In 1993 Rupert Murdoch commented, "advances in the technology of telecommunications have proved an unambiguous threat to totalitarian regimes everywhere.”  China took notice and quickly scuttled Murdoch's plans for expanding satellite media in China.  Jump 20 years later to 2013, and it looks like the Communist Part of China is using this threat to its advantage to save itself.  

Today, millions of China's netizens are using microblogging services to raise awareness and bring transparency to 2 issues which threaten the Communist Party's legitimacy:

• Corruption by government officials
• Government officials fast-tracking their children into highly sought after government positions

And the central government is letting it happen.

The joining of internet users and officials is a new approach in graft-busting in China with officials taking clues from the public in social media before  launching investigations into implicated officials

The Central Commission for Discipline Inspection (CCDI) said Liu Tienan, vice-director of the National Development and Reform Commission (NDRC), was being investigated by the agency for serious violations of discipline - a common euphemism for corruption.  The official report follows accusations against Liu first made in December by Luo Changping, a deputy editor with Beijing-based Caijing magazine, who posted the allegations on his microblog account, which has tens of thousands of followers.  Previously, several high-profile corruption allegations by internet users led only to the downfall of low- to mid-level corrupt officials.

"The joining of hands between internet users and disciplinary officials is a seemingly new approach in graft-busting," Wang said, adding that the latter took note of clues provided by the public before launching investigations into allegedly implicated officials.

Unlike the 1980s, ordinary people are now more willing to stand up and point fingers at suspected corrupt officials.  The current leadership has shown its determination to crack down on corruption at all levels.  With the help of internet users, central government leaders will keep targeting corrupt officials, as this helps drive support from the general public.

China's netizens are exposing a culture of nepotism in the promotion of young officials which is causing overwhelming public disgust in China

Recent cases:

• 30-year-old Yuan Huizhong, the daughter of a former secretary of the Communist Party political and legal affairs commission in Yangzhou , whose appointment as deputy secretary of Yangzhou's Communist Youth League in February was exposed by a microblogger.  The media quoted an expert as saying it usually took at least nine years for a township cadre to be promoted to her level.
  
• Chang Junsheng, 22-year-old deputy secretary of China Communist Youth League's Wangjiang county committee in Anhui province, was sacked just over a week ago after the qualifications he presented in an open selection of officials were found to have been falsified. His father is the official in charge of promotions in the county.
• Xu Tao, nominated as deputy secretary of Xiangtan county in Hunan in December at the age of 27, was removed from the post on May 7 after microbloggers raised questions about his five years of work experience. His father had been chairman of the local people's congress and his mother was deputy director of the district's procuratorate.
  
  

With support of the top leadership, the internet and social media netizens are nullifying the old Chinese saying "the sky is high and the emperor is far away", which is used to describe how central officials make policy, then local officials do whatever they want.

Sources:

• "Nepotism puts system for promotions in spotlight", South China Morning Post, May 26, 2010
  http://www.scmp.com/comment/insight-opinion/article/1246072/nepotism-puts-system-promotions-spotlight
• "Social media seen as new weapon in graft-busting in China", South China Morning Post, May 14, 2013
  http://www.scmp.com/news/china/article/1237116/joint-effort-between-social-media-and-officials-hailed-probe-official
• "The Son also Rises: nepotism doesn't disappear in China, it just gets a promotion", South China Morning Post, May 13, 2013
  http://www.scmp.com/news/china/article/1236343/son-also-rises-nepotism-doesnt-disappear-china-it-just-gets-promotion
  
• "How Murdoch Got Lost in China", New York Times, May 4, 2008
  http://www.nytimes.com/2008/05/04/business/media/04shelf.html?_r=0

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.

A recent settlement between the U.S. SEC and a husband-and-wife team that ran a Chinese maker of pollution control equipment provides another shining example of how due diligence was not "do" diligence.

In this case, CEO Zou Dejun and his wife, the chairwoman, Qiu Jianping, ran Rino International, at one time worth about US$500 million on Nasdaq.  It collapsed after short seller Muddy Waters accused it of claiming revenue from nonexistent contracts. More than three years ago, the company raised $100 million from American investors in a stock offering.

The S.E.C. complaint said the company kept two sets of books. The Chinese books, which the S.E.C. said were correct, showed total revenue of $31 million from the first quarter of 2008 through the third quarter of 2010. The United States books, which were used in financial statements, showed revenue of $491 million, or about 15 times as much.

Shocking!  A Chinese company with more than one set of books?  This surely has never happened before in China or anywhere else.  Nod, nod, wink, wink.

The S.E.C. said that days after the 2009 public offering, the couple, who together controlled 65 percent of the company’s stock, used $3.5 million of the money raised to buy a home for their use in Orange County, Calif., then gave conflicting accounts to auditors regarding how the money was used. They eventually signed notes indicating that they had borrowed the money from the company.  So they got caught with their hand in the company cookie jar, and the auditors did not think maybe something else is going on and just took everything else at face value?  Well done to the due diligence team.

The fraud fell apart in November 2010 after the Muddy Waters research Web site, which seeks out stocks to sell short and has exposed a number of Chinese frauds, released a report saying some of the company’s reported revenue came from fraudulent contracts with purchasers.   A few days later the company’s auditors, Frazer Frost, reported that Mr. Zou had admitted that some of the contracts did not exist. The auditors withdrew their previous certifications of the financial results.

Again, well done to the Frazer Frost auditors for the level of rigorousness on this one.  They were clearly more concerned with getting paid than fulfilling their responsibility for investors.

On Nov. 30, the company sent a letter to the S.E.C. saying it intended “to file restated audited financial statements” for 2008 and 2009 “as soon as practicable.” It has made no such filings since, and the company’s Web site is no longer available.

Source:
"Couple Settle Fraud Case Involving Chinese Company", New York Times, May 15, 2013
http://dealbook.nytimes.com/2013/05/15/chinese-couple-settle-s-e-c-fraud-case/

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.

It is no secret one must be skeptical and sanity check Chinese government statistics and data.  It is not that there is always an element of deceit, but rather China is just too big to manage since most local officials grade their own report cards on a generous curve.  The sky is high and the emperor is far (天高皇帝远 / tiān gāo huángdì yuǎn).

Many of the people analyzing or reporting Chinese government statistics do not actually understand what goes into certain statistics.  Take retail sales for example.  In China, the reported figures include purchases by the government and consumers.  Since the government routinely orders government departments to make purchases when the economy is slowing, it is hard to use the retail sales figure to gauge real consumer demand.

Different data points give different pictures in China.  For example:

• The official retail-sales index in December 2012 was up 15.2% yoy. 
• Nielsen's index of sales of fast-moving consumer goods, which should include fewer of the government purchases which distort the official data, was up just 9% in December 2012 yoy.
• Latest result from sports retailer Nike, fast-food Yum Brands  and home-electronics giant Gome were all weak.

If you are going to use Chinese statistics in your business planning or valuation models, you must understand what is and what is not included in Chinese government statistics.  Then vigorously sanity check using public sector proxies without losing your sanity.  Difficult, but not impossible.

Source: "Hidden Risks of a Hard Landing in China", The Wall Street Journal, February 24, 2013.
http://online.wsj.com/article/SB10001424127887323864304578320410950879552.html?mod=ITP_businessandfinance_6

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.

Summary

• The concept of guanxi is not unique to China
  
• Guanxi in China is often based on transactions & reciprocity not emotional personal connections
  
• "Face" makes guanxi different in china
  
• A LinkedIn will succeed in China, just maybe not the LinkedIn
  

A recent article by Agence France-Presse about the challenge a company liked Linkedin will face in China triggered this post.  Many people Chinese people improperly convey guanxi's (关系) meaning to foreigners, and in turn many non-Chinese misunderstand guanxi.

The main premise of this article is Linkedin will struggle in China to overcome the obstacle of guanxi.  In the article, Wei Wuhui, a professor at Jiaotong University in Shanghai, states online alternatives to guanxi like LinkedIn will have a hard time supplanting guanxi's deeply embedded cultural role.  He states, "I don’t think the Chinese middle class has the same needs in terms of professional networks as people in the West, because of the concept of guanxi.  In China people do not want to meet with people they don’t know. The Chinese have a culture based on relationships among family members and close friends.”  Absolute nonsense.

Guanxi (关系) is usually defined as China’s system of personal relationships or connections reinforced by mutual favours which plays a vital role in getting things done, whether conducting business, navigating government bureaucracy, or anything which requires a favor to get something done.  It is the words "personal" and "relationships" which creates the misunderstanding how Chinese and non-Chinese understand guanxi.  Guanxi in China is purely about reciprocity.

THE CONCEPT OF GUANXI IS NOT UNIQUE TO CHINA

Contrary to popular portrayal, guanxi is not something special or unique about operating in China.   The concept of people trading favors based on one’s experience or position or using a relationship to get something done exists in every culture.  This is as old as the human race.  In other parts of the world guanxi is called:

• Greece: rousfeti (literally reciprocal special favor)
• India: vyavahar 
• Italy: arrangiarsi 
• Poland: załatwić
• Russia: blat or swjasi

GUANXI IN CHINA IS OFTEN BASED ON TRANSACTIONS & RECIPROCITY NOT EMOTIONAL
PERSONAL CONNECTIONS

Guanxi in China is based on transactions and reciprocity and often completely lacking any emotional connection to the other party.  One of the reasons corruption is so prevalent and entrenched in Chinese culture, which is not to say it does not exist anywhere else because if of course does, is because many relationships are not based on friendship or family ties, but rather "what have you done for me lately".  A recent confession by a retired Chinese government official online in Xinhua (since taken down by censors) but reported in the South China Morning Post exposes the farce of guanxi:

• "A retired Chinese official said he was disappointed that old acquaintances, who used to give his children lai see packets containing thousands of yuan, did not give them any this year, reported Xinhua state news agency this week.  Nothing has changed except that he’s now retired, the former official said.  “In the past a single red envelope could contain as much as 10,000 yuan (HK$10,240),” the unnamed former official said.  But "friends" stopped passing out heavy lai see packets after he retired. Now it’s only relatives who give out red envelopes - and much thinner ones."

China is full of open secrets to instant guanxi in all parts of China society:

• School headmasters and teachers accept bribes.
• Doctors take special care of individual patients.
• Drug companies bribe their way into hospitals.
• Suppliers bribe key people at companies they want to supply.
• Judges can be bought.
• Government officials are in bed with the business owners they are supposed to supervise. In many cases, even owning shares (directly or indirectly via family members) in the companies they are supposed to oversee.

In China guanxi is closely tied to and actually reinforces corruption throughout all of Chinese society including government and business.  If you cannot trade favors, you can just buy them.  If you do not have guanxi based on a personal relationship such as relative, friend or schoolmate, bribes speed up the relationship building process.

The best guanxi is of course established over time.  A company’s guanxi will become established through its own relationships and reputation with its business partners and government officials.  A foreign company’s guanxi will ultimately be based on the number of people it employs, the taxes it pays, and its social contributions.  Guanxi does not quarantee success.  Coca-Cola learned this when its proposed acquisition of Huiyuan was rejected by the Chinese government.

The long-term is another myth in China.  Guanxi is all about what can you do for me right here, right now.

"FACE" MAKES GUANXI DIFFERENT IN CHINA

Face (面子) and guanxi are closely intertwined within Chinese culture.  When a real personal relationship is involved, not extending guanxi will impact one's face or perceived status.  But this only applies when there is a real personal relationship.  When guanxi is based on transactions and reciprocity, guanxi in China is the same anywhere else in the world.

A LINKEDIN WILL SUCCEED IN CHINA, JUST MAYBE NOT THE LINKEDIN

It is no secret most Western internet companies have been spectacular failures in China.  What is usually missed by people is the reason they fail.  By the time the Western internet company enters the China market, whether Google, eBay, Groupon, etc., there are already many entrenched local competitors with a long head start.  The foreign company does not give Chinese users a good reason to switch.  A LinkedIn in China will probably succeed, it just may not be the LinkedIn and may be a local competitor.  Professional social networking sites have yet to take off in China, partly because language is an issue.  LinkedIn is not in Chinese, yet.

Wei Wuhui, a professor at Jiaotong University in Shanghai, thinks business network sites face a huge extra obstacle to success of  guanxi.  He states online alternatives will have a hard time supplanting guanxi's deeply embedded role in Chinese society. He does not think the Chinese middle class has the same needs in terms of professional networks as people in the West, because of the concept of guanxi.  “In China people do not want to meet with people they don’t know. The Chinese have a culture based on relationships among family members and close friends.”  True, but guanxi in China is often not about family members and close friends.

Alibaba is an interesting case of why a LinkedIn will succeed in China.  Alibaba's success was built on a platform providing a means for Western buyers to connect with Chinese suppliers.  '"Connect" being the operative word.  Chinese companies are active participants in the platform because it opens a window to new business opportunities.  This is why a LinkedIn will do well in China.  A LinkedIn is a means to develop new opportunities by helping a user develop and maintain their guanxi.  

There are several additional reasons a LinkedIn will succeed in China.  For those who have spent time in China, it is no secret fake qualifications are rife in China.  There is also distrust of dealings over the internet because of fraud.  Viadeo says it is developing a system to check profiles, akin to Twitter’s verified identities.  This is something companies will find valuable as a tool to weed through candidates with fake backgrounds.  Candidates with legitimate backgrounds will aggregate on a LinkedIn, because companies will be attracted to this user base when looking for new hires.

Chinese employees are notorious for job hopping.  A user will be attracted to a LinkedIn to be able to find and have access to company job postings matching their interests and background.  It is all about maximizing employment opportunities.  If a LinkedIn can successfully do this, professional social networks will become successful in China.  The internet allows people to maintain one's close/strong connections and develop your new ones.  What Chinese person looking for new opportunities would not be attracted to this?

Interesting side note, Professor Wei Wuhui's name is a homonym for wùhuì  (误会), a noun or verb meaning misunderstand.

Sources:

1. "LinkedIn, others face challenges against China ‘guanxi’", Agence France-Presse, February 24, 2013.
   http://www.scmp.com/news/china/article/1157651/linkedin-others-face-challenges-against-china-guanxi
2. "Retired official says family no longer receives heavy lai see packets", South China Morning Post, February 15, 2013.
   http://www.scmp.com/news/china/article/1150868/retired-official-says-his-family-no-longer-receives-heavy-lai-see-packets

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.

Chinese company ChinaCast Education went public in the U.S. via a reverse-merger in 2007. It was de-listed from Nasdaq in June 2012 after a former executive siphoned off the firm's assets.  All this happened under the watch of a Big 4 accounting firm and Board of Directors.

What went wrong?:

• Same bed different Dreams.  In early 2011, U.S.-listed shares in several Chinese companies started falling on reports of financial fraud, especially firms like ChinaCast which legally dodged U.S. disclosure rules by listing through reverse mergers.  U.S. investors thought the company's performance in the face of this falling share price signaled it was time for ChinaCast to launch a share buyback. Investors were then pleased when Chen announced a plan to repurchase US$ 50 million worth of common shares over 12 months.  Shareholders waited for the buyback to begin, but nothing happened. Frustration ensued and soon the two sides were fighting.   Chen was offered but refused two years compensation in exchange for a voluntary resignation. Chen was then removed by the seven-member board, four of whom backed Sherwood, and replaced Chen with Feng.
• In 2011, American shareholders, the 10 largest of which controlled 55% after the listing, initiated a shakeup of the company's management, ousting then CEO and chairman Hong Konger Chen ZiAng.  Derek Feng Yiyi was installed as the new chairman.
  
• In February 2012, Deloitte attempts to check the books at the company's Shanghai office were blocked by the company's employees.
  
• In the weeks prior to Derek Feng's appointment as Chen's replacement as Chairman in March 2012, Chen looted the company before shareholders or the Board could do anything to stop him.
• In December 2012, ChinaCast announced all quarterly and annual financial statements from the beginning of 2009 to the end of September 2011 could not be trusted - despite being audited by a Big 4 firm.  The announcement also revealed other problems at the firm, including loss of control of equity in subsidiaries and a great amount of assets that did not exist.

What was Chen able to do:

• Several hundred million yuan was transferred from company accounts without the approval of the board of directors.
• In September 2011, ChinaCast subsidiaries Shuangwei Co. and Yupei Co. each had 100 million yuan in Shanghai's Bund Branch of Huaxia Bank. The money was used as collateral in September 2011,  for loans issued to three other companies unrelated to ChinaCast.
• Company's business license vanished.
• Company's registration seals vanished.
• Company's computer records vanished.
  
• Company's paper files and accounting were shredded.
  
• Loss of control of equity in key subsidiaries.  Ownership of ChinaCast's colleges – Hubei Polytechnic University School of Business, Guangxi Normal University Lijiang College, and Chongqing Normal University's College of Foreign Trade and Business – had been transferred to several people including a former company president Jiang Xiangyuan without board approval.
• Large amount of assets did not actually exist despite being audited by Big 4 firm.

Ned Sherwood, who held 800,000 shares, was the leader of the management reorganization.  He says he never authorized the asset transfers and was later stunned by the financial maneuvering that eventually hollowed out the company.  No disrespect intended, but I am guessing he is not very experienced at doing business in China.  If he was, he would have known a foreigner cannot make any changes to the leadership of a Chinese company without having many trusted people physically on the ground and in key positions such as holding the company chops, controlling bank accounts and having authorized bank signatories, the heads of HR and finance.

Sherwood said he conducted due diligence before buying ChinaCast stock on the Nasdaq exchange.  Really.

Due Diligence should be 'Do' Diligence and not just rolling the dice:

• ChinaCast's former president Jiang Xiangyuan, who was also removed in the shakeup and, according to records obtained by Caixin, may have played a role in the disappearance of funds.  A probe by Feng's management team found Jiang had been convicted in 2001 by the Shanghai Hongkou District Court for misappropriating public funds and given an 18-month suspended sentence.  Jiang's conviction had gone undetected during due diligence long before ChinaCast crumbled.

The key lesson for investors is due diligence can do very little when the shell is in the U.S. and the business is in China. Overseas investors and regulatory agencies will always be at a disadvantage trying to understand what really goes on on the ground in China, or any market for that matter.

Sources: 

• "Shareholders of Looted Firm Sue Auditor in NY Court", Caixin Online, February 20, 2013.
  http://english.caixin.com/2013-02-20/100492666.html
• "Hard Lesson for China-Concept Stock Investors" Caixin Online, May 16, 2012.
  http://english.caixin.com/2012-05-16/100390800.html
  

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.

When something happens domestically in China which makes China look bad or exposes serious flaws in the system and party, CCTV has instructed its foreign correspondents to find analogous situations in the country where they are stationed. Think landslides, bridges collapsing, food scandals, environmental pollution, etc.  China's CCTV is on a mission to convince Chinese people problems happen around the world, and not just in China.  Fair enough, but Chinese people are seeing through this misdirection when it is a blatant attempt to divert attention on serious local problems such as environmental pollution/degradation and food scandals.  

While there are problems everywhere around the world, in many instances, China's problems are the direct result of fraud and corruption.  The moral compass is missing.  Case in point.  CCTV is dedicating large amounts of coverage to the horse meat scandal in Europe.  Horse meat is not toxic, it is just not the beef it is labelled as.  At the same time, CCTV is giving scant coverage to the latest food scandal which involved Chinese people adding hazardous and poisonous chemicals to duck meat in order to pass it off as more expensive mutton.  In Chinese this is called 鱼目混珠 (yú mù hùn zhū) which translates as "to pass fish eyes off as pearls".  It is a common theme when doing business in China, which is why no one trust anyone else in China.

Chinese people are understandably interested in both what happens in China and overseas.  Seemingly constant Food scandals and environmental pollution is seen as the result of incompetent or worse corrupt regulators responsible for stopping this.  China's netizens are always very active online in these themes.

China's government has a history of trying to distract its people from its own problems by focusing attention on something overseas.  Usually it is Japan's invasion of China.  

Honesty really is the best policy in the digital world as people have access to much greater information, even in China behind the Great Firewall of China.  Chinese people are not going to be distracted from their concern about their own food and environmental issues, regardless of what happens in Europe or the U.S.  Chinese people care about their lives in China.

Understandably, CCTV's efforts have simply created a backlash against itself and CCTV and China’s already loathed food safety and environmental regulators.  In the West, the press/media serves as a check and balance on companies and government.  In China, Chinese netizens are filling this void when Party mouthpieces like CCTV continue to live in past when propaganda was unquestioned.

Soft power is hard to do right.  China still has a long way to go.

Source:"In China, Horse With a Side of Poisonous Fake Mutton", Bloomberg, February 20, 2013.
http://www.bloomberg.com/news/2013-02-19/in-china-horse-with-a-side-of-poisonous-fake-mutton.html

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.

China's latest food safety scandal involved poisonous fake mutton made from cheaper duck meat and illegal chemicals in northeast China's Liaoning Province.

Large amounts of chemicals, dye and adhesive as well as imported mutton grease from New Zealand were used  to make the duck meat taste like mutton and to endure the high temperature of hotpot cooking. 

Ref flag something was wrong: The fake mutton was sold at <RMB20 per kilogram while real mutton costs RMB40-60.

The fake mutton was found to also contain excessive amounts of heavy metals and cancer-causing sodium nitrite exceeding national food standard by >2,000x.

A 2009 version of the same scam: duck was dipped in non-toxic lamb urine to infuse it with muttony flavor.  Now that is a piss-poor idea, pun intended.

Do not take anything at face value (also pun intended) in China.

Source: "34 Suspects Seized in Poisonous Fake Mutton Ring", CRIenglish.com, February 4, 2013
http://english.cri.cn/6909/2013/02/04/2982s746760.htm

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.