FORTUNE, February 3, 1997 Asia Edition, p. 48

 

JOINING FORCES WITH CHINA'S PLA  

Should you do Business with the People’s Liberation Army? Despite the problems, a few pioneers find it can bean effective ally in the world’s most populous market.

 BY KARL SCHOENBERGER

 

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ENTION the people’s Liberation Army, and many people will think of the Chinese tanks that rolled in to crush the Tiananmen Square pro-democracy protests. An older generation may recall the awesome swarm of Chinese troops who descended from the north in the Korean War. But to more and more executives doing business in China today, the acronym PLA evokes an entirely different image it stands for just another powerful commercial empire you’re bound to bump into sooner or later. 

   The revolutionary army has always tilled the Soil and manufactured goods to help feed and equip itself. But under orders from the bosses in Beijing a few years back to do more to pay their own way, the army’s leaders began aggressively beating at least some of their swords in market shares. Enterprises launched by the PLA’S soldiers of fortune now generate a profit stream conservatively estimated at $2 billion to $3 billion a year. With 20,000 companies making everything from auto parts and toys to combat boots and medicine. PLA Inc is actively and openly seeking foreign technology –and investors. 

   Most have hung back, deterred both by a host of practical problems-among them a murky legal status that could make contracts with PLA enterprises hard to enforce in a court of law-as well as by the image problems that arise from doing business with folks still referred to in some quarters as “the butchers of Beijing” insists Jeffrey Fiedler, a sleuthing AFL-CIO official who has been tracking the PLA’S exports to the U.S.:’The American consumer should not be surrounding the PLA by buying its products. The U.S is playing a dangerous game-we don’t think the PLA is an immediate threat, so it’s safe to strengthen them.” To end that game, some critics of America’s China policy advocate targeting known PLA affiliates for trade sanctions. 

   What’s new is that despite the risks, a small but growing number of analysts and Western businessmen maintain it’s time to stop fearing and start joining forces with the PLA. “Most foreign companies impose an arm’s-length distance when they learn they’ve been talking to is the PLA,” says China consultant Robert Broadfoot, head of Hong Kong’s Political & Economic Risk Consultancy. “But if you’re looking into how to cut through a bureaucratic maze, this is one very viable strategy.”   

   The military’s control of a wide swath of China’s radio broadcast band, for instance, makes it a power to be reckoned with in the booming wireless telecom market. Investors such as International Wireless Communications , a San Mateo, California, telecommincations startup, are lining up for a piece of that action.IWC recently invested $20 million and committed another $28 million for a 40% stake in a subsidiary of Hong Kong’s Star Telecom that plans to help the PLA build new cell phone networks. IWC’s vive chairman, Hugh McClung, a former Bell communications department will grab an “important percentage” of the cell phone market and is bargaining for a share of tariff revenues in the networks he’ll help his partners set up. McClung is not terribly jittery about who sits on the other side of the negotiating table. “It’d be fair to say they hold active-duty capacity, but they don’t wear uniforms,” says he. “It’s the general consensus that PLA participants are quite savvy business people.” 

   McClung and his Hong Kong partners are not alone in these renches. Hutchinson Whampoa, controlled by Hong Kong tycoon Li Ka-shing, is also going after PLA wireless system contracts, and Li’s Cheung Kong Holdings has an equity interest in Yangpu Land Developments Co., a PLA-affiliated infrastructure project on China’s Hainan Island. Another player with a 30% stake in this project is Kumagai Gumi made some unlikely alliances with well-known consumer brands. Baskin –Robbins blasted into the mainland market three years ago in partnership with the agency that provides command control for China’s satellites. Gregory Bach, chief representative in Beijing for Baskin-Robbins, a unit of London –based Allied-Domecq, reports that the sales alliance with China satellite Launching & Tracking Control happened (Hong Kong), a spin-off of the Japanese construction giant, which says it plans an initial public offering for the Yangpu project in Hong Kong next year. 

   The list goes on. Citibank’s investment fund Citicorp Everbright owns 2% of Nanfang Pharmaceuticals, a subsidiary of PLA linked Sanjiu Enterprises. The Peninsula Hotel Group, which belongs to Hong Kong’s fabled Kadoorie family, manages and owns 20% of the PLA’s Beijing Palace, a five-star hotel around the corner from Tianamen Square. Douglas Webster, finance director for Peninsula’s parent, Hongkong & Shanghai Hotels, confirms that the palace’s 60% “silent partners” are military officials, but he’s not sure who. “You never know who the shareholders really are in China, but I’ll tell you this much-the chairman is a general,” says Webster. “This is fairly commonplace. In the Chinese context, I think it’s something to be considered advantageous.” 

   PLA-affiliated enterprises have even made some unlikely alliances with well-known consumer brands. Baskin-Robbins blasted into the mainland market three years ago in a partnership with the agency that provides command controls for China’s satellites. Gregory Bach, chief representative in Beijing for Baskin-Robbins, a unit of London-based Allied Domecq, reports that the sales alliance with China Satellite Launching & Tracking Control happened spontaneously: One of the agency’s senior engineers was visiting Los Angeles on business with client Hughes Electronics Corp and took a break at a strip mall ice-cream shop. The Chinese racketeer went ballistic over those 31 flavors, says Bach: “They’re a strong partner –they have an attitude they can solve any problem, and this spirit that they don’t want to hear no for an answer.” Yet he adds: “They’ve opened doors, but they’ve also had doors closed on them because of who they were.” 

   That’s because even inside China, the PLA stirs controversy. Military cadres are notorious for their arrogance, especially in the rich coastal areas where generals tool around in Mercedes Sedans with military plates, abusing traffic rules. PLA companies also suffer from the reputation that they are beyond the reach of the law –a particularly damaging charge in China’s already high risk business environment. The PLA’S furtive way of conducting business can make China’s opaque state-owned enterprises seem highly transparent by comparison. And the quality of management controls are , to put it kindly, open to question: At the low end of the command structure, some renegade troops get into nefarious real estate deals and operate sleazy Karaoke bars. Last spring, a band of operation, smuggling crates of AK-47s into California, supposedly destined for urban street gangs. The indictment alleged complicity by Poly Technologies, a subsidiary of one of the top PLA conglomerates, and China North Industries Group (Norinco)the behemoth weapons-manufacturer directly controlled by the State Council, China’s cabinet officials have denied involvement in the case. 

 

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he top PLA command has tried to rein in its troops by imposing stricter discipline on the expanding business empire, mainly by consolidating autonomous money making schemes into more centralized conglomerates grouped under its major military departments. The PLA’s seven regional military commands and 24 group armies are still in business, but units below the army level were forbidden in 1993 from engaging in commerce. 

   And the PLA’s traditional military linked companies have been diversifying. Lethal weapons now account for only a fraction of PLA’s merchandise. While many of the PLA’s traditional output oriented factories are big losers-making them no different from the rest of China’s state sector, which lurching into privatization burdened by the legacy of myopic central planning and crippling employee obligations-some of its newer, service-oriented enterprises are market-driven and getting rich.  

   All of which reinforces the most important trend-that the PLA’s generals are, for the most part, buying whole hog into the dogma of capitalism. Some may caution that hasty economic reform could erode state control of defense production and harm national security, but no one disputes the general direction. That in turn reduces the odds that the PLA would back party hard-liners who might try to reverse course once the architect of reform, patriarch Deng Xiaoping-92 years old and ailing-gives up the ghost. 

   The apt comparison here is Russia, where the Kremlin hasn’t sanctioned moneymaking by the Red Army and where despite the shift from dictatorship to a fully functioning, if chaotic, democracy-it’s an open question how committed the under-nourished and poorly paid troops are to Boris Yeltsin’s reforms. Says Tai-ming Cheung, an analyst with Kim Eng securities in Hong Kong and a leading authority on the PLA’s business activities: “In Russia what’s happening is desperate and disorganized-soldiers are selling off their weapons. But in China you have the army exercising direction and control. 

   If any single event serviced to point up the PLA’s growing economic clout, as well as to legitimize dealing with it in Western eyes, it was the creation in late 1995 of China Telecom-Great Wall Mobile Communications. This joint venture between China Telecom, the state phone company run by the ministry of Post and Telecommunications, and China Electronic System & Engineering Co, controlled by the PLA General Staff’s communications department opens up for a commercial exploitation a 10-MHz wide chunk of the military’s broad-cast bandwidth that otherwise would have been left in unproductive static. All the big global equipment suppliers-Motorola, Northern Telecom, Ericsson, and AT&T’s spin off Lucent-are expected to compete for procurement contracts to supply dozens of new provincial operators when the Great Wall system gets up and running . Industry analysts see this development as the first real step toward liberating China from its hidebound phone monopoly. 

   China Telecom-Great Wall also brings out from the shadows a number of alliances between the PLA and Hong Kong investors who have for years helped provide private paging and cell-phone services on the PLA bandwidth. Nelson Wong, the patient-laden electrical engineer who founded Hong Kong’s Star Telecom, was says he had a ‘grand scheme to help China transform its econmy’with better technology, got his first contract in 1990 to provide paging services to the PLA regional command in Guangzhou.

Since then he had expanded his technology-sharing partnership with the military to 13 local cell phone systems in seven provinces. Now it’s payback time, and Wong figures he’s established enough good will with for Star Telecom to enjoy a strong position among foreign players competing for Great Wall contracts. 

   Essentially, the PLA and its partners are offering to let outsiders like Wong share revenues with Great Wall’s provincial operating companies in exchange for supplying technology and capital. To get off the ground in China, Wong figures that Star Digital, his joint venture with California’s IWC, needs to raise an additional $150 million to $200 million in financing. A big chunk of that should come from Indonesian tycoon Oei Hong Leong, who last December signed a letter of intent to buy half of Wong’s stake in Star. The Great Wall deals are high-risk propositions, because foreign financiers will have to pump in cash without being allowed an equity stake. But Wong a mainland native is confident about his roll of the dice.’ The army is very trustworthy he insists.   They live by their word.” 

   His American investment partner, IWC’s McClung, shares that sunny assessment. Says he: “We basically bought into Nelson Wong’s version. Were a small company, but what we have is flexibility.”  McClung says IWC spent more than four months conducting due diligence on the long-established, if unofficial, alliance that Wong had forged with the PLA-and came away satisfied. “We made the judgment that star’s relationships were excellent,” he says. “The triggering element for our positive view was the announcement of the Great Wall joint venture. That was the driving force.” How to explain the PLA partners to IWC’s investors back home? No problem, says McClung: “I’d say there’s an increasing recognition that Great Wall is a very strong story.” 

   Still, most PLA companies, even those eager to attract Western partners, remain anything but open books. Consider the tangled thread we unraveled when trying to check out the China Xinxing Group. One of the biggest PLA-linked companies-it encompasses most of the General Logistics Department’s commercial ventures-Xinxing began by making uniforms for soldiers, then moved into consumer textiles. Today Xinxing owns some 60 domestic factories that make everything from chemicals to automobiles to specialty steel, claiming total manufacturing revenue of more than $1.2 billion and group pretax profits of $122 million. Other assets include a chain of hospitals, real estate development concerns, hotels, and offices in Los Angeles, Moscow, Singapore, and the Middle East

   You can find all this potentially useful information in a recent bilingual company brochure along with a heart-felt, if somewhat awkward, sales pitch: “Abundant resources as land equipment, and in expensive lab our provide more business opportunities for investors,” declares this unusual public window into the murky world of PLA business. “Xinxing Group looks forward to establishing extensive economic and trade relations and technical cooperation with investors from home and abroad.”  You’ll hear a similar line from Liu Shu Long, managing director of Xinxing’s Hong Kong’s office and one of the few PLA-company officials we found willing to grant an interview. Says he: “Our main function is to serve as a liaison for foreign trade, investment, and consulting.”

He cites a joint venture with Hong Kong-based Company owned by a Chinese-American investor that operates a luxury tour boat on the Yangzte River as one venture established with the help of his office. Liu, a former state council bureaucat, hints at other possibilities: “Our most valuable asset is land” – land presumably attached to those 60 former PLA factories that Xinxing was bequeathed. 

 

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et when pressed about its ties to the PLA, liu dismisses the notion that the army retains any influence. “Xinxing has a relationship with the PLA, but it’s not part of the PLA,” he says. “It’s only a company. A few years ago, China Xinxing had PLA officials as its leaders, but the leaders are not uniformed now.” Maybe not, but when FORTUNE contacted a representative of Xinxing USA, the company import ex-port subsidiary based in the Los Angeles suburb of El Monte, the official declined to discuss its business, referring questions to Xinxing headquarters in Beijing. There, we were told, it would be necessary to gain permission from their “military supervisors” before they could talk. Asked who these supervisors might be, the representative couldn’t really say. Some window. Does such maddening furtiveness reflect simple reticence, a real lack of knowledge in a complex, evolving organization-or as PLA critics fear, a lingering impulse to camouflage the truth? Maybe all three. Despite the consolidation taking place under the big conglomerates, the PLA’s commercial interests remain highly decentralized and amorphous, says analyst Tai-ming Cheung, who is writing a book on the PLA’s business empire. Legally, no military outfit can actually claim ownership over a state or private enterprise. But there are ways of getting around such technicalities in China’s underdeveloped legal system. The result is an intricate and shifting web of moneymaking activity that the the military’s central command itself cannot even fathom. What’s certain is that more and more PLA-owned or PLA-backed companies will crop up in the entrepreneurial jungles of Greater China. The Central Military Commissions plans to downsize the 2.9 million man army by some 500,000 troops over the next several years, adding impetus to the policy of out placing veterans in its commercial ventures.   

   Increasingly, these enterprises will be hard to distinguish from the so-called prince ling companies run by the offspring of elite party cadres and already playing an outsize role in China’s shadowy private sector. Case in pont: Chinas Poly, an entrepreneurial outgrowth of the PLA’s General Staff Department, whose members actually command combat operations.  

   Today Poly has so diversified its operations that more than 80% of sales are believed to come from the nonmilitary sector. Its activates range from exporting frozen fish to parlaying its control over military land reserves into private-sector real estate development-including the construction of Shanghai’s new stock exchange. Poly boasts at least four major subsidiaries in Hong Kong and a web of offices and front companies around the world, among them a 45% stake in a British Virgin Islands-registered sportswear company, best fulfill, which corporate documents identify as a subcontractor to Nike and Adidas. The group’s estimated $1 billion in assets include a $70 million landmark office complex in Beijing’s central business district, Poly Plaza, which features a glittery hotel and 1,200-seat International Theater. China Poly is also the PLA partner in the infrascture project in the Hainan free trade zone being positioned for an IPO by Humagai Hong Kong.  

   Behind the frenzy of diversification are a pair of prince lings-one military, one civilian. Until a few months ago the man running Poly’s day-to-day operations, vice chairman He Ping, was a major generaland director of the PLA General Staff’s equipment department. But he is also the husband of Deng Xiaoping’s youngest daughter, Deng Rong. While news reports say he retired from the military after being denied a promotion to the rank of Deputy Chief of general staff, an executive in one of Poly’s affiliates suggests that He, a former defense attaché in the Chinese embassy in Washington, took off his uniform to “concentrate on business.” 

 

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he Chairman of Poly Group, Wang Junm is the son of a former vice president of the PRC. He also happens to be hands-on head of China International Trust & Investment Corp, one of China’s most influential state-owned business groups, and thus the boss of his good friend and fellow princeling Larry Yung-the respected head of Critic’s Hing Kong subsidiary (see “The Man to Know in Hong Kong” January 13). As all this suggests, Poly, which was formed as an independent business unit within Citic and became a stand-alone company in 1992, could hardly hope to have a more legitimate pedigree.  

   And yet, you will recall, this is the same Poly whose subsidiary got fingered in last year’s California AK-47 smuggling sting and which then closed its Atlanta offices after an indictment was brought against the subsidiary in federal court. Result: Those unpleasant associations were immediately evoked when the news broke in December that Chairman Wang had attended an intimate coffee Klatch hosted by President Clinton at the White House in February 1996. “The head of a weapons-trading company owned by the Chinese military” is how the Washington Post described Chairman Wang in its account. Caught up in the media feeding frenzy over the Democratic Party’s questionable fundraising from Asian donors, Clinton quickly apologized, saying the meeting with Wang was “clearly inappropriate.” (Actually, while Citic does have a major equity stake in that indicted subsidiary, Poly Technologies, its involvement is limited. “Wang is not an arms dealer.” analyst Cheung insists, though “he’s well connected in those circles.”)

Nonetheless, the incident provided an all too public reminder of the political risks associated with dealing with the PLA.  

   Cheung believes the Chinese government has new reforms in the works aimed at severing more cleanly the connections between China’s army and the companies it has spawned. Such changes should help ease Western doubts about the true role of the PLA in China’s economy-but won’t erase them. James Lilley, former US ambassador to Beijing and director of Asia Studies at the American Enterprise Institute, maintains this debate mirrors the larger argument over how-and how quickly-to engage China in the global economy. Says he: “How you feel about China.”  Our translation: If you feel you need to do business now in the world’s most populas market, you might start thinking about dealing with the PLA.  

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