Hong Kong’s Merger Muddle

Merrill Lynch offers what could well be described as “the best advice money can buy.” And, when it comes to being paid a huge sum to give advice on the acquisition via a 50-year lease by Hong Kong’s Mass Transit Railway Corporation (MTRC) of the assets of the Kowloon Canton Railway Corporation (KCRC), the government is getting what it is, indirectly, paying for.

The MTRC is majority-owned by the government, but since 2000 has been a publicly listed company. The KCRC is wholly government-owned. Merrill Lynch was hired to advise the minority public shareholders on the merits of the deal.

But Merrill’s advice to accept the offer runs counter to the views of independent commentators, ranging from shareholder activist and HK Exchange board member David Webb to South China Morning Post columnist and former investment banker, Jake van der Kamp. Simply put, the board of government officials and appointees has hired an advisor who was clearly very keen not to ask awkward questions and to say what was in the interest of the government.

Among other things, Merrill Lynch has reportedly failed even to discuss, let alone justify, one of the key issues for MTRC shareholders: fare autonomy. When the company went public it was with the promise that it would be allowed to set its own rail fares on a commercial basis. This was widely praised at the time, notably by investment banks, and professor of finance at the Hong Kong University of Science and Technology, Chan Ka-kuen.

But now under the deal which Merrill Lynch supports, the MTR is to surrender that fare autonomy by the imposition of fare caps. Meanwhile Professor Chan, having joined the government as Secretary for Financial Services, has changed his tune and supports the plan. Another case of what money and status can buy.

The so-called merger of the two railways has long been plagued by disagreements of all kinds, not least between the managements. A fare reduction and future fare cap was the political price the government paid for getting legislation approved to allow the deal.

It also followed an unseemly row in early 2006 and an exodus of senior professionals from the KCRC who were fed up with being bossed around by a non-executive chairman, Michael Tien, who had scant qualification for the job other than being the well-connected son of a textile billionaire. He also happens to be the brother of James Tien, leader of Hong Kong’s Liberal Party, a gathering of entrenched business interests that controls many seats in the Legislative Council. In a deal reminiscent of guanxi winning over professionalism, Tien’s connections enabled him to win his battle with professional management. Now, despite the MTRC’s superior operational record, it is being forced by the government to take on KCR assets at a disadvantageous price.

To make matters worse, the government seems to believe that securities laws do not apply to it. So it is perhaps not surprising that in its attempt to railroad this deal there has been a sudden – 25 percent in 10 days – surge in the MTRC share price after a long period of being flat. As Van Der Kamp has pointed out, this looks like blatant market rigging by a government using its investment bank toadies to buy up share and try to prevent minority shareholders defeating the merger plan. If so it would appear illegal under the securities law and also a grossly improper use of public funds.

As for Merrill Lynch, its apparent behavior is par for the course. For most investment banks anything which makes money is fair game, apart from the more obvious forms of theft. That is particularly the case when it comes to pleasing governments that have actual or potential investment banking deals to be done.

Clearly, upsetting a government for the sake of the relatively small fees from advisory work is not worth it when a share or bond issue or privatization is a far more profitable business. Remember what happened last year to Morgan Stanley chief Asian economist Andy Xie when in an internal memo he had some abrasive (but essentially true) comments about Singapore and Indonesia? He was sacked.

As for the Hong Kong government, its inability to keep public and private interests apart gets more pronounced by the day. Chief Executive Donald Tsang’s new-found Chinese patriotism finds an outlet in moving closer to the capital market practices of the mainland.