“Let’s call it a draw”

To fans of the Sopranos it has an air of familiarity. They will no doubt recall the episodes of the hit TV show when mob boss Johnny ‘Sack’ Sacramoni ran the Lupertazzi’s mafia business from behind bars – giving instructions to his brother-in-law who visited him in jail.

That also seems to be the strategy of incarcerated billionaire Huang Guangyu, who has also been trying to run the business he founded, Gome, from a cell – although in his case it’s in Beijing rather than New Jersey.

His efforts to exercise control of the Chinese electronics retailer came to a head this week at a key shareholder meeting in Hong Kong. He narrowly failed to get his way, but the sheer audacity of his jail-based power grab has sparked a debate in China and beyond. Aside from the corporate governance concerns it raises, Huang also attempted to play the ‘economic nationalism’ card against Gome’s second largest stockholder, the foreign private equity firm, Bain Capital.

From the boardroom to behind bars. A brief history

Huang’s not a gangland boss, but he’s certainly done his share of criminal behaviour. The 42 year-old tycoon was found guilty of insider trading and bribery in May, and sentenced to a 14 year jail term. The Guangdong-born entrepreneur had founded Gome – which literally means ‘national beauty’ – in 1987 and over the next couple of decades built it into the country’s biggest seller of houseshold appliances, with over 1,100 stores nationwide. His meteoric rise saw him named China’s richest man by the Hurun report in 2004, with his wealth peaking at $6.3 billion in 2008.

A classic case of rise and fall (see Chinese Character, WiC36), many assumed that after his jailing, the disgraced boss would exit the corporate scene. Huang had other ideas.

Bain of his life?

The arrest of the company’s founder in late 2008 understandably left Gome in a state of disarray – a fact that weighed on the stock price. Its reputation tarred by association with Huang, Gome’s new management sought to restore confidence by inviting Bain to become a shareholder. Last June, the US firm paid $417 million for bonds that were recently converted into a 9.9% stake.

The arrival of Bain seems to have infuriated Huang. So too did the behaviour of his replacement as chairman, Chen Xiao. He had arrived in Gome courtesy of Huang, who had bought his much smaller firm, Yongle, and merged it into his own in 2006. According to the Southern Metropolis Daily, Huang saw Chen’s cooperation with Bain as a breach of trust and an act of personal disloyalty. He became intent on his removal.

He had two weapons at his disposal. His first bargaining chip was that he still personally owned 400 of Gome’s stores. This bizarre state of affairs raises any number of corporate governance issues in its own right: how can the Gome brand be used in both the listed firm’s stores and the ones owned by Huang? Not surprisingly, Gome’s new management was keen to get control of these outlets to add to the more than 700 stores it operated itself – and was equally eager to ensure he didn’t sell them to a rival firm.

But Huang’s main hold over the new management was that he remained the single largest shareholder: he still controlled 32% of Gome’s stock. In May he opposed the nomination of three Bain board nominees. As China.org put it: “The gloves came off and a public blood-letting began.”

What next?

Huang’s goal was no less than to regain control of the day-to-day affairs of the company. To Western fund managers, the idea of someone running a listed firm from jail may seem as implausible as James Bond stopping in the street to ask an old lady for directions. But Chinese capitalism is a work-in-progress activity and, as the Gome situation confirms, pretty much anything is possible.

To facilitate his coup, Huang called a special general meeting, wanting his sister and lawyer appointed to the board, and Chen and Bain’s nominees kicked out.

Ahead of the vote, Huang’s forces stirred up a bout of economic nationalism, says Wang Xiaobing, a senior editor with Caixin. This was fomented on the internet and directed primarily against Bain, portraying the fight as one of national honour: keeping a cherished local brand in Chinese hands rather than losing it to a foreigner. Wang points out that this was far from the first time such an approach had been employed – Wahaha’s Zong Qinghou had successfully used it against Danone (see WiC39).

Fundamentally, it was also a battle over Gome’s strategy. Under Huang, the firm had been the industry’s market leader, grabbing market share with the breakneck expansion of its retail outlets. Since his incarceration, Gome’s leadership position has been ceded to its biggest rival Suning (run by Zhang Jindong, see WiC39). Huang put forward a five year development plan designed to regain the top spot.

Chen and Bain took a different view, and had hired McKinsey to do a strategic review. The conclusion was that Gome should forsake market share – i.e. close the marginal stores in favour of improving the profitability of the remaining outlets in the best locations (when Bain bought Toys R Us it also closed stores). In the first six months of the year Gome’s net profit was up 66% to Rmb962 million – vindication, perhaps of Bain’s ‘less is more’ strategy, versus Huang’s ‘more is more’ approach’.

A battle of values?

The PR war was fought through the media and online. ‘Patriotic’ netizens threatened to boycott Gome stores and it was suggested that Bain had little interest in growing the business – just selling off its real estate and making a quick profit on its investment. A poll on Sina.com saw an incredible 2.43 million express support for Huang; only 210,000 voted for Chen (and by extension Bain).

Huang may have been jailed, but in the court of public opinion he was very much the victor. Typifying the popular mood Li Qiang, a Gome small shareholder, said he would vote for Huang at the special general meeting because he was a “genius businessman”. He also told Bloomberg that: “A flawed hero is still a hero.”

Chinese journalists have spilled much ink on the battle. For some it was about more than just Gome. It symbolised the clash between two competing corporate structures. In one corner, the modern corporation, run by professional management for the benefit of minority shareholders; in the other, family ownership. (Of course, it’s a bit less black and white: Walmart is the world’s biggest retailer and is both professionally managed and controlled by one family, the Waltons).

For the foreign press, the Gome showdown also has a wider message for investors.“This is a very unusual case,” Jamie Allen of the Asian Corporate Governance Association told the Financial Times. “It’s a good example of the risks of investing in private companies in China.”

And the winner is…

There was high drama at Tuesday’s shareholder meeting. Huang lost, but by a surprisingly narrow margin. Chen got 52% of shareholder votes and will remain chairman. Bain retains its three board seats, while Huang’s sister and lawyer failed to get elected.

As the Shanghai Daily pointed out, although Huang had “failed to regain control of the company” he did manage one victory. He’d also put to the vote the board’s general mandate – which allows it to issue up to 20% more stock without prior shareholder approval. That was voted down, meaning Huang’s stake cannot be diluted.

This is significant, since as long as he holds more than 30% he can still call special general meetings and be disruptive. Little wonder, then, that FT’s Lex column called the outcome a “stalemate”.

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