How a Hong Kong Firm Is Taking Over China

For young people, Chinese New Year means a bonanza of lucky money in red packets doled out by relatives and friends. Frank Lai Ni Hium is not a kid (he is 49), but he also shares the same expectations of the festive season.

 
Except that, in his case, the avalanche of Chinese New Year money comes to some RMB5 billion (US$769 million) every year.
 
“That’s how much people in China usually spend on our prepaid cards,” explains the CFO, Executive Director and Company Secretary of Hong Kong’s China Resources Enterprise (CRE), which owns the mainland’s largest supermarket chains, including Olé (pictured) and Vanguard. Millions of Chinese buy the cards to give as New Year gifts.
 
And that is a problem, albeit a welcome one. “You know how low bank saving deposit rates are,” says Lai. His solution: lend the money for three to six months to other companies in the China Resources group at interest rates of 3% to 4% a year. Some investors balked, but the scheme was approved last December – by a narrow 50.8% of independent stockholders.  
 
The company has since been doing a bit of intra-group lending, but the bulk of the excess money – CRE had HK$14 billion (US$1.8 billion) in cash and cash equivalents at the end of 2010 – is currently in structured deposit products with a large financial institution, which is paying 3% to 4% in interest. “It’s safer in the bank,” says Lai.
 
Not that the money will stay too long there. CRE is aggressively expanding. In January, it signed an agreement to form a US$1 billion joint venture with Japan’s Kirin that will sell soft drinks and non-alcoholic beverages across China. Last year, it acquired 80% of Pacific Coffee, which operates stores in China, Hong Kong, Macau, Malaysia and Singapore.
 
“We’re always making new acquisitions,” says Lai. “You have to be big because retail is a low-margin volume business.” The company plans US$1.1 billion in capital spending this year, up from US$619 million in 2010.
 
Its mission, as it unabashedly declares in its annual reports, is to become “the largest consumer goods company in China.”  
          
Methodical Spree
CRE is not the only company with cash to burn. American multinationals are estimated to be sitting on US$2 trillion of excess money. A study last year by credit-ratings agency Moody’s found US$230 billion on the balance sheets of 120 Asian non-financial corporates, including China Mobile (US$48.5 billion) and Korea’s Samsung (US$18.4 billion).
 
However, unlike many of its peers, which are very cautious about spending their cash, particularly US companies unsure about America’s (and thus the world’s) economic prospects, CRE is not shying away from aggressive growth.
 
Lai says there is method in the buying. With the renminbi so strong and economic problems in the West driving down asset values, companies and brands in the US and Europe are looking very cheap. The temptation is strong to pick up bargains in these developed markets.   
 
But the US$11-billion-a-year-in-sales Hong Kong blue chip (CRE is a component of the Hang Seng index) is resisting that urge. China is the market we know, says Lai. “This is our core competency.”
 
With a population of 1.3 billion people and annual GDP growth of nearly 10%, China is also the world’s fastest growing consumer market. Retail sales jumped 16.3% to US$657 billion in the first quarter of 2011, continuing the pattern of robust spending in recent years.
 
CRE is so focused on the mainland that it sold its stake in Esprit, a Hong Kong fashion empire that recently opened a massive 3,600-square-metre emporium in Frankfurt and an 18,000-square-metre store in New York. Lai booked a net gain of HK$3 billion (US$387 million) from the 2010 transaction.
 
Laissez Faire
Even so, China is a tough market. Competitors abound. In retail, which accounts for 63% of CRE’s revenues, Wal-Mart, Carrefour and a host of domestic chains are duking it out for market share. And Starbucks is still far larger than Pacific Coffee in China and elsewhere in Asia.
 
In beer, which accounts for 25% of CRE sales, local Chinese brand Tsingtao remains No. 1 in turnover. However, CRE’s Snow brand, developed and launched nearly two decades ago with South Africa’s SABMiller, has overtaken Tsingtao in volume. “We will be the leader in turnover as well,” vows Lai.   
 
It helps that CRE is a Hong Kong company with a history and business culture rooted in the former British colony’s laissez faire capitalism, rather than a mainland entity trying to reconcile entrepreneurship and China’s evolving brand of market socialism.
 
Foreign partners like SABMiller and Kirin feel that CRE speaks the same language and operates under the same rules as they do. At the same time, CRE has an intimate knowledge of China and what works best there.
 
Its parent, China Resources Holdings, started life as mainland-focused Hong Kong export-import firm Liow & Company in 1938. Among others, it became known for its upscale Chinese Arts & Crafts stores, which sourced jade, silk, rosewood furniture and other elegant items from China for sale to the millions of tourists that flocked to Hong Kong.
 
Starting out as a small listed property company in 1992, CRE was restructured to become China Resources Holdings’ consumer goods arm. It bought the parent’s hypermarkets and other retail assets, acquired several small Chinese breweries, and moved into food (CRE is Hong Kong’s largest pork importer) and beverages.
 
CRE now operates more than 3,100 retail outlets across China. “We have a multi-format strategy,” says Lai, who was CFO of CR Microelectronics, China Resources’ semiconductor subsidiary, before joining CRE in 2009. (He was recently named Pacific Coffee board chairman as well.)
 
“We have convenience stores, standard-size supermarkets, hypermarkets, and specialist merchants like China Arts & Crafts, herbalist China Resources Care and wine-seller Voi-la! – a whole range of shopping experience to serve our customers,” he explains. “Companies like Carrefour focus only on one format.”
 
The joint venture with SABMiller was formed in 1994 and involved injecting CRE’s brewery assets into the JV. “We were a latecomer in beer,” Lai recounts. “Today, we have 20% of China’s beer market.”
 
The winning strategy, he says, is to combinec SABMiller’s R&D, brands and manufacturing expertise with CRE’s distribution reach and intimate knowledge of the mainland Chinese market. The result: Snow beer, which started out as an affordable mass brand, but now has premium extensions as well.
 
Taking on Coke
Lai says CRE will use the same strategy in its assault on China’s US$49-billion softdrinks market, which is dominated by Coke, Pepsi and a slew of local companies such as Wahaha and Huiyuan Juice Group.
 
Both CRE and Kirin have only a modest presence in this segment. The Hong Kong company sells C’estbon bottled water and fruit-flavoured drink O PA mainly in southern China. And even though it is Japan’s best known beverage brand, Kirin markets only small volumes of its premium black tea and coffee drinks in China.
 
After 13 months of negotiations, the two sides have agreed to inject all these and other non-alcoholic beverage products (excluding the iconic Kirin beer) into a joint venture company. Kirin will inject US$400 million in cash and assets for a 40% stake, while CRE will contribute US$600 million for the remaining shares.
 
The deal is still being reviewed by China’s antitrust regulators, but Lai is confident it will pass muster because CRE and Kirin’s combined market share is small compared with those of its foreign and local competitors. (Coke’s bid to acquire Huiyuan was rejected in 2009 on antitrust grounds.)  
 
“It’s a saturated market,” the CFO admits, “but one that is growing at a 20% pace a year.” Taking a leaf from the successful partnership with SABMiller, CRE plans to combine Kirin’s world-class R&D, brands and manufacturing know-how with its own distribution networks and savvy, including its supermarket shelves, specialty shops and Pacific Coffee outlets.
 
“Every year, we will have our pick of 50 to 100 new beverage products from Kirin,” says Lai. “CRE will not need to worry about R&D and the new-products pipeline. We will just need to think about how to develop and fine-tune [the Kirin beverages] to suit Chinese tastes.”
 
Squeezing Cents
In the meantime, Lai and his team will continue to scout for more expansion and acquisition targets while making sure financial management at CRE is cost-effective, efficient and productive.
 
Lai admits that his proposal to use CRE’s excess cash for intra-group lending was controversial. If the company has so much idle funds, shareholders asked, why not return it to them in extra dividends or in the form of stock buybacks?
 
And why should companies that CRE does not own benefit from CRE’s cash? It’s really the holding company and its other subsidiaries that ultimately gain, not CRE and its independent stockholders.
 
Lai told shareholders that CRE needed the cash for acquisitions and joint ventures when the right opportunity comes along. But while waiting or negotiating, it wants to earn as much in interest on the idle funds as possible.
 
“It’s not that I have long-term reserves that I don’t know how to use,” says Lai. “This is actually short-term working capital that I’m trying to manage.” He chose to lend to other China Resources companies because he has working knowledge of their financial condition. “I don’t have the time and capability to assess the credit risks of other companies,” says the CFO.
 
In the end, a bare majority of independent shareholders (China Resources Holdings did not vote) approved the scheme. Lai built in safeguards, such as requiring a guarantee from the holding company and limiting the companies that CRE can lend to only six entities, all of them public companies. CRE can also call in the money within two weeks, even though the loan term is from three to six months.     
  
Treasury management, supply chain, cost management and operational excellence -- “everywhere you can squeeze a cent out, you should,” says Lai. “Because we have such big volumes, even a 50-basis point [additional yield] is a big help.”
 
Every cent counts when you are trying to become the company of choice of 1.3 billion consumers.
 
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation.
 
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