China's Uneasy Billionaires

They’re young, brash and rich—symbols of their nation’s runaway growth.

It isn’t easy to be rich in a communist country. Chen Tianqiao earned his first billion dollars at age 30, after his Shanda Interactive Entertainment Ltd. went public on the Nasdaq Stock Market and its shares quadrupled within seven months. A year and a half later, $1 billion of his net worth evaporated after the stock collapsed as competition heat- ed up in online games.

Still, Chen, who says he wants Shanda to be China’s version of Walt Disney Co., 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 $460 million based on Shanda’s May 8 stock price.

A quarter century after Deng Xiaoping broke with communist or thodoxy, telling his countrymen, “To get rich is glorious,” China has a burgeoning class of tycoons. The country has produced seven billion- aires—who include two former farmers, a blacksmith, an engineer and a one-time ice cream salesman—and 400 entrepreneurs with fortunes of $60 million or more, says Rupert Hoogewerf, 34, 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 & Co. and Capgemini SA. Three hundred million people have been lifted out of poverty since 1978, according to a September United Nations report, and mil- lions 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 Appliance Holdings Ltd. in 1987. Huang, worth $1.7 billion, is now China’s richest man.

The driver of this new wealth is Chi- na’s searing economic growth. China has expanded an average of 10.1 per- cent annually for the past 15 years— propelling it past the U.K. 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 U.S. Cranes tower over its bustling cities. In Beijing alone, 1 billion square feet (92.9 mil- lion square meters) 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 U.S. in the 19th century; everything is up for grabs,” says Chang Sun, 49, who over- sees $700 million of Chinese investments for New York–based private equity firm Warburg Pincus LLC. “There’s a gold rush mentality here.” One major difference is that China is changing at a 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, 50, chief executive officer of International Risk Ltd., a Hong Kong–based consulting firm.

China’s rapid rise could be dangerous. China’s banks, forced for decades to prop up unprofitable state-owned enterprises, are burdened with $164 billion worth of bad loans, according to the country’s banking regulator. A growing in- come disparity between the country’s new rich and its poorest rural peasants has created unrest. Some 200 million Chinese live on less than $1 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 JPMorgan Chase & Co., the third-biggest U.S. bank. “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 in- crease 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 $6 bil- lion, was executed by lethal injection for the 2003 murder of a man who had tried to blackmail him. Over the past three years, two entrepreneurs 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 $940 mil- lion, was jailed in 2003 for 18 years for defrauding share- holders by inflating profits at his Hong Kong–listed company, orchid grower Euro-Asia Agricultural (Holdings) Co. The company was subsequently liquidated. Shanghai Land Holdings Ltd. was delisted from the Hong Kong stock exchange last year after its founder, Zhou Zengyi, was jailed for fraud. “The rich lists become wanted lists because so many fortunes have been made illegally,” says Laurence Brahm, 45, 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 Ltd., 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 percent in the 2.5 years leading up to the handover. Then it plum- meted. On May 8, Citic Pacific shares traded at 25.80 Hong Kong dollars, about half of their price at their peak in August 1997, giving his 18 percent stake a value of $1.25 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 NetEase.com Inc., got rich when the company listed on the Nasdaq Stock Market in June 2000. Its shares then plunged 96 percent 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 NetEase.com 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. In- stead, 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 percent stake in NetEase.com, Ding was worth $1.33 billion on May 8.

Chinese rules, too, can trip up investors. Until last year, Chinese 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 arrangement didn’t impress Mark Mobius, 69, who manages $30 billion of emerging-market funds for Templeton Asset Management Ltd. “When you have a family’s holding that is separate from a listed company, you have a conflict of interest,” says Singapore-based 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 $900 million from the sale. Gome shares rose 4.4 percent the day the acquisition was announced to a one-year high of HK$8.40.

Sometimes, 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 region was where former leader Deng hatched his first capitalist experiments, back when Huang was a child helping his parents work in the rice paddies outside the city of Shantou. Deng set up so-called special economic zones in Shen- zhen and Zhuhai, just across the border from Hong Kong, and later in Shantou itself. Investors from Hong Kong and later Taiwan, attracted by cheap land and labor, 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 salespeople—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 $62 million—a 33 percent increase from 2004—on revenue of $2.2 billion.

Huang runs the company with his wife, Du Juan, 35, a former loan officer at Bank of China Ltd., the country’s second-biggest lender. They’ve also built an unlisted property empire, including 50 percent of Beijing’s 32-story Eagle Plaza, where Huang works out of 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 27 percent this year as of May 8, though it’s still 20 percent below its level of two years earlier. The benchmark Hang Seng Index rose 33 percent in the two years.

One reason the shares have tumbled is that competition is increasing as domestic and international retailers vie for a share of China’s $1 trillion in annual household consumption, says Chris Ruffle, who helps manage $10 billion at Edinburgh-based Martin Currie Investment Management Ltd. and doesn’t own Gome shares. Huang is locked in a price war with three domestic home appliance chains. And he’s being challenged by WalMart Stores Inc., the world’s biggest re- tailer, which has 58 stores in China, and Best Buy Co., the biggest U.S. electronics retailer, which is due to open its first Chinese store by year-end. On May 12, Best Buy announced it would pay $180 million for a majority stake in one of Gome’s rivals, Nanjing, China–based Jiangsu Five Star Appliance Co., which owns 136 stores.

Huang, who drives a BMW 6 Series sedan and works out of a Beijing office suite 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 Huang, a chain smoker who stands 5 feet 6 inches (1.68 meters) tall.

Huang has plans to expand Gome even faster than the 225 stores–a-year pace in 2005. “If you’re going slowly in China, there’s something wrong with your business model,” says Mark Greaves, 49, a director of Gome who runs his own London-based private equity company, Hanson Capital.

China’s retail sales are increasing at 13 percent a year, and by 2014 the country will account for 11 percent of global con- sumption, according to a Credit Suisse Group report. Now, the Chinese government is trying to persuade its citizens to spend more of the $1.7 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 Sun of Warburg Pincus, which has invested $150 million in bonds and warrants that can be converted into a 9.7 percent stake in Gome. “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 auto parts business by leveraging his base in China. Lu’s Wanxiang Group, which employs 40,000 people in China, Germany, the U.K. and the U.S., makes universal joints, transmission systems, bearings and vibration absorbers for customers such as Ford Motor Co. and Delphi Corp., the largest U.S. auto parts maker. Lu—who Hoogewerf estimates is worth $1 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 auto parts makers in Europe and the U.S. and then turns them around by reducing costs. A big part of that is moving some manufacturing to China, where labor is cheaper: An auto parts worker in the U.S. earns about $75,000 a year compared with $3,500 in China, Lu says. Though Chinese productivity and quality are lower, Lu says, he can still undercut U.S. producers’ prices by 20–30 percent even after the cost of shipping the parts. The U.S. 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 percent 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, in 1962 at age 17, opened a bicycle repair shop. He’s exporting China’s brand of capitalism to the U.S. through Elgin, Ohio–based Wanxiang America, which is run by his son-in-law, Pin Ni.

Wanxiang America employs 1,000 people and has already acquired stakes in six U.S. auto parts compa- nies, including closely held Loves Park, Illinois–based Rockford Power- train Inc., a 116-year-old maker of heavy-duty driveline components, and Chicago-based Universal Auto- motive Industries Inc.

Ni says Wanxiang is turning the companies around by applying its own business 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.”

In the U.S., Ni, 42, says, that means sharing the rewards and responsibili- ties with employees. If salespeople come back with business, they get some of the profits, Ni says; if they don’t, they’re only reimbursed for 65 percent 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 every- thing with is investors in his publicly traded company, Wanxiang Qianchao Co., which is listed on the Shenzhen Stock Exchange, the smaller of China’s two domestic stock markets. While closely held Wanxiang Group’s profit rose 60 percent to $262 million last year on sales of $3.11 billion, Wanxiang Qianchao made a net profit of just $17 million—a 10 percent fall from 2004—on sales of $352 million. Its shares are down 14 percent in the two years ended on May 8 compared with an 8 percent rise in the Shen- zhen benchmark A-share index.

Wanxiang Group owns 58.5 percent of Wanxiang Qianchao, according to data compiled by Bloomberg. Wanxiang spokesman Mo Xiaoping declines to say exactly what percentage of the overall business is contained in the public company. “It’s just a small part,” he says.

‘I can’t imagine Ben & Jerry’s moving into hand grenades,’ French says of soft drink mogul Zong’s plan to diversify into defense.

“These entrepreneurs are very aggressive and very ambitious,” JPMorgan 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 auto parts companies. “I think it’s an excellent idea,” says Darrell Butler, 41, managing director of Chicago-based investment bank Billow Butler & Co. “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 correctly on technologies tied to the Internet. For Ding, that meant massively multi- player online role-playing games, or MMORPGs. These games allow thousands of users to interact in a virtual world by assuming roles of characters, acquiring weapons such as swords and sometimes killing each other. The games, most of which are martial arts or Chinese history themed, are so popular with teenagers that NetEase.com and other companies have agreed to limit the amount of 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 pop- ular game, Fantasy West- ward Journey, which is based on a mythical Chinese monkey king.

In an April 21 report, Credit Suisse estimated the value of China’s online gam- ing market would soar 39 percent this year to $886 million and could soon reach $3 billion. The number of online game players will double to 80 million in 2010 from 40 million this year, according to Shanghai- based Internet research firm iResearch Inc.

Mary Meeker, New York–based head of technology re- search at Morgan Stanley, says she likes the way Ding has created original games rather than selling foreign-developed products and says the Chinese gaming industry has a real chance of becoming a global business, with some games pos- sibly achieving the success of those of Nintendo Co. that feature the Mario character. “One can’t rule out that in the next five to 10 years, a Chinese developer could create a global hit,” Meeker says.

‘These days, the spirit of capitalism is stronger in China than it is in America,’ Wanxiang America’s Pin Ni says.

Doing, whose father was an engineer, grew up in Cheng- du, 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 went to a little-known local college, Chengdu’s University of Electronic Science and Technology, where he obtained a bachelor of science degree in electrical engineering. He worked for two years at a local telecommunications company and then became a program- mer for the Chinese unit of Dublin, California–based Sybase Inc., a company that makes database software that stores and finds information.

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 Hotmail-style free e-mail service in Chinese and English. So in 1997, with a staff of 20, he founded NetEase.com and then expanded from e-mail to online auctions, chat rooms, personalized Web sites, instant messaging and Web hosting.

His most successful products were games. He decided to base them on the Chinese mythology and martial arts that fas- cinated him as a child. Ding, who likes to play online games himself, says he also saw an educational opportunity. “Our edu- cation system currently doesn’t emphasize traditional Chinese culture enough,” Ding says in his 19th-floor headquarters in Beijing’s Oriental Plaza, an office and retail development a block from Tiananmen Square. “The current generation of parents is too busy. Plus, these parents themselves are by- products of a previous generation that grew up when China was enduring the Cultural Revolution and education was completely stopped.”

Games accounted for 84 percent of the company’s $114 million profit last year, and Ding says he aims to spend $420 million on online games and acquisitions. Ding, who’s unmarried, spends his spare time swimming or travel- ing around China’s more-remote regions and 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 Ltd., died after a long illness at the age of 37. “I can’t say I like being CEO." Ding says. “It’s full of stress.”

Zong Qinghou, 60, who sells beverages and yogurt in China in partnership with Paris-based Groupe Danone, has no such qualms about running an empire. Until 1979, Zong says, his entre- preneurial instincts were sup- pressed. He worked as a farmer and then managed a state factory where he experimented at

manufacturing 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, while chain-smoking and drink- ing coffee in a Beijing restaurant. “People like me were constantly punished. Deng Xiaoping liberated us.”

Zong’s billion-dollar idea came when he was selling ice cream on a commission basis. He decided that China's one-child policy had spawned a generation of spoiled children who were too picky about food. He invented a nutritional drink based on Chinese herbs. “With 300 million children, the potential was huge,” says Zong, who called the company he founded Hangzhou Wahaha Beverage Co.

Ding’s games are so popular that NetEase.com and its rivals have agreed to limit the time teenagers can stay on line playing them.

Zong expanded into juices and mineral water. Then, in 1996, he formed the joint venture with Danone, which has so far in- vested $100 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 in- vestment. “Mr. Zong is an outstanding entrepreneur who has unique insights into how to grow the China market,” he says.

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

Now, Zong says he plans to diversify: He’ll invest $500 million in new areas, including oil, coal and other com- modities China consumes in vast quantities. He says he’s even thinking of betting on defense contracts, follow- ing a decision by the People’s Liberation Army this year to open its procurement process to private contractors who can supply products rang- ing from battlefield weapons to dairy products. The 2 mil- lion–strong PLA spends $35 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 yogurt 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 pro- vider in China, its stock was the best overall performer on the Nasdaq, soaring to $44.30 in December 2004 from $11 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 traded at $12.86 on May 8.

One investor that hasn’t bailed out is San Jose, California–based Cisco Systems Inc., which owns a 9.7 percent stake, worth $88 million based on the May 8 stock price. “We have done well out of it,” says Dan Scheinman, Cisco’s senior vice president of business development. Scheinman, 43, declined to disclose Cisco’s initial investment, made through the Softbank Asia Infrastructure Fund, a unit of Japanese Internet incubator Softbank Corp.

Chen, an economics gradu- ate of Shanghai’s prestigious Fudan University who learned near-fluent English with the help of his schoolteacher moth- er, began his working life as an executive with a government- owned property company.

A fan of Walt Disney Co. and an enthusiastic computer game player, Chen says he saw the fascination for the Internet among young Chinese and decided to use the new technology to provide entertainment. “My games are virtual Disney- lands,” he says.

Chen founded Shanda in 1999 with $70,000 raised from family and friends and began producing cartoons for the Internet. That business was doomed, he says, because the cartoons were often pirated. The answer to piracy, he discovered, was online games, which could not be copied as easily.

What changed his luck, he says, was when he played a Kore- an role-playing martial arts game called The Legend of Mir 11. In November 2001, he bet the company’s last $300,000 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, another martial arts epic.

Chen, whose net worth reached $1.5 billion at its peak, says wealth hasn’t changed his life. Until his wife gave birth to a daughter two years ago, they lived with his parents in a 1,500-square-foot apartment. He drives an Audi A8 sedan. “I like it because it’s not so high profile,” Chen says.

Shanda is facing increasing competition from Net- Ease.com and other companies battling for the attention of 26 million gamers who typically pay $4–$6 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 Corp. to pro- duce a system that lets subscribers use televisions to go online or watch videos on computers. Chen has also started offering three of his eight role-playing games free to attract more users.

He’s also diversifying into movies and music, in hopes of reducing Shanda’s reliance on game revenue to 50 percent from 80 per- cent now. In May, Shanda reported first-quarter profit had fallen 95 percent to $1.47 million from $27.5 million a year earlier. “It’s a drastic move,” says Dick Wei, a Hong Kong–based analyst at JPMorgan Securities Inc., who has an “underweight” rating on the stock. “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 $150 million private equity fund that invests in Chinese entrepreneurs in hopes of finding the billionaires of tomorrow. One bet, Singapore-listed Celestial NutriFoods Ltd., which makes soybean-based products, tripled in price from December, when Mobius’s Templeton took a stake, to May 8. The stake of 42-year-old founder Ming Dequan is worth $215 million.

Jonathan Bell, who manages $10 billion of emerging-market shares at Pictet Asset Management in London, is also throwing in his lot with private entrepreneurs. “You get exposure to the best and brightest in China,” says Bell, 33, who bought NetEase.com stock in January. “They’re absolute risk takers. They’ve grown a business organically against incredible odds in many cases.”

Never has an economy this big grown this fast for so long. Investors who decide to sit on the sidelines and watch while China’s entrepreneurs follow their uneasy course toward wealth are taking a risk, too. As China creates its new class of billion- aires, they could miss out on glorious riches.

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