No stranger to controversy

“Publish and be damned” was the famous retort from Arthur Wellesley (better known for inventing the Wellington boot and seeing off the French at Waterloo) on news that a former lover was writing a memoir featuring more than a smattering of nineteenth century kiss-and-tell.

In China this week the attitude to publishing differed markedly from the liberal line taken by Wellesley, a former British prime minister.

This became apparent when Caijing Magazine – a respected national business publication – wrote a cover story on Huawei, the information technology heavyweight.

After appearing at airport bookshops and some news-stands on Sunday, the issue was recalled the following day.

Even by Chinese standards, this was unusual. As was Caijing’s explanation to distributors that it was due to ‘technical reasons’.

The more likely cause? A government order is the favoured explanation. Fortunately, WiC was able to purchase a copy before the recall, and we were curious to see what the fuss might have been about.

What does the story cover?

At first reading, the article is rather a technical one, describing the evolution of Huawei’s employee incentive scheme.

Since 1990, the company’s founders have rewarded many of their staff with the right to buy Huawei stock (until 2001 at a price of Rmb1 per share), also entitling them to an annual dividend. Ten years ago, the system was formalised into a restricted or virtual stock arrangement. This seems to have been a scheme with Chinese characteristics, which for Huawei means that the staff shares are issued and then bought back through a calculation process known only to a mysterious few.

But there probably isn’t too much here that comes as a shock to veteran Huawei watchers, especially as the share scheme was challenged in the Guangdong courts in 2003 by two employees claiming that they should have been paid more than the repurchase price offered by the company at the time.

The courts ruled against them, stoking local debate that Huawei’s stock plan looked less like equity ownership and more like a form of contractual benefit.

Despite this, employees seem to be happy enough with the set up, especially as the annual dividends often add significantly to salary. As Caijing points out, virtual stock was sold to staff last year at Rmb5.42 a share but paid out Rmb2.98 (per share) in annual dividend, and similar returns over the years mean that at least 60,000 employees have been eager to take up their allocations. “No one I know would hesitate to buy,” one employee told the magazine.

The arrangement has proved a financial boon to Huawei too. Caijing’s estimate is that staff purchased Rmb26.3 billion ($4.13 billion) in virtual stock between 2004 and 2011, supporting the company through its rapid growth.

So what’s the problem?

The main revelation is that many of Huawei’s employees weren’t in a financial position to buy into the stock plan in the first place, so they borrowed the money from the Shenzhen branches of four leading banks: Bank of China, ICBC, China Construction Bank and the banking arm of insurer Ping An.

And the problem here is that most of this cash seems to have been lent improperly as personal business loans, which are not supposed to be made available for purchases of stock in this way. Despite this, it was only last year that the China Banking Regulatory Commission (CBRC) stepped in to call a halt to further lending. Moreover, it insisted earlier this year that outstanding loans to staff are paid off in full by the end of next month.

Of course, this raises a number of questions. For example, if the CBRC directive on repayment is properly enforced, Huawei will have to pay out on its commitments to staff (and it has already started doing so, agreeing a buyback at Rmb5.42 a share last month). So the scheme’s demise will have an impact on cash reserves, as well as force bosses to rethink their approach for retaining employees.

More obliquely, the article throws light on how Huawei – which frequently reassures the wider world of its private company status – has also been the recipient of significant capital from three state-owned banks, albeit indirectly via the stock purchases of thousands of its employees.

Of course, one way to read this is as lax lending behaviour from banks keen to pull in Huawei employees as retail customers. An alternative is to see billions of yuan in loans flowing from state lenders into a company that prides itself as a private enterprise.

More significantly, the news touches on a raw nerve – the question of who owns the company.

Ask company bosses, and the response is that the employees are the owners.

But Caijing’s investigation seems to highlight something rather different: there are actually two shareholders, Huawei Holding (an employee union with about 99% of the equity but controlled by company founder Ren Zhengfei) and Ren Zhengfei himself, with the remaining 1%. Employees buy into the virtual stock and are paid a dividend. But they have no actual ownership rights.

In fact, corporate spokespersons have been careful not to over-represent the ownership terms in the scheme. Bill Plummer, vice president of external affairs, told an industry forum in March that Huawei was “an employee-owned company” but went on to say that these are not “grants of stock” but “grants of the opportunity to purchase stock”.

But Caijing’s article peels back much more of the detail on how the employee incentive scheme has been working over the last decade. And the underlying point is that company founder Ren continues to stand behind everything at Huawei. Profits are shared but the implication is that controlling power lies in Ren’s hands.

Why does this matter?

Because Ren is something of a bugbear for Huawei’s critics, who rarely fail to mention him without alluding to his former career at a technical institute within the People’s Liberation Army (PLA).

Ren usually avoids interviews, although his limited public statements have shown a fondness for the occasional military metaphor (a favourite – borrowed from Mao – described a sales focus on rural areas as “surrounding the cities from the countryside”).

That helps to stir the pot on accusations that Huawei is a front for the Chinese military. In the US, this is provoking anxiety that purchases of its networking equipment could put national security at risk by sneaking in ‘backdoor’ chips that allow snooping; or, worse, embed ‘kill switches’ that could splinter the technological backbone supporting the entire economy.

This isn’t a new charge – we discussed it in WiC96 last year – but it was beefed up by the launch of an enquiry last November from the House of Representatives Intelligence Committee into Huawei’s ties to the Chinese state.

At the time Dutch Ruppersberger, the senior Democrat on the committee, warned that this would review the extent to which Chinese telecoms firms like Huawei “provide the Chinese government an opportunity for greater foreign espionage [and] threaten our critical infrastructure”.

Hasn’t Huawei heard all of this before?

Yes. On the rumours about its military links, company spokesmen have long claimed a case of mistaken identity. Huawei’s Plummer – hired for his international PR skills – told Fortune magazine last year that this stems from a longstanding mix up in which it was confused with “another Chinese company with a similar name”.

However, recognising that the perceptions were proving detrimental to its US business, Huawei has gone through a painstaking effort to win over the doubters, including hiring industry veterans from Europe and the US into key executive roles. The company’s message has also been consistent. Yes, Huawei has Chinese heritage. But the firm is now a global one, with operations in 130 countries, employing thousands of foreign staff and selling products to almost all the world’s leading telecommunication operators.

Company bosses have made clear that they have been buying billions of dollars worth of goods from American companies, and investing millions more in American facilities and American jobs.

The firm has also tinkered with its commercial approach in the United States, stepping back from chasing contracts with the large carriers to focus more on supplying the smaller telcos, as well as offering enterprise solutions to large companies.

Plus it has diversified into selling consumer products like smartphones and tablet computers. This looks like a smart approach, as the better Huawei is known to middle America, the harder it becomes to cast it as bogeyman.

To return to the military analogies favoured by Ren Zhengfei, Huawei is eschewing the shock-and-awe of massive contract bids and instead trying to take the American market street-by-street.

So why such high-level sensitivity about Caijing’s article?

One answer is that the timing is awkward, with the intelligence committee writing to Huawei again this month for more information on its links to the government, the military and the Communist Party. It also wanted a list of US telecoms operators using its products or services, as well as more information on its pricing strategies.

Of course, it will likely remain a mystery as to who was ultimately behind getting copies of Caijing removed from news-stands. The government obviously views Huawei as one of its national champions, and may have considered the story too negative. Equally the banks and the CBRC may also have found the article sensitive.

While that’s a mystery, one incontrovertible fact remains: copies of the magazine did disappear from shops. Given the publication’s high profile that’s an event that is hard to miss.

And if it was pulled with government help, it would seem to validate what many US congressmen have long been saying: that Huawei’s ties to the government are close.

In fact, there are grounds for arguing that the decision to order the recall from shop shelves could prove more damaging than the article itself.

After all, the restricted stock scheme is hardly new, and first came up for external discussion nine years ago when the employees lost their case in Guangdong. Nor is the suggestion of Ren Zhengfei’s background control a great surprise. WiC mentioned the limitations of shareholder rights for the rest of the staff back in issue 85.

In retrospect, Caijing’s article focuses as much on the banks for breaching lending rules as on Huawei’s shareholding practices. Admittedly, it looks like these rules have changed (or more specifically, that they might now be properly enforced) and this means that Huawei will have to rethink how to incentivise its staff, as well as what the new regulations might mean for capital-raising.

But the article makes no great claim of internal crisis as a result of the changes. Nor does it say anything in support of the allegations being made by the company’s more fearful critics overseas.

On the other hand, the mystery of the recall could well provide further ammunition for those keen to stoke paranoia about Huawei as it seeks to push further into overseas markets.

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