling international-telecom operation that had been funded by blue-chip foreign investors, including News Corp. and MSD Capital LP, Michael Dell's private investment vehicle.

The deal's underwriters, Citigroup Inc. and Goldman Sachs Group Inc., are refusing to comment, as are China Netcom officials. But people familiar with the situation say bankers are scrambling to keep the IPO on track and reassure investors about China Netcom's finances.

High-profile financial scandals at other Chinese companies that have gone public overseas or are seeking international listings, including China Life Insurance Co. and China Minsheng Bank, along with concerns that China's economy may be overheating, have put several IPOs from China on hold until market conditions improve.

Ping An Insurance Co., China's second-largest life insurer, has reduced its Hong Kong IPO to $1.5 billion from $2 billion, citing tough market conditions. China Shipping Container Lines, the dedicated container-shipping arm of state-owned China Shipping Group, has lowered its Hong Kong IPO to $1.3 billion from $2 billion and delayed its roadshow as a result of poor market sentiment. And the blockbuster $5 billion IPO of China Construction Bank, the healthiest of China's massive state-owned lenders, has been put off until next year.

At this year's start, the IPOs of some Chinese companies in Hong Kong were red-hot, with portions of deals earmarked for retail investors ending up more than 1,000 times oversubscribed. But sentiment has reversed recently: Shares of Semiconductor Manufacturing International Corp., China's largest chip maker, and Chinese Internet company Tom Online Inc. fell after their market debuts in March.

Shares of other Chinese telecom companies have hit the skids lately, with China Telecom Corp.'s shares falling nearly 33% since the start of this year on the New York Stock Exchange. China Unicom Ltd.'s shares have dropped about 45% from their 52-week high in mid-February.

But the tough market isn't the only thing causing problems for China Netcom. The company, in some ways, is a case study in the quirky attributes of big Chinese companies, particularly those with businesses that previously were run by the Communist government.

Those businesses "weren't built to go public," says Dave Carini, business-development manager at Norson Telecom Consulting in Beijing.

China Netcom, which went through a major restructuring and management change last year to get it ready for public markets, is a hodgepodge of three different companies. They were cobbled together by the Chinese government two years ago as part of the breakup of China Telecom, the country's former phone monopoly.

The more traditional business includes fixed-line phone operations inherited from China Telecom in 10 northern Chinese provinces. It represents only about a third of China Telecom's former fixed-line network and is in some of the country's more remote and least populated areas, including Inner Mongolia and Jilin, which adjoins North Korea.

China Netcom also includes two old broadband businesses: the former Jitong Network Communications Co. and the original China Netcom, a high-flying tech concern formed in 1998 with help from the well-connected Jiang Mianheng, son of former Chinese President Jiang Zemin.

The practice of listing only a company's best assets, at least at first, is common among Chinese telecom companies and helped newly listed Chinese telecoms prop up their stock values initially. But the practice also could disguise problems in nonlisted operations that are linked to the company's overall financial health, and could hide potential liabilities.

Still, China Netcom's broadband business is expanding quickly. It also is making money from its low-end "personal handyphone system," or PHS business, a sort of wireless/fixed-line hybrid that is also a big revenue source for rival China Telecom. Analysts say China Netcom is likely to emphasize its broadband and PHS businesses during its coming international roadshow.

Although the low-cost PHS business could shrink when China starts introducing more advanced, "third-generation" wireless services that could lure in some PHS users, China Netcom is in a good position to snare a new wireless license from the government. It could start a pure mobile business that could turn into an even bigger growth driver for the company.

A possible alliance between China Netcom and Hong Kong phone outfit PCCW Ltd. has thrown another wild card into the mix. PCCW announced last month that the two companies were in "confidential discussions" about a joint venture, including the possibility of China Netcom's taking an equity stake in PCCW's fixed-line phone business.

While some see a deal as a way for China Netcom to gain management expertise and exposure outside China, others question whether linking up with another fixed-line outfit, PCCW, would be a drag on business. A deal, if done soon, could be "inconvenient" for Netcom's IPO, ABN Amro analyst Helen Zhu said in a report.