When I initiated on the day of the China Shipping Container Lines IPO with a Sell rating back in 2004 I did so for three main reasons: 1) there was a complete lack of disclosure of the related party nature of a main customer which effectively made CSCL a subcontractor at low market rates; 2) the leased in container fleet was expensive and effectively a large off balance sheet item (despite CSCL owning ships that had been bought on the cheap); and 3) there was a shortage of other quality assets such as ports to lower network costs. The company had earlier ripped off investors by carving out the 25% stake owned by the sister listed company China Shipping Development for a song (1).
By 2005 it was Cosco Holdings’ turn to rip off investors in Hong Kong. I wrote report after report underlining Cosco Group corporate governance travesties leading up to the IPO. Since I had also followed the behind the scenes formation of Cosco Holdings, including the creation of Cosco Logistics out of a mish-mash of related party transactions and Cosco Group operations related to logistics, I tried to warn investors how highly contrived the Cosco Holdings company being sold to investors was.
Banks on the deal ultimately couldn’t differentiate between working for value creating structures or Frankenstein structures for the express purpose of raising as much money as possible. The main criteria for picking the banks for the deal (as often would be the case, but perhaps on better footing), was to throw in as many assets and create a conglomerate that could putatively be valued at top dollar.
Captain Wei Jiafu was exceptionally proud of the creation at the time. He had managed to talk up values left and right. The only kink was that a growing number of analysts, some even within the underwriting syndicate (HSBC; UBS; JPM) this time, declared they had trouble coming up with a real valuation for the new company.
Cosco Pacific, which had listed back in the early- to mid-1990s as Florens, was always relatively easy to value. It had a track record. And many of the numbers could be objectively verified, despite some questions surrounding long term container lease contracts back to the parent. But with Cosco Holdings, the bulk fleet proved exceptionally hard to value. The core container fleet was also difficult to estimate (2).
Cosco Logistics for years was a valuation smoke and mirrors exercise and traded back and forth intra-group. A few years earlier, during the peak of the internet bubble, Cosco Logistics had been marketed as a B2B platform, but had never gotten to the capital raising stage. Cosco was not alone in trying to milk the story back in 2000, as the likes of Hutchison had tried to value its LINE online platform for billions as well.
But not doing proper work organising Cosco’s far flung subsidiaries and seeking to overstuff the IPO was a recipe for 1) additional corporate governance nightmares, 2) a complete lack of transparence on asset values, and ultimately 3) mis-valuation of the IPO vehicle to investors. Years later, any long term investor would be out massive opportunity costs if they had held shares from IPO. Of course, the only strategy that worked at certain points in time was to trade the shares with mainland trading syndicates. And for traders there were clear reasons to trade despite holding misgivings on valuations.
Another key item which has never been properly looked into is the entire mechanism for vessel chartering within the two groups, especially in the early days. We know and can at least understand private and public companies with long term financial track records and delineations of ownership cutting deals on the side for fees and commissions on vessels chartered-in, but Cosco and China Shipping were essentially state held companies, even though senior executives like Li Kelin eventually became identified with particular strategies. Other Chinese groups, including many steel companies also engaged in a sea of debatable charter transactions. This has always been the nature of the industry. But what was different was the scale of movement of capital from the state to private hands.
Captain Li Kelin was the hero, the creator. He created structures which grew massively, even if originally he did so from state assets while creating corporate governance mishaps. Wei Jiafu was the anti-hero, the captain politician who sat atop a lumbering group with the appearance of growth. CSCL, even though it ripped off investors initially, actually moulded itself into a better company over time, even though ultimately it likely would have faced tremendous difficulties without state subsidies (again this raises the issue of personal gain for senior managers for companies living dangerously).
Cosco was the opposite in some ways. Its core container business was and is an operationally viable operation. Many managers are strong and relatively competitive on a global scale. But the corporate structure on top, led by people like Wei Jiafu, was a financial drain on operations. It made all the wrong calls on asset timing, but managers still drained off benefits for themselves on the sidelines. And Cosco’s conglomerate held as many dog assets as viable ones. But the biggest problem was the mismanagement from the top.
Here is one anecdotal experience from a friend few years back that was an eye popper. He had met Wei several times and thought of him as an acquaintance he would call on when in Beijing. But whenever he was in Beijing and called on him, he was told Wei was not in the office or out of country. One time, after just being told the same hours earlier, he ran into a group that had just finished a meeting with Wei. It was then that he learned that the company secretary he went through generally arranged meetings for the captain only after certain rewards had been provided. He was shocked. How naïve could he have been.
This story does not surprise so much as illustrate an endemic problem that likely existed at many companies. It tells the story of corruption at many levels and in many shades.
One of the reasons I left Citi back in 2008 was because of Cosco. Bankers and colleagues complained I was biased. As soon as I left, the recommendations changed (3), and a buy was issued on Cosco Holdings by the new coverage analyst. I had tried to reason with them on logic on some other similar plays before I left. But to them Cosco was going to be a big buy recommendation. That the recommendation went sour fast was a sideshow. The key issue was the breakdown of logic and valuation work to anchor the many reports that came out, from this and many other analysts trying to play market sentiment and trading syndicates. Getting some good trades in and moving with the market is certainly worthwhile and something traders can do. Analysts can also participate if they have a way to express trading views. But the actual analytical work is a completely separate exercise.
In the end, it was perhaps Rongsheng, the giant private shipyard based in Jiangsu province, that epitomised the poor work done by many bankers and a total lack of analysis by pretty much all of the deal analysts. The bankers missed key issues in the due diligence, which I wrote on for Transport Trackers at the time. The analysts failed to properly identify the tremendous risks for large investors at the IPO stage. Rongsheng, Cosco and a few other companies tell a very sad story that despite raising massive amounts of ‘free’ money (ie, money that had no concept for the real cost of money), and receiving massive subsidies seen in few other places in the world, these companies were still not able to balance their books within a few years of raising their capital.
I am still hopeful that CSCL can turn itself around more effectively despite some challenges. I also see a silver lining for China’s equity markets long term.
1 See for instance a piece on China and corporate governance and business practices I contributed to the South China Morning Post in 2014.
2 Years earlier Cosco Container Lines/CCoscon and Coscon N America had executed a number of receivable securitisations with Bank of Boston and others. But it was unclear how these had been wound down or carved out. None of these discussions could be had with management. I still have a one page financial statement from Cosco’s parent from the 1990s. The challenge for the accountants was always and constantly a challenge of consolidation of financial statements.
3 In fact most seasoned investors ignore most if not all analyst recommendations. Recommendations are most needed by sales people. More important for all, including bankers, analysts, investors and sales, however, is the trend, and the latest piece of information, wherever it may come from. Markets are not always efficient in acting, but the processing of information by key parties nevertheless remains one of the most important jobs to do somewhere, somehow in the market.