INTERVIEW WITH CESAR BACANI
ON HIS NEW BOOK “THE CHINA INVESTOR”
Question 1. You have been a Hong Kong resident journalist for years and your articles in Asiaweek where you served as both a business editor and the magazine’s personal finance editor were staples to many in Asia. How long have you been interested in investing in Asia and why did you pick the current year to both write and publish your new book “The China Investor”?
Answer 1. As a financial journalist and personal investor, I’m always looking for materials on stocks and other investment option in Asia, particularly in China. While investment banks and stock brokerages periodically issue research reports, I have yet to find a personal finance book that specifically addresses the concerns of the retail investor interested in the region. Certainly not one on China – the many worthy tomes I have read tend to be economic and political treatises aimed at academics. So when AOL Time Warner closed Asiaweek in December 2001, I decided to take some time off to fill the need for a practical guide to personal investing in China.
Question 2. The premise of your book seems to be that China is and will be the major growth economy in Asia and the world over the next several decades and that as such investors should not count themselves out of this investment opportunity. Is this a fair statement of your new book’s premise and can you tell us why you are so “bullish” on investing in China?
Answer 2.Yes, that’s a fair summation. I know that the China Story – 1 billion people creating and recycling wealth as they produce and consume goods and services – had seduced and disappointed many people in the past. But after nearly three decades of reform, including accession to the World Trade Organization in 2001, I believe China has now achieved critical mass. This is a leap of faith that the markets are not yet willing to make, traumatized as they are by global terrorism and still unsure of the political, socio-economic and corporate-governance risks in the mainland. When they come around in a big way (and that process can start in 2003), the investor who bought shares in well-managed, solid China companies and China mutual funds at today’s cheap valuations will reap a nice reward.
Question 3. Although your book is advertised solely as a book on “investment,” the first and final portions of your book deal both with the problems and challenges facing China and also the many indications of either initial success or progress in addressing these. I found this portion very informative and an excellent concise aid to a new Asia hand or even for many veterans on China’s current conditions. Obviously you are optimistic when it comes to China. Can you explain to us why you feel this way and why you feel the coming decade will be China’s chance to shine?
Answer 3. In the short term, membership in the World Trade Organization is encouraging record levels of foreign direct investment, which translate into soaring exports as China cements its position as the workshop of the world. The tariff cuts and tighter competition are also lowering the prices of cars, outbound travel and other big-ticket items, helping stimulate domestic consumption. The economy could ride the momentum on to 2008, when Beijing hosts the Summer Olympics and stokes another short burst of domestic consumption and inbound tourism.
Medium-term drivers already in train could continue fueling growth. These include the deregulation of key sectors like aviation, finance, power and property, the rehabilitation, privatization and listing of big state-owned enterprises, and the closure of no-hoper government companies. Beijing’s strong support of the emerging private sector could unleash the kind of entrepreneurship that has made the Chinese community a leading business force in Southeast Asia and elsewhere. The seemingly smooth transfer of power from aging leaders led by President Jiang Zemin to long-groomed successors such as Vice President Hu Jintao bodes well for continuity and the institutionalization of orderly political transitions.
In the long term, initiatives in the experimental stage or in early implementation today could help sustain economic expansion. These include the clean up of the technically bankrupt banking sector, reform of the underfunded pension system, development of left-behind inland provinces and increasing farm incomes to address the growing wealth gap, and the overhaul of the justice system, particularly in regard to business and commerce. There are also tentative steps toward democratization with village-level elections.
I am optimistic on China in the short term. An economy taking off from a low base has a lot of room to grow given a favorable internal and external climate. I am a bit cautious in the medium term. While I believe that China’s deregulation and liberalization efforts are genuine and unstoppable, the devil will be in the implementation details. I am hopeful but wary about the longer term. It seems to me that the internal contradiction of quasi-communists running a market economy could no longer be papered over when a new generation of Chinese demands more personal freedoms, a more open and participatory political process and accountability of those in power. Continued political and economic stability would depend on how China rises to these challenges.
Question 4. In the first portion of your book (pg. 3-4) you note the various measures of growth over the last several years in China – the official being in advance of seven percent – and also note the qualitative methods used by Prof. Thomas Rawski of the University of Pittsburgh’s Department of Economics and analysts such as Dr. Jim Walker, an economist with CLSA Emerging Markets, who utilize systems that yield a figure of closer to four percent. Could you discuss how these two systems can come up with such divergent estimates, discuss the importance of various GDP measures in evaluating China and give your personal guesstimate of current China GDP growth?
Answer 4. We tend to forget that economics is an imprecise science. We are seduced into thinking that econometricians had analyzed, measured and weighed everything when they announce that GDP expanded, say, by 7.8%. In fact, that figure is at best an informed guesstimate, based on reports by various sources that may or may not massage the numbers to make themselves look good, collated by statisticians who may or may not validate the accuracy of the information, and processed according to formulas that may or may not fully reflect the unique circumstances of a particular economy.
The difficulties are compounded in a vast and exceedingly populous developing country like China. The National Statistics Bureau said it punished 19,000 people in 2001 after discovering 60,000 cases of violations of the Statistics Law. It is implementing recommendations by the International Monetary Fund to improve its systems and expanding its own surveys. Some stock brokerages routinely lop off a percentage point from the reported GDP numbers to account for false reporting. Prof. Thomas Rawski of the University of Pittsburgh tries to triangulate growth by looking at the relationships between “entirely plausible” data such as air travel, energy use, excess capacity, inventory accumulation and levels of idle bank deposits. He suggests that China’s GDP probably grew only 4% in 2001, not 7.3% as reported, and that it could have shrunk by 2%in 1998 and another 2.5% in 1999.
I prefer the approach taken by Dr. Jim Walker of CLSA Emerging Markets, who looks at China through the prism of Austrian Economics. This is a school of thought that focuses on the purposefulness of human action instead of obsessing over numbers, which are considered inadequate on their own to understand an evolving economy. Walker gives greater weight to policy choices and anecdotal evidence about their on-the-ground implementation. He believes that China’s GDP is not expanding as fast as the government says – his forecast for 2002 is about 4%, far slower than Beijing’s preliminary number of 8% – but he thinks the quality of the growth is improving. “For the first time in seven years, we are confident about China’s future,” he concludes.
As a personal investor, the actual quantum of growth, whether 4% or 8%, is not really that important to me. I am more concerned about the sustainability of that expansion and the kind of environment it provides for corporate profits. China’s economy, in my estimation, is growing at an accelerating pace under the stimulus of reform, globalization and domestic consumption and likely to continue doing so in the foreseeable future.
Question 5. Also early in your book (starting on page 10) you cite your six rules for the China Investor. Could you name these and perhaps explain how best they should be utilized?
Answer 5. I’m not so enamored of China to be blind to the risks there and to forget the importance of diversification in long-term investing. So my first rule is: Don’t bet the bank on China. Depending on your age, appetite for risk and the tax implications, keep your exposure to mainland assets at 5% to 20% of your total portfolio. If you are unsure of your stockpicking skills, let professional managers handle some of your China money. In stockpicking, use both value and growth styles. Invest only in companies that are well managed, transparent and regulated. My preference is to buy shares only in China companies listed in Hong Kong, Singapore and the U.S. I am not yet confident that regulatory oversight in Shanghai and Shenzhen is strong enough to forestall corporate misgovernance.
In looking at financial statements, make sure to know which accounting standards were followed in their preparation. China’s Generally Accepted Accounting Principles tend to be less strict than those in Hong Kong, the U.S. and other more developed markets. Finally, remember that China is not one monolithic bloc of 1.3 billion consumers. The country is actually a collection of virtual countries with their own sizeable populations, level of development and business ways. I prefer companies that operate in the richer provinces.
Question 6. In your book you discuss the various stock investment options – A shares, B shares, H Shares, S shares, P shares, red chips, green chips and purples. All of this is a little daunting to the new China investor. Could you briefly explain the difference in these and how important is a precise understanding of all this alphabet soup?
Answer 6. Listed in Shanghai and Shenzhen, A shares and B shares trade at high valuations largely because too much money chase too few of them. A shares are available only to local investors and outsiders accorded the status of Qualified Foreign Institutional Investor. B shares are open to foreign investors and locals with foreign-currency deposits. B shares in Shanghai are in U.S. dollars while those in Shenzhen are in Hong Kong dollars.
Many China companies listed outside the mainland trade at lower valuation. H shares are secondary issues floated in Hong Kong by a China-incorporated and listed company. Red chips are companies incorporated and listed in Hong Kong whose main assets and operations are in China. Singapore hosts a number of China companies, many of them owned by private entrepreneurs who could not list at home because the bourses give priority to state-owned firms. I call them S shares. N shares are China companies with a secondary listing in New York in the form of American Depositary Shares. A number of China companies also trade in London in the form of Global Depository Shares.
In my book, I profile 11 red chips and H shares that I already consider blue chips. I call them purple chips. (Mix red and blue and you get purple.) I also profile seven companies founded by private entrepreneurs, which I call green chips (others call them P shares). I limit my investing activities to these 18 companies, although I keep watch on many other stocks. I do have some exposure to A and B shares, but I entrust the stockpicking to professional mutual fund managers.
Question 7. In Chapter 2 (starting page 23) you list five broad investment trends in China and explain why they are important to the China investor. Could you discuss these trends briefly and why you see these as being important in making investment decisions in China?
Answer 7. One investment approach to China is to pick and choose red chips and H shares that are likely to gain from a tsunami of mainland money when Beijing finally allows its citizens to invest in Hong Kong. But you don’t know when this will happen, if at all. The best strategy is to invest in well managed companies that will benefit the most from key trends in the Chinese economy. They include property developers, car makers, travel companies and advertising agencies, all of which could ride surging consumer demand. Selected power companies, airlines and media groups could emerge as winners as the government deregulates and restructures their industry. Exporters, importers and logistics providers would benefit from a trade boom, while energy firms and steel makers could gain from rising industrial production. Finally, companies founded and run by private entrepreneurs – P shares – could perform strongly given the new recognition the government is according private capital.
Question 8. Two of the above broad investment trends are booming trade and rising industrial production which imply booming exports. China is a very big country with nearly 25% of the world’s population, how can China logically export its way to an increased standard of living for its people and for the nation without engendering a backlash by other nations whose industries are devastated because of the inability to compete with China’s low wage levels, lower safety and other factors?
Answer 8. There could be a backlash, but I don’t see that going beyond angry words and political posturing. China belongs to the World Trade Organization, so fellow members hurt by its export prowess must go through proper channels to register their complaints. Paying low wages and having lax safety and environmental standards are not yet considered unfair trade practices. (The developed economies would like to see minimum labor, safety and environment standards for all WTO members, but developing nations, including China, are resisting the idea.) Any country that unilaterally imposes punitive tariffs on Chinese products on these grounds runs the risk getting booted out of the world’s biggest market as well. Remember, China needs airplanes, trains, machinery, software and other big-ticket items to upgrade its infrastructure, so the U.S., Japan, Europe and other industrialized economies would be loathe to launch a trade war over garments, toys and electronics. And don’t forget that many of China’s export factories are funded by foreigners, so a trade war would hurt a country’s own companies as well. Regarding other developing countries, Beijing has taken initiatives to forestall trade trouble, such as a proposed free trade agreement with ASEAN.
Question 9. The middle portion of your book includes reviews of state owned China companies and new entrepreneur owned companies that you believe deserve a look and possible investment. Two of the companies you list are Beijing Capital Airports and Chaoda Modern Agriculture. Could you discuss the differences in management, investment, transparency and other factors you feel important in these companies and what led you to note these companies in particular?
Answer 9. Beijing Capital (Hong Kong listed, code 694) is one of 11 purple chips I profile in my book. I like this company because it owns and operates Beijing’s international airport, which is one of the world’s top 25 busiest aviation hubs, and another international airport in the prosperous port city of Tianjin in the southeast. Negotiations are ongoing for stakes in other airports, which would give Beijing Capital exposure to the growth of other cities. The company expects higher travel and cargo traffic from stronger business and manufacturing activity as a result of WTO membership, Olympics-related travel and domestic tourism. After earnings fell 17% to US$241 million in 2001 as a result of the global slowdown and terrorist attacks in the U.S., Beijing Capital recovered strongly in the first half of 2002 and is forecast to finish the year with a 15% rise in profits, and another 21% in 2003. Dividend yield is around 3%. While controlled by the government, a third of the shares are in the hands of Hong Kong and other overseas investors. France’s Aeoroports de Paris owns about 10% of Beijing Capital through subsidiary ADP management.
Chaoda Modern (Hong Kong listed, code 682) is one of seven green chips profiled in my book. Like other P shares, it focuses on a niche that the big state-controlled enterprises do not bother with. Chaoda grows organically grown fruits and vegetables on more than 6,000 hectares. A third of the company’s annual production of 400,000 tons is exported to Hong Kong, Japan, the U.S. and Europe. Chaoda claims profit margins of more than 60%. It says a pumpkin that costs it a penny to grow sells for US$1.90 in Tokyo. Organic farming requires personalized labor, and there is a lot of cheap willing hands in China ready to lavish attention on every gourd, leaf and tuber. Be warned, however unlike overseas listed state enterprises, China’s private entrepreneurs are still learning about corporate governance and the care of minority shareholders. Chaoda’s shares were briefly suspended in 2002 over a misunderstanding with its auditor, PriceWaterhouseCoopers, regarding the treatment of tax incentives and onsite inspection of some assets. The issues have been ironed out, but the company’s stock price has yet to recover from the scare. It is currently trading at a cheap four times latest reported earnings, and just 3.4 times forecast 2002-03 earnings (Chaoda’s financial year ends in June). Earnings jumped 25% in 2001-02 and expected to rise another 35% in 2002-03. Dividend yield in 2001-02 was a high 6.8%. Dividends could equal 9.2% and 11.4% of the current stock price in 2002-03 and 2003-04, respectively.
Question 10. Your book also includes a chapter on mutual funds, how to organize and manage your investments and a section titled “The Enablers” discussing various investment houses, investing over the Internet, tapping into investment research, etc. The section is very useful for the “expatriate” manager new to Asia and to the growing middle class in Asia looking to better manage their money. How much of your focus in writing this book was your former reader base in Asiaweek where you served as personal finance editor and how easy is it for investors in places like Bangkok, Vietnam or Indonesia to replicate what you are doing in Hong Kong?
Answer 10. I did have Asiaweek readers in mind when I wrote the book, but I also tried to address the concerns of personal investors in the U.S. and Europe. I believe that any portfolio will benefit from exposure to China assets. Investing in China is easy for those based in Hong Kong and Singapore, but people in other places can also access China equities and mutual funds through the Internet and depository receipts listed on their home bourses. I detail the relevant information in my book.
Question 11. Late in the book you set out your views on what could go wrong to make China not the road to riches but instead a potential financial sinkhole for investors. Among the potential pitfalls is everything from an implosion of the banking system, a rapid disintegration of the communist party, chaos in the aftermath of mass unemployment and many other factors? Of the factors listed which events would you rate the most likely and which the least likely and why?
Answer 11. I hesitate to assign probabilities to risks that, on balance, I judge to be manageable. The good thing about China is that national and local leaders are showing willingness to tackle the tough issues, in contrast to the paralysis in Japan. It helps that China’s economy is on the rise, giving the government breathing room to experiment with solutions. Critics fault Beijing’s initiatives for being too soft and gradualist – one goal is to reduce non-performing loans at the Big Four banks by only two to three percentage points a year, for example. But China’s problems are convoluted and intertwined. The government can assume the non-performing loans of the Big Four banks, but that would mean diverting money for pump-priming activities that help create jobs and keep the economy humming, not to say for social service and safety nets for the unemployed. Beijing can close state-owned enterprises on life support, but that would worsen unemployment. I believe that making haste slowly is the most prudent approach for China at this stage of its development.
Question 12. I know you and many of the other talented writers and other professionals from Asiaweek which stopped publishing in 2001 have formed a group in Hong Kong and are actively pursuing a number of projects. Can you tell us a little about this and what sorts of projects you are pursuing?
Answer 12. The Editors Group is a Hong Kong based editorial-services partnership that utilize the skills and contacts of former Asiaweek editors and correspondents for outsourced corporate projects. We have written brochures for leading Asian corporations, edited research reports for investment banks and shepherded a book on banking for a major consultancy. The Editors Group is looking to expand into investor and press relations, industry reports and publishing. For more information, please check out www.theeditorsgroup.com.
Question 13. Lastly, you have been an educator, a respected international journalist and now an equally well regarded author, what new roles are you actively considering and are you currently working on another book or return to personal finance column?
Answer 13. I write a personal finance column focused on China for Hong Kong-based monthly wealth-management magazine Benchmark. I also contribute to Personal Wealth, a similar monthly based in Singapore. I am doing research for my second book, a guide for the Asian MBA, which leverages on my work as education editor for Asiaweek. I am mulling a third book on investing in Asian markets, including India, Korea and Thailand. I am also on call for consulting and other projects for The Editors Group.
About the Interviewer:
Christopher W. Runckel, a former senior US diplomat who served in many counties in Asia, is a graduate of the University of Oregon and Lewis and Clark Law School. He served as Deputy General Counsel of President Gerald Ford’s Presidential Clemency Board. Mr. Runckel is the principal and founder of Runckel & Associates, a Portland, Oregon based consulting company that assists businesses expand business opportunities in Asia. (www.business-in-asia.com)
Until April of 1999, Mr. Runckel was Minister-Counselor of the US Embassy in Beijing, China. Mr. Runckel lived and worked in Thailand for over six years. He was the first permanently assigned U.S. diplomat to return to Vietnam after the Vietnam War. In 1997, he was awarded the U.S. Department of States highest award for service, the Distinguished Honor Award, for his contribution to improving U.S.-Vietnam relations. Mr. Runckel is one of only two non-Ambassadors to receive this award in the 200-year history of the U.S. diplomatic service.
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