CITIC Pacific Ltd.

Level 35, Two Pacific Place
88 Queensway
Hong Kong
(852) 2820 2111 Fax: (852) 2877 2771
Web site: http://www.citicpacific.com

Public Company
Incorporated: 1990
Employees: 5,000
Sales: HK$10.836 billion (1995)
Stock Exchanges: Hong Kong
SICs: 5012 Automobiles & Other Vehicles; 4899 Communications Services, Not Elsewhere Classified; 6552 Subdividers & Developers, Not Elsewhere Classified

In less than a decade, CITIC Pacific Ltd. has become the premier “hong” in Hong Kong, challenging the leadership of that territory’s four largest trading houses. But CITIC Pacific is not the typical British-controlled conglomerate that has dominated Hong Kong’s economy for the past century. Until 1996, CITIC Pacific was 43 percent controlled by private CITIC Hong Kong, which in turn is 100 percent controlled by the ruling cabinet of the People’s Republic of China and its foreign investment company China International Trust and Investment Corporation (CITIC). From its formation as a largely passive investment vehicle—a so-called “red-chip” stock that gave investors financial and political ties to China’s ruling party—CITIC Pacific has matured into a capitalist powerhouse with primary interests in infrastructure, real estate, trading and distribution, and Hong Kong’s aviation industry. In its rise, CITIC Pacific has enjoyed a unique relationship with the mainland: its chairman, Larry Yung Chi-kin, is the son of China’s vice-president and “red capitalist” Rong Yiren (Yung and Rong are different English transliterations of the same family name), himself a close ally of Deng Xiaoping, who died in early 1997. But CITIC Pacific is no puppet of the Chinese government; rather, Yung and CITIC Pacific have enjoyed from the company’s inception an independence crucial to establishing CITIC Pacific as the soon-to-be former colony’s top investment play. At the end of 1996, CITIC Pacific achieved still greater independence, when Yung and other management purchased an additional 15.5 percent of the company’s shares from its Chinese parent, reducing CITIC Hong Kong’s control to 26.5 percent. Yung took the majority of these shares, raising his own stake in the company to more than 18 percent.

Launched by Chinese Economic Reform in the 1980s

The China International Trust and Investment Corporation was established in 1979 as the first step in Deng Xiaoping’s “open door policy” of economic reform. Deng chose Rong Yiren to form and lead CITIC, which would become China’s primary domestic and foreign investment vehicle. Rong’s own history was steeped in capitalism. Before the communist takeover in 1949, the Rongs had been one of Shanghai’s wealthiest families, with control over much of that region’s textile industry. Most of the Rong family left China when the communists took over, but Rong—who did not himself join the communist party—stayed in Shanghai and worked with the new government. Rong, and son Yung Chi-kin, were able to maintain much of their wealth through the 1950s. But the Cultural Revolution of the mid-1960s saw the family fall from grace. Rong was stripped of his property and son Yung was sent off to be “re-educated,” doing hard labor on collective farms in remote regions of the country.

The family’s fortunes revived with Deng Xiaoping’s rise to power. Rong and Yung were rehabilitated in 1972, and their personal property was restored to them. Yung went to Stanford to study business; in 1978, he moved to Hong Kong, where he ran a small company that manufactured electronic watch movements. While his father was launching CITIC, Yung was enjoying success as an entrepreneur: together with a group of Chinese and American friends, Yung invested in a small software company in California. That company merged with another software company, going public in 1984. Yung sold his shares in the company, netting US$50 million.

As talks between the British and Chinese governments finalized plans to return Hong Kong to Chinese control, CITIC launched its CITIC Hong Kong investment subsidiary. In 1987, Yung was placed in charge of the new company, with US$30 million in startup funds. From the outset, Yung insisted upon—and received—a large degree of independence, including the ability to make local investment decisions and the ability to hire his choice of management, giving Yung a unique position among other Chinese government-controlled companies. Under Yung, CITIC HK bought large shares of two primary Hong Kong businesses, Cathay Airlines and Hong Kong Telecommunications. Named CITIC HK’s managing director, Yung was able to make these and other purchases at deeply discounted prices—with China’s looming return to control, Hong Kong businesses were eager to establish ties with the government. And CITIC HK offered an attractive route to China’s State Council, especially once Rong Yiren was named the country’s vice president.

CITIC HK operated primarily as a passive investment vehicle. But China needed to go beyond regaining governmental control of Hong Kong, it needed to establish itself as a force in the powerful Hong Kong economy, and this meant taking a place in the territory’s stock market. Yung took a backdoor to the market in 1990, when CITIC HK bought an inactive but listed holding company, Tylfull Co. Ltd. CITIC HK placed some of its assets, including shares of Cathay and Hong Kong Telecom, into the public company and renamed it as CITIC Pacific Ltd. The company quickly added to its holdings, building its share of Cathay Airlines—Hong Kong’s premier international airline—to 12.5 percent; gaining 38.3 percent of Hong Kong Dragon Airlines, known as Dragonair, which was partly owned by Cathay and was the premier airline carrier along Hong Kong-China routes; and buying 20 percent of Macau Telephone. In addition to these investments, CITIC Pacific quickly established the second of its principal focus markets, buying up HK$647 million of Hong Kong real estate properties.

Top “Hong” in the 1990s

CITIC Pacific’s ambitions went beyond simply building a portfolio of passive investments, however. In order to gain position in the Hong Kong economy, CITIC Pacific would need to establish itself as one of the territory’s “hongs,” or trading houses. The four principal hongs, Jardine Matheson, Hutchison Whampoa, Swire Pacific, and Wharf Holdings, were all conglomerates rooted in British control (although Hutchison and Wharf were by then run by Hong Kong entrepreneurs), with interests ranging widely beyond trading into the colony’s infrastructure, manufacturing, and real estate. In order to achieve hong status, CITIC Pacific needed to diversify into more active holdings. The company took the first step toward that end in October 1991, when it took a 36 percent share in a consortium organized to make a HK$7 billion purchase of the private Hang Chong company. Hang Chong, itself a smaller version of a hong, had extensive real estate holdings in Hong Kong, as well as in Japan and the United States. But CITIC Pacific’s real interest was in Hang Chong’s primary subsidiary, Dah Chong Heng, with food and shipping interests, and a chain of 40 car dealerships that controlled 40 percent of the Hong Kong automobile market. CITIC Pacific’s 36 percent interest in Hang Chong quadrupled the company’s net assets.

Three months later, CITIC Pacific bought out the other members of the consortium (which included ultimate parent CITIC) and gained a more than 97 percent share of Hang Chong. Under terms of the deal, valued at HK$3 billion (US$385 million), CITIC Pacific also bought an additional 7.8 percent of Dragonair from CITIC, boosting CITIC Pacific’s share of the airline to 46.1 percent, for HK$93 million (US$12 million). The company’s sales, which had reached HK$118 million in 1991, skyrocketed to HK$7.8 billion in 1992. Net profits for the year were up 212 percent, to HK$1.2 billion.

The move was seen as a major step forward in China’s economic stake in Hong Kong. It could also been seen as some assurance that the mainland would honor its commitment to the “one country, two systems” policy that was to govern the return of Hong Kong in 1997. With its large stake in Hong Kong’s market, China would be less likely to dismantle the territory’s economy. In turn, CITIC Pacific enhanced CITIC’s credibility with the international financial community. Banks were reluctant to lend to the Chinese government; with CITIC Pacific, however, China had the opportunity to prove its integrity to investors. At the same time, investments in CITIC Pacific offered a more stable method of investing in the mainland. In January 1993, CITIC Pacific’s position as the leading “red chip” (a term given to Hong Kong listed companies that were attractive investments because they were controlled by mainland parent companies, thereby giving investors entry into the mainland’s political and economic arenas) enabled it to raise HK$7.2 billion. By then, however, CITIC Pacific had also turned “blue,” after it was added to the territory’s Hang Seng Index of blue chip stocks.

CITIC Pacific used that money to purchase a 12 percent share in Hong Kong Telecom from CITIC HK. Under terms of the deal, CITIC HK increased its ownership of CITIC Pacific to 46 percent; CITIC Pacific received a HK$3.3 billion loan from CITIC HK, as well as controlling shares in two mainland power plants and a 20 percent share in Hong Kong’s Chemical Waste Treatment Centre. CITIC Pacific also made a separate purchase of a 51 percent share of the Shanghai Children’s Food Factory. In another deal, the company entered a joint-venture with Swire for HK$2.85 billion real estate purchase in Hong Kong’s Yau Yat Chuen area. In June 1993, CITIC Pacific also purchased a 20 percent stake in Chase Manhattan Bank’s Manhattan Card Co. Hong Kong credit card business. Apart from further diversifying CITIC Pacific’s assets, these deals helped boost the company’s market capitalization to HK$24 billion, placing it in the top 20 of Hong Kong companies. The success of CITIC Pacific was also encouraging other China-backed companies to move into the Hong Kong market, a development that would soon come to haunt CITIC Pacific.

In the meantime, CITIC Pacific continued its aggressive expansion. With sales topping HK$10 billion for 1993, the company paid HK$3.06 billion (US$390 million) for a 50 percent share of a residential development on Hong Kong’s Discovery Bay island. The company was also active on the infrastructure front, paying HK$104 million (US$13.3 million) for 25 percent of the Western Harbour Crossing, a tunnel project linking Hong Kong with the territory’s Kowloon airport. The company also acquired 28.5 percent of another Hong Kong tunnel project, the Eastern Harbour Crossing, as well as gaining 50 percent of a mainland tunnel, in Shanghai. These moves were also seen as part of CITIC Pacific’s attempt to counter criticism that the company was still not much more than a holding company for passive investments. The company slowed its acquisition growth to concentrate on taking a more active management role in the tunnel projects and its Hang Chong subsidiary. Revenues continued to grow, topping HK$12 billion in 1994. The diversity of CITIC Pacific’s projects, which by then included a joint-venture with Japan’s Isuzu to build cars and light trucks on the mainland, as well as a 20 percent stake in a joint venture to build an airport railway system, seemed to have finally elevated the company to true hong status.

Not all of CITIC Pacific’s critics were convinced, however. Analysts faulted the company for having no clear investment strategy. And the company’s trading subsidiary, Dah Chong Hong, in which CITIC Pacific had taken its most active management role, was suffering heavy losses. Nevertheless, the company continued to attract investors, in part because of its close ties with China’s government; at the same time, however, the company—and Yung—were widely praised for refusing to exploit the political clout of its parent, relying instead on its own entrepreneurial skills to build the company. But competition from other mainland-backed companies was heating up, and as its position as the premier China investment vehicle came under attack, CITIC Pacific needed to step up its entrepreneurial activities. In 1995, the company began reducing its stake in its more passive holdings, such as Cathay Airlines and Hong Kong Telecom, raising a war chest of some HK$10 billion. The company’s revenues, however, dropped to HK$10.83 billion for the year, dragged down by Dah Chong Hong’s poor performance amid a weak retail market.

A Blue Chip for a Red Future

The following year saw CITIC Pacific’s first real challenge from another mainland company. China National Aviation Corp. (CNAC), controlled by the mainland’s civil aviation agency, which in turn had strong ties to the country’s powerful military, announced its intention to establish a third Hong Kong airline. CNAC’s ties with China’s civil aviation agency would give it a decided advantage in winning important air routes to the mainland’s major cities, possibly taking routes away from Dragonair. The move would directly threaten CITIC Pacific, which had been reducing its role in Cathay in favor of boosting its activities in Dragonair.

Meanwhile, the company continued to refocus its business, turning away from minority investments and investing its war chest instead into a new string of infrastructure deals, including a US$200 million purchase of 45 percent of Shanghai’s Xu Pu Bridge. The company also added to its infrastructure portfolio with controlling interests in another two mainland power stations. In real estate, the company purchased, for HK$3.5 billion, the former British naval headquarters site in Central Hong Kong’s Tamar Basin in order to build the company’s 37-story headquarters, expected to be completed in 1998.

By May 1996, the situation with CNAC came to a head. In a sudden turnaround, CITIC Pacific agreed to sell a 17.6 percent stake in Dragonair to CNAC; at the same time, however, the company increased its share of Cathay, from 10 percent to 25 percent, for HK$6.3 billion. Analysts read several implications into the agreement. For one, it was believed that CITIC Pacific had been forced to sell the Dragonair holdings by its parent, CITIC, under direction of China’s State Council—with the further implication that CITIC Pacific, despite its blue-chip status, continued to operate at the will of the Chinese government. For another, the agreement suggested a potential shift in the Chinese government’s power base from the reform-oriented position of the ailing Deng Xiaoping (and Rong Yiren, who himself was 80 years old) to the more left-wing Old Guard, represented by CNAC and its parent, the Civil Aviation Administration of China.

The deal caught the Hong Kong investment community by surprise. Despite the fact that CITIC Pacific had relied on its own business skills, rather than Larry Yung’s political ties, to build the company, a shift in the power base was nevertheless seen as harmful to CITIC Pacific’s future. In response, the company stepped up its emphasis on its infrastructure portfolio, adding a purchase of 13 water treatment plants in mainland China for HK$1.26 billion in October 1996. But at the end of the year, Yung surprised the market again, when he led other members of CITIC Pacific management in buying up 15.5 percent—at a 28 percent discounted price—of the company from CITIC HK. Yung, who took most of the stock, increased his personal share of the company to 18.5 percent, making him the company’s second largest shareholder. While some analysts suggested the deal was a way of rewarding Yung for acquiescing in the CNAC agreement, others pointed to the political situation on the mainland. Deng Xiaoping’s death was announced in early 1997, suggesting that Yung’s political allies were fading. Gaining tighter control of CITIC Pacific placed Yung in a stronger position to steer the company—especially after the imminent return of Hong Kong to Chinese control.