Chinese Character

Recipe for disaster

A classic rise-and-fall has lessons for whole Chinese economy

Wei Dong: in happier times, before he discovered convertible bonds

Henry Ford’s pioneering use of assembly lines to build the first Model T in 1908 quickly made the company bearing his name into one of the largest carmakers in the world.

But when Chinese entrepreneur Wei Dong tried to do something similar in catering, he learned the hard way what can go wrong when a company grows too fast. These days, his Fu Ji Food and Catering Services is a byword in China for ‘cautionary tale’.

Fu Ji means “lucky shop” in English, and that’s exactly how things seemed at first. At its peak, it was one of the country’s largest caterers, serving over a million meals a day – including thousands at the 2008 Beijing Olympics.

Success helped Wei rank 73rd on the 2006 Hurun rich list, with an estimated wealth of $438 million. But that all changed last year when Fu Ji declared bankruptcy, owing investors more than $282 million.

Wei’s first line in business had nothing to do with food. After majoring in tax at Nantong University in Jiangsu, his first job was as a tax officer with the civil service. It was routine work and Wei looked set to have a normal career until, at 30, he decided to go into business for himself.

In 1998, he used a $240,000 bank loan to open a restaurant in his hometown. His total lack of experience did not bode well for the venture, but observers credit his time in the civil service for what happened next. “The so-called pioneering entrepreneurs were rarely equipped with management concepts,” explains the National Business Daily, and that gave Wei an edge. He adapted the principles of bureaucratic control he’d learned at the tax office to create a “complete management model… with a clear division of responsibilities.”

Wei realised that his management philosophy made the business scalable, so he ploughed the restaurant’s earnings back into opportunities for expansion. It wouldn’t take him long. In 2000, the newly christened Fu Ji acquired two more restaurants in Suzhou. Less than a year later it would open its first restaurant in Shanghai.

And it was in Shanghai that Wei would make the key decision that turned Fu Ji into a food powerhouse. Nearby factories all needed to feed thousands of workers – and he gambled that he could win their business by offering to serve reliable, low-cost canteen food on a large scale.

He spelled out his ideas on streamlining the food distribution business in a 2002 textbook The Fu Ji Vertical Method, which quickly became the benchmark for best practice in the industry. Wei placed heavy emphasis on quality, painstakingly spelling out each step from purchasing and processing, to marketing and delivering food. That meant that Fu Ji not only had some of the highest quality food in the business, but also a price that few could match. It’s estimated that wages took up just 5% of Fu Ji’s cost base, against an industry average of 30%.

But to achieve the scale he wanted, Wei needed a lot more capital. So in 2004, the company raised $37 million through a public offering in Hong Kong. It would not be the last time Fu Ji went to the public for money.

That December Fu Ji’s restaurants and canteens were churning out 100,000 meals a day, an impressive logistical feat in its own right. But Wei saw no reason why Fu Ji couldn’t be preparing a million meals. All he needed was capital.

The cheapest way to raise money would have been from a bank, but the amount he wanted scared off most lenders. And in any case, private businesses like Fu Ji often take a back seat at mainland banks, which prefer lending to state-owned giants.

So in October 2005 Fu Ji was back in the Hong Kong capital markets, raising another $79 million through convertible bonds. It was a modest amount for a company with rapid growth prospects that had earned $24 million in profit that year. As Fu Ji’s share price continued to hit new highs, all of those bonds would later be converted into stock at the bargain price of just over HK$10 a share.

If that were all, it would have left Fu Ji a highly profitable, well-capitalised company. But Wei was ambitious, and like a gambler he kept going back to the card table. Fu Ji tapped the convertible bond market again for $128 million in 2006, and another time for $220 million in October 2007 – just as the US sub-prime housing bubble was bursting.

This time investors would not simply convert the bonds into shares – they would have to be paid in cash. Shares in the company had fallen far from their bubble high of HK$29, and there was no prospect they’d reach the HK$33 needed to make conversion a profitable choice.

Warren Buffett’s often quoted as saying that it’s only when the tide goes out that you discover who’s been swimming naked. And as it happened, Fu Ji was doing just that. Even as Wei continued to pour money into his catering empire, it was becoming apparent there was no way Fu Ji could grow fast enough to repay investors in just three years. It’s earnings topped out in 2007 at $51 million.

Investors knew the company was in real trouble when it missed the July 2009 deadline to publish its annual report. The firm then applied to go into liquidation that October and its shares were suspended from trading at HK$7.60.

“Fu Ji paid the price for rapid expansion as problems arose amid the absence of efficient management,” rued former company executive Hu Zhiqiang.

But the move into liquidation outraged investors who, accused the company of acting in bad faith. After all, the business was still profitable – the last reported earnings netted $36 million in profit for the first half of 2008. By winding the company up, investors are likely to recoup close to nothing unless a new buyer can be found.

So why not just refinance? “We think the game of financing is too complicated for us,” a Fu Ji official explained to the South China Morning Post, “We just want to quit it by liquidation.”

Some observers think a more supportive Chinese banking sector might have helped Fu Ji avoid its fate. Fudan University Professor Chen Zhao argues that: “Mainland financial institutions still need to strengthen their support for the development of private enterprises.” And if Fu Ji’s is a cautionary tale, the real lesson may be in what it says about the Chinese financial system and its involvement with the private sector. These firms – unlike their Western peers – have tended to depend on family loans and informal financing to aid their growth. Fu Ji grew beyond that and thus used international convertible bonds. But if local banks had been more supportive it wouldn’t have had to take such financing risks.

“Fu Ji was a typical private enterprise,” Professor Chao explains, “it was doing pretty well in its main business, but the problem lay in funding.”


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