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China's Uneasy Billionaires

'To get rich is glorious,' said Deng Xiaoping. But it's also risky. William Mellor and Allen Cheng report on China's chief capitalists.

IT ISN'T easy to be rich in a communist country.

Chen Tianqiao earned his first $US1 billion ($1.3 billion) at age 30, after his Shanda Interactive Entertainment went public on the US Nasdaq stockmarket and its shares quadrupled within seven months. A year and a half later, $US1 billion of his net worth evaporated after the stock collapsed as competition heated up in online games.

Still, Chen, who says he wants Shanda to be China's version of Walt Disney, is one of the luckiest of the country's rich. Other wealthy Chinese have ended up bankrupt, in jail or dead. "Some disappear," says Chen, who's worth about $US500 million based on Shanda's share price this week.

A quarter century after Deng Xiaoping broke with communist orthodoxy, telling his countrymen, "To get rich is glorious", China has a burgeoning class of tycoons. The country has produced seven billionaires - who include two ex-farmers, a blacksmith and an engineer - and 400 entrepreneurs with fortunes of $US60 million or more, says Rupert Hoogewerf, a Shanghai-based British accountant who compiles the Hurun Report, a list of China's richest people.

China also has 300,000 millionaires, according to the World Wealth Report compiled by Merrill Lynch and Cap Gemini. Since 1978, 300 million people have been lifted out of poverty, a United Nations report says, and millions more are starting businesses in hopes of joining the country's rapidly expanding plutocracy.

"In China today, even the poor are richer than the richest people were when I was a boy," says entrepreneur Huang Guangyu, 37, a peasant's son who founded retailer Gome Electrical in 1987. Huang, worth $US1.7 billion, is now China's richest man.

The driver of this new wealth is China's searing economic growth. China has expanded an average of 10.1 per cent a year for the past 15 years - propelling it past the UK to become the world's fourth-biggest economy. China is the world's largest consumer of everything from iron to cement, to wheat, to mobile phones. Its 1.3 billion people are the world's No.2 users of the internet, second only to the US. Cranes tower over its bustling cities.

In Beijing alone, 92.9 million square metres of office and residential space is under construction - the equivalent of three Manhattans, says Jack Rodman, Beijing-based partner at consulting firm Ernst & Young.

As China hurtles toward capitalist prosperity, it's spawning a class of entrepreneurs and foreign investors hoping for big payoffs. "This is like the robber baron age in the US in the 19th century; everything is up for grabs," says Chang Sun, who oversees Chinese investments for New York private equity firm Warburg Pincus. "There's a gold rush mentality here."

One major difference is that China is changing at breakneck pace. "You are being caught up in an industrial revolution that's taking place at 10 times the speed it occurred in the West," says Steve Vickers, chief executive officer of International Risk, a Hong Kong consulting firm.

China's rapid rise could be dangerous. Its banks, forced for decades to prop up unprofitable state-owned enterprises, are burdened with $US164 billion in bad loans, according to the country's banking regulator.

A growing income disparity between the country's new rich and its poorest rural peasants has created unrest. Some 200 million Chinese live on less than $US1 a day, according to 2004 World Bank estimates.

At the same time, China ranks third in the world in sales of luxury goods, says Jing Ulrich, chairman of Chinese equities at JP Morgan Chase. "That's a stark contrast, and I don't expect the gap to close," Ulrich says. "Foreign investors must factor in this risk when investing in China."

Last year, there were 87,000 protests involving more than 100 people - an eightfold increase since 1994, according to China's Ministry of Public Security. Many were over farmers' land being seized by corrupt officials for sale to developers.

Such disparity can breed envy, or worse. In March, Yuan Baojing, 42, a former stockbroker who acquired 60 companies and who Hoogewerf says may have been worth $US6 billion, was executed by lethal injection for the 2003 murder of a man who had tried to blackmail him. In the past three years, two millionaires have been murdered and at least two have committed suicide.

Despite Deng's exhortation, wealth and glory don't necessarily go hand in hand in China. Yang Bin, 43, who in 2001 was China's second-richest man with a fortune of $US940 million, was jailed in 2003 for 18 years for defraud-

ing shareholders by inflating profits at his Hong Kong-listed company, orchid grower Euro-Asia Agricultural. The company was later liquidated.

Shanghai Land was delisted from the Hong Kong Stock Exchange last year after its founder, Zhou Zhengyi, was jailed for fraud. "The rich lists become wanted lists because so many fortunes have been made illegally," says Laurence Brahm, a Beijing-based American lawyer, consultant and author of books on doing business in China.

An entrepreneur's bona fides are no guarantee of success. Investors flocked to Citic Pacific, controlled by China's state-run investment company, before Hong Kong's handover to China in 1997 because of Citic's guanxi, or connections to officials in Beijing. Chairman Larry Yung, 64, a former official in China's Ministry of Electric Power, is the son of a former vice-president of China.

The stock soared 250 per cent in the 2½years before the handover. Then it plummeted. On May 22, Citic Pacific shares traded at $HK23.65, about half of their price at their peak in 1997, giving his 18 per cent stake a value of $US1.2 billion.

As Chinese companies get used to the rules of Western capitalism, they can take investors on a bumpy ride. William Ding, 34, founder of internet firm, got rich when the company listed on the Nasdaq in June 2000. Its shares then plunged 96 per cent in 13 months, more than twice the Nasdaq's post-bubble decline.

In September 2001, Nasdaq suspended trading in the stock for four months after failed to file an annual report and then had to twice restate its earnings.

During the turmoil, Ding and his board attempted to sell out but were unable to find a suitable buyer, he said in a statement at the time. Instead, Ding replaced his CEO, posted a profit the following year and has since seen the stock price rise 13-fold, scandal free. Based on his 46 per cent stake in, Ding was worth $US1.23 billion this week.

Chinese rules, too, can trip up investors. Until last year, authorities declined to give Gome's Huang permission to list all of his company on the stock exchange. So he kept one-third of Gome's stores in a private, family run company while the rest were held by his public company.

That didn't impress Mark Mobius, who runs emerging market funds for Templeton Asset Management. "When you have a family's holding that is separate from a listed company, you have a conflict of interest," says Mobius, whose funds own 1 per cent of Gome's stock.

This year, Huang got Government approval to sell the remaining stores to the public company, earning $US900 million from the sale. Gome shares rose 4.4 per cent the day the acquisition was announced to a one-year high of $HK8.40.

Success can be hastened by something as simple as being in the right place at the right time. Huang had the good fortune to be born in 1969 in Guangdong, the southern province adjacent to Hong Kong.

That was where then leader Deng hatched his first capitalist experiments, back when Huang was a child helping his parents work the rice paddies outside the city of Shantou. Deng set up so-called special economic zones in Shenzhen and Zhuhai, just across the border from Hong Kong, and later in Shantou itself. Investors from Hong Kong and later Taiwan, lured by cheap land and labour, came to set up factories.

Manufacturers first concentrated on making simple home appliances, most of which were in short supply in northern China, particularly in Beijing.

When Huang left school at 16, he spotted an opportunity. He took samples of radios, batteries and other small electrical goods to the capital and collected orders from retailers there that he filled back in Guangdong.

Two years later, Huang, working with his older brother Huang Junqin, had made enough money as a middleman to buy a clothes shop in Beijing named Gome, which means "beautiful country".

Huang switched to electrical appliances, using his connections in Guangdong to gain access to the scarce inventory. And he invited manufacturers to take space in his stores and staff the shops-within-shops with their own sales people - saving him the cost of their salaries.

Today, Gome runs 523 stores across China and plans to add as many as 200 more this year. Last year, Gome made a profit of $US62 million - a 33 per cent increase from 2004 - on revenue of $US2.2 billion.

Huang runs the company with his wife, Du Juan, 35, a former loan officer at Bank of China, the country's second-biggest lender.

They've also built an unlisted property empire, including 50 per cent of Beijing's 32-storey Eagle Plaza, where Huang works on the 18th floor - a supposedly lucky number because 18 in the Chaozhou dialect is sop ba, which sounds like "getting rich". Brother Junqin, 39, owns the other half of the building.

So far, Huang has delivered more for himself than he has for investors. The stock is up 23 per cent this year, but only 9 per cent above its level of two years earlier. The benchmark Hang Seng index rose 37 per cent in that time.

One reason the shares have underperformed is that competition is increasing as domestic and international retailers vie for a share of China's $US1 trillion in annual household consumption, says Chris Ruffle, a fund manager at Edinburgh-based Martin Currie Investment Management.

Huang is locked in a price war with three domestic home appliance chains. And he's being challenged by Wal-Mart Stores, the world's biggest retailer, which has 58 stores in China, and Best Buy, the biggest US electronics retailer, which hopes to open its first Chinese store this year. On May 12, Best Buy announced it would pay $US180 million for a majority stake in one of Gome's rivals, Nanjing-based Jiangsu Five Star Appliance, which owns 136 stores.

Huang, who drives a luxurious BMW and works out of a Beijing office that contains a double bedroom, says he's not intimidated. "Gome gives its rivals far more pressure, so it isn't me who's suffering from insomnia," says the chain-smoking Huang.

He plans to expand Gome quickly. "If you're going slowly in China, there's something wrong with your business model," says Gome director Mark Greaves, who runs his own London-based private equity company, Hanson Capital.

China's retail sales are rising 13 per cent a year, and by 2014 the country will account for 11 per cent of global consumption, according to a Credit Suisse report.

Now, the Chinese Government is trying to persuade its citizens to spend more of the $US1.7 trillion they've amassed in savings in an effort to make the economy less dependent on exports and fixed-asset investment.

"Gome has a very good brand name and a good customer base," says Warburg Pincus's Sun. "Yes it's a competitive market but the real question is who's going to win the competition."

Lu Guanqiu, 61, is taking on rivals in the global car-parts business by leveraging his base in China. His Wanxiang Group, which employs 40,000 people in China, Germany, the UK and the US, makes universal joints, transmissions systems, bearings and vibration absorbers for customers such as Ford and Delphi, the largest US car-parts maker.

Lu - who Hoogewerf estimates is worth $US1 billion - says he wants to acquire units of Delphi, which sought Chapter 11 bankruptcy protection last October. "If we had an opportunity, of course we would buy," he says. Delphi says it's not in talks with Lu.

Lu buys troubled car-parts makers in Europe and the US and turns them around by reducing costs. A big part of that is moving some manufacturing to China, where labour is cheaper: for car-parts workers, annual pay in the US is about $US75,000 compared with $US3500 in China, Lu says.

Although Chinese productivity and quality are lower, Lu says, he can still undercut US producers' prices by 20-30 per cent even after shipping costs.

The US campaign to force China to allow its currency, the yuan, to increase in value is a threat to that strategy, he says. Anything more than a 10 per cent increase would wipe out his profits from exports unless he increased prices, he says.

Lu, who was born in Hangzhou, in Zhejiang province, trained as a blacksmith and then opened a bicycle repair shop in 1962, aged 17. He's exporting China's brand of capitalism to the US through Wanxiang America, which is run by his son-in-law, Pin Ni.

Wanxiang America employs 1000 people and has already acquired stakes in six US car-parts companies, including closely held Rockford Powertrain, a 116-year-old maker of heavy duty driveline components, and Universal Automotive Industries.

Ni says Wanxiang is turning the companies around by applying its own philosophy as it cuts costs. "These days the spirit of capitalism is stronger in China than it is in America," Ni says. "Mr Lu represents that spirit."

Ni, 42, says that in the US, this means sharing the rewards and responsibilities with employees. If sales people come back with business, they get some of the profits, Ni says; if they don't, they're only reimbursed for 65 per cent of their travel expenses.

"It's basic stuff - we share together," he says. "It's show me the money, and if you succeed, you are a hero. If you don't, you share in the costs."

One group Lu isn't sharing everything with is investors in his publicly traded company, Wanxiang Qianchao, which is listed on the Shenzhen Stock Exchange, the smaller of China's two domestic stockmarkets.

While closely held Wanxiang Group's profit rose 60 per cent to $US262 million last year on sales of $US3.11 billion, Wanxiang Qianchao made a net profit of just $US17 million - a 10 per cent fall from 2004 - on sales of $US352 million.

Its shares are up 19 per cent for the past two years compared with a 22 per cent rise in the Shenzhen benchmark A-share index. Wanxiang Group owns 58.5 per cent of Wanxiang Qianchao.

"These entrepreneurs are very aggressive and very ambitious," JP Morgan Chase's Ulrich says. "But the question is whether they leave enough on the table for their minority shareholders."

Next, Ni plans to raise money from investors for a private equity fund run by Wanxiang Group that will buy car-parts companies. "I think it's an excellent idea," says Darrell Butler, managing director of Chicago-based investment bank Billow Butler. "He's allowing old-line manufacturers the opportunity to exit their businesses at a fair price that many domestic players cannot or will not pay."

Some of China's most successful entrepreneurs earned their 10-figure fortunes by betting on internet technologies. For Ding, that meant massively multiplayer online role-playing games, or MMORPGs. These allow thousands of users to interact by assuming character roles, acquiring weapons and sometimes killing each other.

The games are so popular with teenagers that and other companies have agreed to limit the time players can stay on line by cutting the number of points they can earn after three hours. More than 1.5 million people play Ding's most popular game, Fantasy Westward Journey, which is based on the myth of a Chinese monkey king.

Credit Suisse has estimated the value of China's online gaming market would soar 39 per cent this year to $US886 million and could soon reach $US3 billion. The number of online game players will double to 80 million in 2010 from 40 million this year, according to Shanghai internet research firm iResearch.

Mary Meeker, head of technology research at Morgan Stanley in New York, says she likes the way Ding has created original games rather than selling foreign products and says the Chinese gaming industry could become a global business.

Ding, whose father was an engineer, grew up in Chengdu, the capital of Sichuan province, during the Cultural Revolution. Ding's passion was electronics. He worshipped Thomas Edison and Albert Einstein. By the time he was 16, he says, he had assembled six transistor radios.

On leaving high school, he obtained a degree in electrical engineering. He worked for two years at a local telecommunications company and then became a programmer for the Chinese unit of Sybase, a Californian company that makes database software.

The internet was just coming to China at the time, and the Government was encouraging the industry. Ding says he saw an opportunity to offer the first free email service in Chinese and English.

So in 1997, with a staff of 20, he founded and then expanded from email to online auctions, chat rooms, personalised websites, instant messaging and web hosting.

His most successful products were games. He decided to base them on the Chinese mythology and martial arts he loved as a child. Ding, who likes to play online games himself, says he also saw an educational opportunity.

"Our education system currently doesn't emphasise traditional Chinese culture enough," Ding says in his headquarters in Beijing's Oriental Plaza, a block from Tiananmen Square.

"The current generation of parents is too busy. Plus, these parents themselves are byproducts of a previous generation that grew up when China was enduring the Cultural Revolution and education was completely stopped."

Games yielded 84 per cent of the company's $US114 million profit last year, and Ding says he aims to spend $US420 million on online games and acquisitions.

Ding says he's a reluctant billionaire. He answers questions slowly, his eyes thoughtful behind thick-lensed glasses.

He says he's tried twice to relinquish the CEO job to professional managers and both times has had to take it up again. The most recent case was last year, when chief executive Ted Sun, a former managing director of Bear Stearns Asia, died after a long illness. "I can't say I like being CEO," Ding says. "It's full of stress."

Zong Qinghou, 60, who sells beverages and yoghurt in China in partnership with Groupe Danone of France, has no such qualms about running an empire. Until 1979, Zong says, his entrepreneurial instincts were suppressed.

He worked as a farmer and then managed a state factory where he experimented making fans and electronic watches.

A descendant of government officials who had served the Qing dynasty, which ruled from 1644 to 1911, he says the Communist Party long considered him a "black element".

"I wasn't born well," he says with a laugh. "People like me were constantly punished. Deng Xiaoping liberated us."

Now, with a fortune Hoogewerf estimates at $US800 million, Zong could be China's next billionaire. His big idea came when he was selling ice-cream on commission. He decided China's one-child policy had spawned a generation of spoiled children who were too fussy about food.

He invented a nutritional drink based on Chinese herbs. "With 300 million children, the potential was huge," says Zong.

His company, Hangzhou Wahaha Beverage Co, then expanded into juices and mineral water. Then, in 1996, he formed the joint venture with Danone, which has so far invested $US100 million, Zong says.

"The joint venture has been very successful - profitable since day one," Danone China president Peng Qin says. He declines to confirm the size of Danone's investment. "Mr Zong is an outstanding entrepreneur who has unique insights into how to grow the China market," he says.

Zong pioneered yoghurt drinks in China in the 1990s and has stayed ahead of competition by developing new products, says Paul French, a director of market research firm Access Asia.

Zong now says he plans to diversify: he'll invest $US500 million in new areas, including oil, coal and other commodities China consumes in vast quantities. He says he's even thinking of betting on defence contracts, following a decision by the People's Liberation Army this year to open procurement to private contractors.

The 2 million-strong PLA spends $US35 billion a year on payroll and procurement, according to the official government newspaper, China Daily.

All that might be a leap too far, French says. "You just think 'Ugh!' as a westerner, that his diversification strategy doesn't sound like a good idea," he says. "I can't imagine McDonnell Douglas moving into yoghurt or Ben & Jerry's moving into hand grenades."

The fluctuating fortunes of Chen's Shanda Interactive show how a change of strategy can affect a Chinese company and its investors. When Shanda was just the No.1 online games provider in China, its stock was the best overall performer on the Nasdaq, soaring to $US44.30 in December 2004 from $US11 at its listing in May of the same year.

After Shanda announced it was expanding to sell movies and music as well as games, the share price plunged. The stock was trading at $US14.68 this week.

One investor that hasn't bailed out is California's Cisco, which owns a 9.7 per cent stake, worth $US101 million based on recent share prices.

"We have done well out of it," says Dan Scheinman, Cisco's senior vice-president of business development. Scheinman declined to disclose Cisco's initial investment.

Chen, an economics graduate who learned near-fluent English with the help of his schoolteacher mother, began his working life as an executive with a government-owned property company.

A fan of Walt Disney and an enthusiastic computer game player, Chen says he saw the fascination for the internet among young Chinese and decided to use it to provide entertainment.

Chen founded Shanda in 1999 with $US70,000 raised from family and friends and began producing cartoons for the internet. That business was doomed, he says, because the cartoons were often pirated. He found the answer to piracy was online games, which could not be copied as easily.

What changed his luck, he says, was when he played a Korean role-playing martial arts game called The Legend of Mir 11. In November 2001, he bet the company's last $US300,000 to license the game. Two months later Shanda turned its first profit, he says.

In 2004, Legend of Mir was the most popular online game in China. Shanda began developing some of its own games, including World of Legend.

Chen, whose net worth reached $US1.5 billion at its peak, says wealth hasn't changed his life. Until his wife had a daughter two years ago, they lived with his parents in a 140 square metre apartment.

Shanda faces increasing competition from companies battling for the attention of 26 million gamers, who typically pay $US4 to $US6 a month to play. Shanda's average number of customers fell to 548,000 in the fourth quarter of 2005 from 763,000 in the second quarter. "Everyone is trying to kill the other person," Chen says.

Chen has responded by linking with Intel to produce a system that lets subscribers use televisions to go online or watch videos on computers. He has also started offering three of his eight role-playing games free to attract more users.

He's also diversifying into movies and music, hoping to reduce reliance on game revenue to 50 per cent from 80 per cent now. In May, Shanda reported first-quarter profit had fallen 95 per cent to $US1.47 million from $US27.5 million a year earlier.

"It's a drastic move," says Dick Wei, an analyst at JP Morgan Securities. "But I remain long-term positive. He has a grand vision."

Vision is what everyone is looking for in China. Mobius says he prefers China's state companies to private ones because there are fewer scandals. Even so, he presides over a private equity fund that invests in Chinese entrepreneurs in hopes of finding the billionaires of tomorrow.

One bet, Singapore-listed Celestial NutriFoods, which makes soybean products, has almost tripled in price this year. The stake of 42-year-old founder Ming Dequan is worth $US160 million.

Never has an economy this big grown this fast for so long. Investors who merely look on while China's entrepreneurs follow their uneasy course toward wealth are taking a risk too. As China creates its new class of billionaires, they could miss out on glorious riches.

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