Running a U.S-Listed Company in China

A native of Singapore, Terence Yap is CFO and vice-chairman of the board at New York-listed CSST – that stands for China Security & Surveillance, Inc. He spoke to CFO Innovation’s Cesar Bacani about financial management and M&A in China, capital-raising in the U.S. and Dubai, and other lessons on working and living in the mainland.

Tell me about the business of security and surveillance.
The market in China started in 2003. There’s a lot of small players – the majority have less than US$10 million of revenue per year. It’s still very much dominated by five-person shops that provide value-added installations. Right now we’re the largest, even though our revenue is about US$427 million last year, which is less than 5% of the total market [of more than US$8.5 billion]. It’s like any young industry. You see it highly fragmented now, but after a decade or so of consolidation, then you’ll see a clear winner.
But isn’t closed circuit television an old security and surveillance technology? I would have thought that a socialist society like China would be chockfull of CCTV cameras . . . 
China in the past has not used CCTV as a form of security application. It was mainly human [surveillance]. CCTV is an old technology, but it started to be implemented [in a big way only recently] in China because of the telecoms infrastructure. In the past, everything relied on dug lines. The prevalence and the advances in the Internet, fibre optics, compression technology, YouTube, these allow you to see things remotely over the Net. They have helped a lot in terms of trying to improve the visibility applications of CCTV.
You are listed in the U.S. Do you import technology from there? Is there a problem importing American technology given that surveillance and security have national security implications?
All our intellectual property is [developed] in China. All our R&D is in China. We work with universities, Beijing University, Wuhan University, so we have joint IP with them. We are a Chinese company; 95% of our revenues come from China. From the point of view of Chinese authorities, we are a domestic company that went to the U.S. to raise capital in order to build a business in China.
From our perspective we don’t deal with the military. Our space is within the civil areas, in really improving the safety standards and on. We don’t want to go into the defence area. We don’t do that at all.
We make and install cameras for traffic management systems, disaster recovery, emergency response, pollution detection – everything on a city-wide scale basis. It’s called the Safe City concept. It’s similar to what you have in London, which probably has the most cameras anywhere, about 3-4 million cameras in one single city. Shenzhen has about 800,000. Guangzhou has about 1 million cameras already installed. But the penetration rate for surveillance cameras is about 20%.
The business model, I imagine you’re like a telecom company, where every month you get a steady flow of income from subscriptions, usage fees and so on?
Not yet. That’s where we want to be eventually. In our business plan, there are three different phases. Phase 1 we become a manufacturer. In China, if you manufacture products, you actually get certain approvals and licenses, and once you get those approvals and licenses, you can bid for government projects. We now have the largest security-related manufacturing park in China.
We’ve acquired some companies in the software space, whereby you put several different cameras into one platform, so we can bring everything on your console. We’ve also acquired a company that is into traffic management systems software.
Right now we’re very much in Phase 2 of our business plan, which is installation. China is still a greenfield. Security is still new. So we manufacture it and now we also install it for you. In the past, other companies installed our products. Now we’re doing installation, and this now represents about 75% of our revenues. It’s become our main bread and butter.
But we know we will eventually move to Phase 3 of the business, the recurring revenue model. Every single installation we do right now becomes part of a natural customer base for us for the future recurring business. We’ve recently announced a couple of acquisitions in the services space.
If you look at the large security companies around the world, Security Task, GForce, Seccom in Japan -- they’re all recurring fee. They’ve gone through decades of evolution. They went through the same phases we’re going through: manufacturing, installation and services.


You are listed on the NYSE. Was it hard to persuade U.S. investors to invest in your stock?
We didn’t do any IPO. We did a reverse merger [of a company trading on the Over-the-Counter Bulletin Board in the U.S.] in 2005, and then [went to the NYSE] in October 2007. We became dual-listed in Dubai in 2008. We didn’t do road shows at all because we didn’t do an IPO.
How did you introduce yourself to investors?
In 2007 and 2008, I used to go to the U.S. once a month to meet with the bankers, who would introduce us to their clients.
I imagine there were all sorts of questions asked about your business.
Not really. In the U.S., Homeland Security does a lot of camera. The U.S. is probably the [country with] the most wide surveillance. They can tap your emails. Even on the phone, you mention the word ‘bomb’ . . .
A lot of U.S. investors, they understand the need for security. And they understand that we’re here to provide peace of mind. Like anywhere in the world, there’s bound to be crime rates [in China] and the key for us is that we are already there to provide safety to cities.
How would you describe your investors?
We have a mixture. Investors love us because we’re in security. It’s a good business, a defensive business. Regardless of how the economy goes, up or down, security is always needed. Institutional investors, they understand that we’re not doing defence, that we’re not manufacturing firearms, missiles… I know they have certain policies that restrict them from investing in military-related businesses, which we aren’t. We are a private-sector civilian company.
Do you think it’s worth it, listing in the U.S. and all the legal requirements that’s required? If you listed in Hong Kong or Shenzhen, financial reporting would be simple.
Back in 2005, when our revenues were about US$33 million, we couldn’t go anywhere to IPO. We were just too small. So that’s why we chose [a backdoor listing] in the U.S, which is still the largest capital market in the world.
Listing in the US has bought us a lot of credibility. Being a New York Stock Exchange listed company has brought us good visibility and also prominence, especially in doing M&A in China. There are probably only about three New York Stock Exchange listed companies in Shenzhen and NYSE is still regarded as one of the most stringent and prominent. If you’re listed in one of the strictest, stringent markets in the whole world, it gives the investors comfort in your compliance.
How much do you spend to comply with NYSE rules?
We don’t provide a figure, but it’s certainly not cheap. It’s a lot more expensive than in Hong Kong and Shenzhen. And certainly Hong Kong is not as stringent. A lot more things you can do here.
There’s nothing that would stop you from actually going to Hong Kong and having a third listing?
There’s nothing stopping us, but we will look at whatever is best for the company, and whatever is best for shareholders. Listing in the U.S. and Dubai has helped us a lot in terms of gaining the visibility and approving the business operations in China. Whether or not we look at Hong Kong, that’s subject to further discussions.


Let's talk about financial management. How much money have you raised from the capital markets in Dubai and the U.S.?
We didn’t go to Dubai to source funds. The Dubai listing was really more for credibility and profile because we wanted to penetrate the Middle and Near East region and the Indian subcontinent. The majority of our fundraising has been in the U.S. Since our backdoor listing in 2005, we have raised almost US$150 million.  

Do you have borrowings?

We used to have convertible notes, but we have restructured that. So right now we have deleveraged a lot on our balance sheet, which is quite healthy. We do have a lot of local bank support in China. The stimulus package is actually helping a lot. Right now the bank lending rates is one of the best in the whole world. We’re getting like 4.75% to 6%. Where else can you get a great rate like that? Some of the banks in the U.S., they lend at 15% interest.
But aren’t private-sector companies like CSST having problems getting loans from banks? The perception is that Chinese banks lend only to state-owned enterprises.
Most of our projects are the government’s. The banks want to make sure that you can pay them back, and in China, the most credible payee is the government. Most of our financing right now is with the local banks and it’s mainly for government projects. These are short-term credit and receivables financing facilities, which help in terms of managing our cash flow.
How many people do you have in finance?
I have 250 executives in the finance department – AR, payables, inventory, internal control, internal audit, financial control. Everything is centralised in Shenzhen.
Isn’t that a large number for a company with revenues of only US$427 million?
A lot of it is legacy, because we have acquired a lot of companies. I don’t fire them. I will switch them around. So if you were the financial manager of one acquired company, I’ll transfer you to another company. Sometimes we move them from internal control to internal audit, internal audit to financial reporting. We’re subject to Sarbanes Oxley, so every quarter we do testing for SOX. We’ve got separate internal audit teams that go out every quarter to check on the accounts. That’s a lot of people [to check]. We’ve got 4,500 employees right now.
How many acquisitions have been done?
We did about 20 over the past few years.
And that was funded by the money raised in the U.S.?
The majority, yes. We typically pay part cash, part equity. The equity we lock up for three years – we require a minimum income guarantee for those three years [that will unlock the shares]. We don’t fire people, we absorb them, as part of our incentive. And three years, because it’s around the time required to integrate the company together. On Day One, I control the financials, but management and operations will still be the same.
The philosophy of not firing anyone, that works in China because it’s a growing market?
It stabilises everything, but of course after one year, two years, we integrate everything. Maybe we'll find redundant areas, then we have to let go of people.
But not in the finance function.
No, so far not yet. As a New York-listed company, there’s a lot of things that we have to control. You have Sarbanes Oxley. And as your operations become bigger, the scope of the tasks becomes bigger as well. 


It’s also difficult to find experienced finance executives.
I do hire a lot of overseas people. I’m a Singaporean, my financial controller is from Hong Kong, my legal department head is from Hong Kong as well, my internal control is Hong Kong. We do hire quite a fair bit of people from Hong Kong.

What lessons have you learned from the acquisitions you have done?

We have a huge advantage because we’re a Chinese company. If you’re an international company, you are considered a foreigner, an outsider. As a Chinese local company, we understand the market, we know culturally what to say and not to say.
Whenever we do an acquisition, we always look at the management team. Unlike a lot of foreign acquirers, we don’t change the management team. We absorb the management team. And it’s by part cash, part equity and three years net income guarantee.
We put all our assets in one place. We relocate everyone in the industrial park, because by putting all acquisition assets in one location, it helps integration process. That was the reason why we bought the CSST Industrial Park [in Shenzhen]. Right now all but two manufacturing plants are there.
The biggest challenge in terms of acquisition is culture. In China, most of the companies are started by entrepreneurs. The spirit and the culture of the company are determined by the head. If on Day One you take away the head, the whole company will falter. And that’s the reason why we don’t take away the head.
But we also realise it’s important to create a single culture. Right now we’re creating the CSST culture. And that’s why every quarter we have management training. Every quarter I train my financial division, every quarter we get experts to teach them to come together to create the CSST loyalty culture. It takes a long time to change.
The founder will become part owner of CSST after the three-year lock-up?
Correct, and this will always be encouraged. If you’re given an opportunity to be part of a bigger ship, as a ship we will all row together. It’s not like you sold the company to me, thank you, goodbye.
What are the criteria that you use to decide which companies to acquire and which companies to stay away from?
Because we are in China, we are a Chinese company, we know which are the better companies. We know who are the players that are there. We are a member of the standing committee of the China Public Security Industrial Association. And we have dealt with many companies as suppliers, as vendors, as customers, as competitors. We know their weaknesses, we know their strengths.
Typically we look at, first, their standing and position in the industry. Secondly, we look at management. We should be able to trust management, because if I cannot trust you, how can I expect to work with you for the next three years? And thirdly, we’ve got the same objective. You’re not going to exit, you’re going to help us build the whole industry, build the company into a bigger platform.
Do you go to them or do they go to you, is there a middleman that arranges M&A deals?
Typically, they will come to us because we are quite visible. A lot of companies in China, when you go to a certain level, working capital is the biggest problem. And this is a very new industry at this point in time. There’s still a lot of cottage companies that are not able to go over the threshold. To get over the threshold you need more working capital. You can stay within that particular size, but to grow to a bigger size, you need a lot more support.
What if the founding entrepreneur wants to get out of the company altogether?
Then we need to look at who else is in the management team. If the management team is credible, it they are able to run the business themselves, then we may consider. Or maybe we will say, we will allow you to leave two years later. You still need to be around.
You’ve been acquiring companies for three years now. How would you assess your track record?
So far so good. We’re starting to see some benefits, but there’s still probably a long road ahead to have a fully integrated CSST company.
If you look at manufacturing margins, we are actually able to see some improvement, about 30%. And given that we have moved most of the manufacturing assets into one location, it’s helped in terms of economies of scale as well.
Would you say that 4,500 employees is excessive?
We do review it every year, in terms of the manpower, in terms of redundancy and so on. From my perspective, it’s always a balance, it’s a balance in terms of trying to be slim and effective and the human touch.



A lot of your clients would be local governments. How do you deal with government officials and bureaucrats as a business?
We have a dedicated team that deals with the government sector. Some of the members are ex-government people, so they know how to speak the language. We have more than 100 people in the government sales and marketing division.
We have very good links with the government because we also try to help them improve. We are helping train 3,500 security guards of the Public Security Bureau in Shenzhen, for example. Being a soldier and being a security guard are two different things. The legal environment, how you apprehend a suspected criminal will determine what kind of evidence you will bring to court. We teach them to operate security systems and so on.
Because of our listing in the New York Stock Exchange, we needed to appoint independent directors to the board. One of our independent directors is a semi-retired government official from the Ministry of Public Security. He provides a lot of credibility.
As a U.S.-listed company, are you covered by the Foreign Corrupt Practices Act?
Yes, we have FCPA policies. The law really goes down to your suppliers, vendors, sub-contractors, to your agreements, every single aspect.
But we’re also seeing that China is changing. If you do a government project that’s huge, the local governments will not risk it. That’s why we like to participate in open bids. Then we get measured in terms of our capabilities, rather than ‘who’s your friend.’
But it’s part of the Chinese culture to wine and dine and entertain clients.
Wine and dine is different. You have to do it. You meet government officials to have dinner with them, that’s different. Moving away from that, you’re walking a very fine line.
Who is your main competitor?
We typically compete against the telecom operators. When you do a citywide installation, if you put a camera on the street, the only way to get the images back to the control centre is through the telecom infrastructure, and they want their piece of the pie. The problem is that the telcos do what they do best only, which is telecoms. They don’t manufacture cameras, DVR boxes, everything else. How do you configure the whole thing.
They have two choices. One, they become the project manager. They the camera from this guy, software from this, and try to do everything themselves. Or they will go to a company like mine. They take care of care of telecoms, I take care of all the security. So typically we compete against them but we also cooperate. We have relationships with them, but these are different in different provinces because the telecom sector, even with the Big Four telcos, are also fragmented.
Would you say the barriers to entry to your business are high or low?
For the government sector, it’s very high. For international companies, there are a lot of natural barriers. Some of the licenses are given to local companies only. Secondly, foreign players, they’re prices are about 30%-40% more expensive than local products because they think their brand name deserves a premium. Thirdly, the Chinese government is always trying to encourage local enterprises. 



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