Rocky road

Why PetroChina's recent IPO was such a political hot potato

As the date of its entry into the World Trade Organization approaches, China's presence on the world economic stage is becoming hard to ignore. In little more than a decade it has gone from having no securities markets to speak of to two burgeoning stock exchanges in Shanghai and Shenzhen - as well as the Hong Kong Stock Exchange - accounting for a total market capitalization of roughly $500 bn, or about half of China's overall economic output. However, from the regulators to the brokerage firms to the financial newspapers to the companies themselves, the government still controls everything (it has a majority stake in 95 percent of companies listed at home and overseas), making the idea of an independent and transparent investment arena a bit of a joke.

The government claims the latest raft of Chinese IPOs, which includes oil, telecommunications and insurance companies, heralds a new kind of state enterprise. One such story is PetroChina, which filed its intent to list ADRs in New York as well as ordinary shares in Hong Kong back in February. A profitable company, PetroChina boasts the fifth largest crude oil reserves in the world. It also controls 95 percent of China's

gas reserves. With oil prices soaring, and Goldman Sachs running the PetroChina show, it seemed like a fairy tale waiting to happen. The political furore that followed in the US and continued on past the company's eventual listing in April, combined with the initial lukewarm response from investors, suggested many in the West were not so convinced.

The opposition

'The biggest testament to its success is its stock price today.' So says Paul Bernard, Hong Kong-based executive director at Goldman Sachs. On the day we spoke at the end of May, PetroChina's stock was at HK$1.51, up 19 percent from its March IPO price of HK$1.27. 'It has achieved that growth against a Hong Kong market that has primarily been declining and having launched in a US market that was potentially disastrous.

That's got to say a lot for the story.' According to Bernard, the strength of opposition to the PetroChina offering has been exaggerated by the press: 'The news media gave the opposition far more space on their pages then they deserved. Yes, they made a great deal of noise, but it didn't really impact the IPO at all.'

Despite Bernard's protestations, the noise was at points pretty deafening. This was the stock that everyone seemed to love to hate. On the one side were environmentalists protesting against PetroChina's environmental record, including Tibetan groups unhappy about PetroChina's plans to build gas pipes from Tibet to mainland China and increase exploration there. On the other side were human rights activists protesting against PetroChina's parent company, China National Petroleum, which owns 40 percent of an oil pipeline in Sudan, a target of US economic sanctions. Religious groups also had something to say about the IPO, again because of connections with Sudan, a country not known for its religious tolerance. And a number of unions, led by the AFL-CIO, tried to persuade pension funds not to invest because of a whole range of complaints.

They had some success. Even before the company filed with the SEC on February 29, pension fund giants Calpers and TIAA-Cref both announced that they had no plans to buy the stock. A short while later, the New York City Comptroller's office made a similar decision, 'because of PetroChina's failure to fit the pension system's risk profile and its lack of promise as an investment.' Rather than human rights or environmental issues, the main concerns were corporate governance and minority shareholder protection in a company that had, historically anyway, been very political.

The IPO also faced opposition from the political arena. US Republican Spencer Bachus, chairman of the House of Representatives subcommittee on domestic and international monetary policy, called for an investigation into whether the company had provided sufficient disclosure to potential investors. Bachus said the company's registration statement didn't explain properly how the offer's proceeds would be spent, and his main concern was that some would be steered to China National Petroleum and, indirectly, to its pipeline in Sudan. The company had tried to address some of these concerns in its filing, specifying that PetroChina and its parent company will maintain separate accounts for their separate proceeds - a kind of accounting firewall.

The company also declared the disbursement of funds would be handled by independent counsel and independent accountants. However Bachus and colleagues were not satisfied and tried to put a 90-day freeze on the IPO which, though unsuccessful, stoked the flames of investor disquiet.

The opposition reached a crescendo on March 21. While executives from PetroChina held a meeting in New York to drum up interest for the IPO, in another hotel across the city, labor leaders, environmentalists, pension managers and human rights activists met to discuss how to disrupt it. 'The behavior of our companies is of critical importance to the long-term performance of our pension funds,' said Alan Hevesi, the NY City Comptroller.

The force of protest seemed to take its toll. In March, officials at PetroChina announced a pricing structure that would yield somewhere between $2.8 bn and $3.4 bn. Human rights activists claimed a victory. Comments Michelle Chan-Fishel, policy analyst at Friends of the Earth, 'The Chinese government were originally claiming they were going to raise $10 bn for this deal. In 1999 estimated figures were down to $7 bn and then once papers had been filed it was looking more like $2-3 bn. The coalition against this deal had obviously had a significant impact on the investment community.'

PetroChina's outlook did not look altogether grim, however. On March 23 it announced that several prominent Chinese shareholders - Cheung Kong Holdings Ltd, Hutchinson Whampoa, Sun Hung Kai Properties and Chow Tai Fook Nominee - were to buy US$350 mn worth of the company's stock and promised not to sell for at least six months. A further bolster came with the news that BP Amoco was going to purchase 20 percent of PetroChina as well as enter into a number of strategic alliances on joint oil and gas projects.

BP Amoco's reasoning was clear: cash rich from its agreement to sell Arco's Alaskan oil and gas business to satisfy the Federal Trade Commission's monopoly concerns, it was looking for new opportunities.

And where better than China, where huge natural gas reserves promise unlimited potential. For PetroChina, the BP Amoco announcement gave the deal a new legitimacy. 'It was a vote of confidence in what was happening as well as a good strategic thrust for the company,' explains Goldman Sachs' Bernard.

Muted response

When the IPO finally happened, however, on April 6 in New York - and April 7 in Hong Kong - reaction was muted. The stock started at US$16.44, the price set the week before the launch, and still hadn't moved by the end of the day when the market closed. Although the environmental and human rights coalition claimed a victory, Paul Bernard says it had more to do with market conditions. Indeed, the week of the PetroChina IPO, the Nasdaq Stock Market fell 13.6 percent points in one morning. 'It was testament to the strength of the stock that it survived that kind of bashing. First of all you had an investment climate where investors were far more interested in technology stocks than anything else. Then you had this significant market drop. Many other companies didn't survive it. Either the IPOs didn't happen at all or the stock just flopped. It really speaks for PetroChina that they could launch in such a hostile environment.'

And the stock's performance since then seems to bear Bernard out. After languishing at the March IPO price for the month of April and the beginning of May, it rose by 19 percent in Hong Kong to HK$1.51 in the middle of the month. In New York too, the company's ADR rose 13 percent to US$18.75. The political row, however, has not subsided.

On May 1, a US commission for international religious freedom called for an enquiry into the possible use of proceeds from the offering in retiring the parent company's debt. Concern again is that US investors will end up unwittingly putting money into operations in Sudan. Ma Fucai, PetroChina's chairman, has denied any such use of the money and has reported that most of the funds will go toward developing China's domestic natural gas market. However, Friends of the Earth policy analyst Michelle Chan-Fishel says that no-one really believes the two companies are run separately.

The enquiry does not look like it will go very much further and, with crude oil prices buoyant and its profits up 77 percent from last year, PetroChina's future on the capital markets looks pretty secure. However, the coalition which arose against it claims the company's IPO has been a watershed event. Chan-Fishel explains: 'When foreign issuers come to the US to tap its capital markets for money to use for means that the public do not support, that is a public policy issue. The PetroChina case demonstrated that non-financial issues could be brought to bear on a Wall Street transaction where typically the economics of the deal would have been the only proviso.'

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