Page 1 of 2 More than bribery: Wealth, power and Rio Tinto
By Peter Lee
The closely watched case of the "Rio Tinto Four" - the four employees of the
Australian resource giant on trial in Shanghai on charges related to bribery
and theft of commercial secrets - concluded on March 29 with the imposition of
crushing prison sentences ranging from seven to 14 years.
The defendants plan to appeal. Everyone else seems anxious to move on.
That includes Rio Tinto, which dismissed the four men as soon as the verdict
came down; the Chinese government, which has been trying to contain the case as
a simple matter of commercial law and not a symbol of hyperaggressive Chinese
economic
nationalism; and especially Du Shuanghua, one of China's richest men, who was
forced to expose his business methods and reputation to the enforced notoriety
of a high-profile court case by revealing, in a written deposition, that he had
paid a US$9 million "consideration" (ie bribe) to one of the Rio Tinto Four, Wang
Yong.
If interest in the case quickly fades after the four disappear to serve their
terms in Qingpu Prison, Chinese President Hu Jintao probably can also breathe
easier. That is because Du Shuanghua had attempted to secure his political and
economic position as one of China's steel plutocrats with assistance from Hu
Yishi, the president's nephew once removed.
Du's involvement threatened to take the case beyond the sordid commercial
shenanigans involved in feeding China's need for iron ore, and mingle it with
the business dealings that allegedly occupy and advantage some of China's
supreme leaders and their families.
It appears unlikely that the Chinese government will find it necessary or
desirable that Du's maneuverings are further exposed in open court. China's
motives behind the Rio Tinto case might entail bringing Du to heel economically
- not legally - and that objective has already been achieved.
Beyond the thunder and fire of the behemoths that produce and shape the metal
that is building China, the Chinese steel business has always revolved around
access: to capital, for the hundreds of millions of yuan needed to build the
immense plants; to import permits, for the millions of tonnes of iron ore to
feed the furnaces; and to the patronage of the powerful for opportunities and,
if necessary, impunity.
Du began his career as a staffer at a subsidiary of Capital Iron & Steel
Corporation, known as Shougang: the steel company that taught China's state-run
enterprises how to bend - and perhaps break - the rules.
At the same time that Deng Xiaoping reformed agriculture and gave birth in
Shenzhen to China's decentralized export model, he unleashed Shougang to
demonstrate the potential latent in China's ossified state-owned industries.
Obligated only to return an agreed yearly profit to the state, freed from
traditional restrictions on its scope of operations, and fueled with immense
retained profits and easily available credit, Shougang stormed through North
China and the world. Shougang expanded upstream, downstream, overseas, and into
areas totally unrelated to steelmaking, such as ownership of an investment bank
and Beijing's flagship semiconductor factory.
Shougang displayed an early and aggressive interest in financial engineering,
partnering with Hong Kong tycoon Li Ka-shing to attain the Holy Grail of
entrepreneurial minded Chinese enterprises: a backdoor Hong Kong stock exchange
listing that gave the enterprise added independence, access to capital, and the
visibility and opportunities that accrued to a "red chip" stock.
Shougang's partner in the brave new world of industrial production was the
village of Daqiuzhuang, in Tianjin municipality near Beijing. Under its
tough-talking village headman, Yu Zuomin (and allegedly with the assistance of
powerful friends and possibly the preferential supply of steel from Shougang
and other mills), Daqiuzhuang's numerous factories established a near national
monopoly over the production of welded steel pipe. As a result, the village was
flooded with money and Mercedes cars, and provided China's reformist leadership
with a widely publicized exemplar of the nimble, successful, and profitable
township enterprises that were desperately needed to employ the millions of
farmers driven off the land by agricultural reforms.
Shougang and Daqiuzhuang's buccaneering ways attracted the fear and envy of
their competitors and the concern of state planners watching the enterprises
defiantly slip the macroeconomic and capital control leash again and again.
Even as Deng Xiaoping lay on his deathbed, Shougang received its political and
legal comeuppance. The executive director of the Hong Kong company (which
listed Deng's son, Deng Zhifang, as a director) was arrested for economic
crimes; his father, the chairman of Shougang, quickly resigned. A year later,
after a standoff concerning the murder of an investigating official, PLA troops
invested Daqiuzhuang and carted Yu Zuomin to jail.
However, as a detailed 2008 investigative report at China MBA Net reveals [1],
it appears that Du Shenghua carried on the legacy of Shougang and Daqiuzhuang
in their swashbuckling business model, methods, and even personnel.
Du left Shougang in 1991 and entered the field of steel processing. In the
mid-1990s, he established a key alliance with Liu Fengqi, an experienced and
extremely capable veteran of Daqiuzhuang. Together they set up and ran a
network of pipe factories in Hebei, Shandong and Guangdong provinces that
claimed 50% of the national market and rode China's construction boom to
reported profits of 445 million yuan (US$65 million) in 2003.
In 2004, Du made the fateful decision to move upstream into the
capital-intensive process of iron and steel production and realize a dream
long-held by Shougang but never achieved: the construction of a major facility
in coastal Shandong relying on Shandong coal and imported iron ore.
Du found a willing partner in Shandong's Rizhao city, a prime location that had
long been earmarked by the central government as the site for a world-scale
greenfield plant - and served as the subject of perpetual sparring between the
central government, the province, and the city government.
In an impressive display of financial and political leverage, Du was able to
build the plant as a 100% private venture despite the misgivings of the central
government and a crackdown on wildcat steelmaking projects. He put down a
little less than 10% of the construction costs - 200 million yuan - in cash,
and financed the 2 billion yuan balance with loans from a plethora of local
banks, secured by guarantees from his profitable pipe operations.
Du fast-tracked the startup, ramped up production and the Rizhao Iron &
Steel Corporation began earning significant profits: 600 million yuan in 2005,
soaring to 5.8 billion yuan in 2007 on an output of over 7 million tonnes per
year (tpy).
However, Du Shuanghua had to worry about two key problems.
The first was the jealousy of the national and provincial metallurgical
establishment, which resented his pre-emption of the prime Rizhao location.
Shandong province was saddled with two inefficient and undesirably located
plants at Jinan and Laiwu, and yearned to consolidate production in a 20
million tpy megaplant at Rizhao.
In 2008, an unwilling Du received a team of accountants and lawyers charged
with valuing the company for a merger. In November that year, the parties
concluded a letter of intent for the merger.
However, it transpired that Du had other plans. In early 2009, he torpedoed the
deal by selling roughly 25% of his Rizhao stake to Hong Kong's Kai Yuan
Holdings, thereby following the trail to a backdoor Hong Kong listing blazed by
Shougang. Two of Kai Yuan's key figures are Hu Yishi - the chairman of the
board - and his father, Hu Jinxing, a non-executive director and cousin of Hu
Jintao.
Du's poison-pill strategy succeeded in scuttling the Shandong deal but
immediately raised eyebrows among Hong Kong's hyperactive and hyperanalytic
stock punters.
In return for his interest, Du Shuanghua received no cash. He accepted 200
million shares of Kai Yuan stock at a vastly inflated price of HK$2.60 per
share - at least 12 times their trading price. When these shares were added to
another 100 million that Du had previously accumulated, he became Kai Yuan's
largest shareholder, with around 30% of the stock.
However, Rizhao contributes the majority of Kai Yuan's profits. It would appear
that Du sacrificed 70% of the profits on the stake he injected in Kai Yuan -
amounting to tens of millions of dollars - to Kai Yuan's other stockholders in
return for the dubious privilege of holding another 20% of Kai Yuan's stock.
Hong Kong punters immediately leapt to the conclusion that Du was either
currying favor with Hu Jintao's family for leverage in his tussle with the
Shandong provincial metallurgical establishment, or ultimately had plans to
inject the entire Rizhao operation into the Kai Yuan shell on favorable terms,
and reap the benefits of a public listing for his mill in a global financial
center - or both.
President Hu's extended family is apparently active in business and government
[2]. Aggrieved posters have seized upon a kickback scandal in Namibia involving
Nuctech, a company headed by his son, Hu Haifeng, to raise the specter of
corruption close to the president [3].
The Chinese informational apparatus is apparently extremely sensitive regarding
challenges to Hu Jintao's integrity, and it was reported that it blocked
Internet searches with the keywords "Hu Haifeng", "Nuctech", and "Namibia".
Hu Yixia, a young man in his early thirties who collects yearly compensation of
about HK$1.5 million (US$193,000) from Kai Yuan, recently cobbled together the
wherewithal to exercise an option to purchase 200 million additional shares in
Kai Yuan for HK$35.4 million, bringing his share of the company to close to 10%
[4].
The Rizhao matter might have remained the subject of unwelcome innuendo in the
Hong Kong financial markets if not for the damaging revelations concerning Du's
business practices that emerged at the Rio Tinto trial.
Rio Tinto is the largest iron ore supplier to China, itself the world's largest
importer of commercial iron ore, bringing in a staggering 600 million tons per
year.
In theory, China's 1,000 mills are supposed to present a united front to the
three main suppliers - Rio Tinto and BHP Billiton for Australian ore, and Vale
of Brazil - through the China Iron & Steel Association, under the
leadership of Baoshan Iron & Steel. In practice, more than 100 Chinese
mills and traders are licensed to import ore and exploit their advantage by
assembling speculative inventory and compelling unlicensed mills to buy from
them at double the original price. In a seller's market, the producers have
ample opportunity to play divide-and-conquer and undercut the government
negotiators.
Negotiations this year are especially acrimonious, with the producers taking
advantage of a tightening in supply to demand a price increase of almost 100%
as payback for what they saw as China's insistence on excessive price-cuts in
2009, a lean year when Chinese buyers eschewed long-term contract commitments
and switched to buying less-expensive spot cargoes.
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