By Perry Wu
In the beginning, China created only one telecom. For years, China Telecom was the only provider of fixed line service in China. This situation continued until 2001, when the central government split up China Telecom into both China Telecom and China Netcom. China Telecom is still the dominant telecom, with China Netcom now a respectable second. In the past weeks, China Netcom filed its prospectus for its long-awaited IPO. But we wondered why Netcom had been delaying its IPO, and now perhaps we have a disturbing reason why.

Although the company has the word "Net" in its name, China Netcom's core business is still the traditional fixed land line business. Netcom's land line coverage extends mainly in the Chinese provinces of Hebei, Henan, Guangdong, Liaoning and Shandong, and also includes the prosperous cities of Beijing, Shanghai and Tianjin. These regions collectively account for about 400 million, or 30%, of China's population.

While the marketing of this IPO focuses a lot of attention on Netcom's non-fixed line businesses such as broadband, Netcom's revenue is still nearly all from fixed line services. For the year ending June 30, 2004, 82% (US$3.2 billion out of US$3.9 billion) of Netcom's revenue still came from fixed line services. However, broadband's small contribution to Netcom's top line did grow by US$100 million, or 50%.

To keep up with the ever-expanding group of Chinese who no longer depend on a fixed line but only use a cell phone, China Netcom has made a major push for PHS (personal handyphone systems). More commonly known among Chinese as "Xiaolingtong" or "little smart", PHS are essentially glorified cordless phones. However unlike mobile phones, PHS only can work within a narrow geography, such as a city or a provincial region.

Now we come to the financials. Yes, there buried among all the nice data about growth and opportunities in the IPO prospectus is a rather disturbing bit of information. During the last year, as many investors waited for this IPO, the company delayed. You see, the company was really quite busy.

The executives of China Netcom were busy draining the company of cash, so they could then do an IPO claiming China Netcom needs more cash. Buried in the notes to China Netcom's financials, we find that the company decided to make a dividend payment to its Chinese parent sometime last year, obviously before the IPO.

And even in US dollar terms, this is serious money. It paid a whopping dividend of almost US$1 billion to its Chinese owners. This is like Bill Gates transferring all his assets to his father one week, and the next week going to the government welfare office asking for money because now he is poor. Here China Netcom just sapped itself of its cash, and so now it can go to investors with a tin cup and say, "Hey buddy, can you spare some yuan?"

Friends, you may have thought that this sort of behavior was confined to smaller, fly-by-night operations such as small, about-to-go-public Internet companies. But no, bleeding a pre-IPO company dry of its cash is acceptable to even large, established companies like China Netcom. It is unfortunately all too common for companies to raise capital simply because it is other people's money.

Even Hutchison Whampoa, the Hong Kong-based company controlled by Li Ka-Shing, decided to play a version of this game recently. Hutchison earlier this month decided to raise capital for its Hutchison Telecom subsidiary by doing an IPO. The problem is that Hutchison Whampoa already brags about having over US$17 billion in liquid assets, but on the other hand it goes asking for cash for its Telecom subsidiary. It doesn't add up. Who at Hutchison Whampoa needs to buy a new yacht this month?

Bloomberg News interviewed an astute investor and fund manager, Joseph Levinson, who summed this situation up succinctly. What Levinson said (Hutchison Whampoa Makes Less-Than-Expected Profit on Phone IPO) applies equally to China Netcom: "If Hutchison Whampoa does not have a compelling reason to do the Hutchison Telecom IPO, why should investors have a compelling reason to buy it?" My thoughts exactly. If China Netcom thinks it can hoodwink gullible investors with non-transparent work-arounds, who will believe that the executives at China Netcom are going to run the business for the best interests of investors?

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.