More than bribery: Wealth, power and Rio Tinto
By Peter Lee

The closely watched case of the "Rio Tinto Four" - the four employees of the Australian resource giant on trial in Shanghai on charges related to bribery and theft of commercial secrets - concluded on March 29 with the imposition of crushing prison sentences ranging from seven to 14 years.

The defendants plan to appeal. Everyone else seems anxious to move on.

That includes Rio Tinto, which dismissed the four men as soon as the verdict came down; the Chinese government, which has been trying to contain the case as a simple matter of commercial law and not a symbol of hyperaggressive Chinese economic nationalism; and especially Du Shuanghua, one of China's richest men, who was forced to expose his business methods and reputation to the enforced notoriety of a high-profile court case by revealing, in a written deposition, that he had paid a US$9 million "consideration" (ie bribe) to one of the Rio Tinto Four, Wang Yong.

If interest in the case quickly fades after the four disappear to serve their terms in Qingpu Prison, Chinese President Hu Jintao probably can also breathe easier. That is because Du Shuanghua had attempted to secure his political and economic position as one of China's steel plutocrats with assistance from Hu Yishi, the president's nephew once removed.

Du's involvement threatened to take the case beyond the sordid commercial shenanigans involved in feeding China's need for iron ore, and mingle it with the business dealings that allegedly occupy and advantage some of China's supreme leaders and their families.

It appears unlikely that the Chinese government will find it necessary or desirable that Du's maneuverings are further exposed in open court. China's motives behind the Rio Tinto case might entail bringing Du to heel economically - not legally - and that objective has already been achieved.

Beyond the thunder and fire of the behemoths that produce and shape the metal that is building China, the Chinese steel business has always revolved around access: to capital, for the hundreds of millions of yuan needed to build the immense plants; to import permits, for the millions of tonnes of iron ore to feed the furnaces; and to the patronage of the powerful for opportunities and, if necessary, impunity.

Du began his career as a staffer at a subsidiary of Capital Iron & Steel Corporation, known as Shougang: the steel company that taught China's state-run enterprises how to bend - and perhaps break - the rules.

At the same time that Deng Xiaoping reformed agriculture and gave birth in Shenzhen to China's decentralized export model, he unleashed Shougang to demonstrate the potential latent in China's ossified state-owned industries.

Obligated only to return an agreed yearly profit to the state, freed from traditional restrictions on its scope of operations, and fueled with immense retained profits and easily available credit, Shougang stormed through North China and the world. Shougang expanded upstream, downstream, overseas, and into areas totally unrelated to steelmaking, such as ownership of an investment bank and Beijing's flagship semiconductor factory.

Shougang displayed an early and aggressive interest in financial engineering, partnering with Hong Kong tycoon Li Ka-shing to attain the Holy Grail of entrepreneurial minded Chinese enterprises: a backdoor Hong Kong stock exchange listing that gave the enterprise added independence, access to capital, and the visibility and opportunities that accrued to a "red chip" stock.

Shougang's partner in the brave new world of industrial production was the village of Daqiuzhuang, in Tianjin municipality near Beijing. Under its tough-talking village headman, Yu Zuomin (and allegedly with the assistance of powerful friends and possibly the preferential supply of steel from Shougang and other mills), Daqiuzhuang's numerous factories established a near national monopoly over the production of welded steel pipe. As a result, the village was flooded with money and Mercedes cars, and provided China's reformist leadership with a widely publicized exemplar of the nimble, successful, and profitable township enterprises that were desperately needed to employ the millions of farmers driven off the land by agricultural reforms.

Shougang and Daqiuzhuang's buccaneering ways attracted the fear and envy of their competitors and the concern of state planners watching the enterprises defiantly slip the macroeconomic and capital control leash again and again.

Even as Deng Xiaoping lay on his deathbed, Shougang received its political and legal comeuppance. The executive director of the Hong Kong company (which listed Deng's son, Deng Zhifang, as a director) was arrested for economic crimes; his father, the chairman of Shougang, quickly resigned. A year later, after a standoff concerning the murder of an investigating official, PLA troops invested Daqiuzhuang and carted Yu Zuomin to jail.

However, as a detailed 2008 investigative report at China MBA Net reveals [1], it appears that Du Shenghua carried on the legacy of Shougang and Daqiuzhuang in their swashbuckling business model, methods, and even personnel.

Du left Shougang in 1991 and entered the field of steel processing. In the mid-1990s, he established a key alliance with Liu Fengqi, an experienced and extremely capable veteran of Daqiuzhuang. Together they set up and ran a network of pipe factories in Hebei, Shandong and Guangdong provinces that claimed 50% of the national market and rode China's construction boom to reported profits of 445 million yuan (US$65 million) in 2003.

In 2004, Du made the fateful decision to move upstream into the capital-intensive process of iron and steel production and realize a dream long-held by Shougang but never achieved: the construction of a major facility in coastal Shandong relying on Shandong coal and imported iron ore.

Du found a willing partner in Shandong's Rizhao city, a prime location that had long been earmarked by the central government as the site for a world-scale greenfield plant - and served as the subject of perpetual sparring between the central government, the province, and the city government.

In an impressive display of financial and political leverage, Du was able to build the plant as a 100% private venture despite the misgivings of the central government and a crackdown on wildcat steelmaking projects. He put down a little less than 10% of the construction costs - 200 million yuan - in cash, and financed the 2 billion yuan balance with loans from a plethora of local banks, secured by guarantees from his profitable pipe operations.

Du fast-tracked the startup, ramped up production and the Rizhao Iron & Steel Corporation began earning significant profits: 600 million yuan in 2005, soaring to 5.8 billion yuan in 2007 on an output of over 7 million tonnes per year (tpy).

However, Du Shuanghua had to worry about two key problems.

The first was the jealousy of the national and provincial metallurgical establishment, which resented his pre-emption of the prime Rizhao location. Shandong province was saddled with two inefficient and undesirably located plants at Jinan and Laiwu, and yearned to consolidate production in a 20 million tpy megaplant at Rizhao.

In 2008, an unwilling Du received a team of accountants and lawyers charged with valuing the company for a merger. In November that year, the parties concluded a letter of intent for the merger.

However, it transpired that Du had other plans. In early 2009, he torpedoed the deal by selling roughly 25% of his Rizhao stake to Hong Kong's Kai Yuan Holdings, thereby following the trail to a backdoor Hong Kong listing blazed by Shougang. Two of Kai Yuan's key figures are Hu Yishi - the chairman of the board - and his father, Hu Jinxing, a non-executive director and cousin of Hu Jintao.

Du's poison-pill strategy succeeded in scuttling the Shandong deal but immediately raised eyebrows among Hong Kong's hyperactive and hyperanalytic stock punters.

In return for his interest, Du Shuanghua received no cash. He accepted 200 million shares of Kai Yuan stock at a vastly inflated price of HK$2.60 per share - at least 12 times their trading price. When these shares were added to another 100 million that Du had previously accumulated, he became Kai Yuan's largest shareholder, with around 30% of the stock.

However, Rizhao contributes the majority of Kai Yuan's profits. It would appear that Du sacrificed 70% of the profits on the stake he injected in Kai Yuan - amounting to tens of millions of dollars - to Kai Yuan's other stockholders in return for the dubious privilege of holding another 20% of Kai Yuan's stock.

Hong Kong punters immediately leapt to the conclusion that Du was either currying favor with Hu Jintao's family for leverage in his tussle with the Shandong provincial metallurgical establishment, or ultimately had plans to inject the entire Rizhao operation into the Kai Yuan shell on favorable terms, and reap the benefits of a public listing for his mill in a global financial center - or both.

President Hu's extended family is apparently active in business and government [2]. Aggrieved posters have seized upon a kickback scandal in Namibia involving Nuctech, a company headed by his son, Hu Haifeng, to raise the specter of corruption close to the president [3].

The Chinese informational apparatus is apparently extremely sensitive regarding challenges to Hu Jintao's integrity, and it was reported that it blocked Internet searches with the keywords "Hu Haifeng", "Nuctech", and "Namibia".

Hu Yixia, a young man in his early thirties who collects yearly compensation of about HK$1.5 million (US$193,000) from Kai Yuan, recently cobbled together the wherewithal to exercise an option to purchase 200 million additional shares in Kai Yuan for HK$35.4 million, bringing his share of the company to close to 10% [4].

The Rizhao matter might have remained the subject of unwelcome innuendo in the Hong Kong financial markets if not for the damaging revelations concerning Du's business practices that emerged at the Rio Tinto trial.

Rio Tinto is the largest iron ore supplier to China, itself the world's largest importer of commercial iron ore, bringing in a staggering 600 million tons per year.

In theory, China's 1,000 mills are supposed to present a united front to the three main suppliers - Rio Tinto and BHP Billiton for Australian ore, and Vale of Brazil - through the China Iron & Steel Association, under the leadership of Baoshan Iron & Steel. In practice, more than 100 Chinese mills and traders are licensed to import ore and exploit their advantage by assembling speculative inventory and compelling unlicensed mills to buy from them at double the original price. In a seller's market, the producers have ample opportunity to play divide-and-conquer and undercut the government negotiators.

Negotiations this year are especially acrimonious, with the producers taking advantage of a tightening in supply to demand a price increase of almost 100% as payback for what they saw as China's insistence on excessive price-cuts in 2009, a lean year when Chinese buyers eschewed long-term contract commitments and switched to buying less-expensive spot cargoes.

The closely watched case of the "Rio Tinto Four" - the four employees of the Australian resource giant on trial in Shanghai on charges related to bribery and theft of commercial secrets - concluded on March 29 with the imposition of crushing prison sentences ranging from seven to 14 years.

The defendants plan to appeal. Everyone else seems anxious to move on.

That includes Rio Tinto, which dismissed the four men as soon as the verdict came down; the Chinese government, which has been trying to contain the case as a simple matter of commercial law and not a symbol of hyperaggressive Chinese economic nationalism; and especially Du Shuanghua, one of China's richest men, who was forced to expose his business methods and reputation to the enforced notoriety of a high-profile court case by revealing, in a written deposition, that he had paid a US$9 million "consideration" (ie bribe) to one of the Rio Tinto Four, Wang Yong.

If interest in the case quickly fades after the four disappear to serve their terms in Qingpu Prison, Chinese President Hu Jintao probably can also breathe easier. That is because Du Shuanghua had attempted to secure his political and economic position as one of China's steel plutocrats with assistance from Hu Yishi, the president's nephew once removed.

Du's involvement threatened to take the case beyond the sordid commercial shenanigans involved in feeding China's need for iron ore, and mingle it with the business dealings that allegedly occupy and advantage some of China's supreme leaders and their families.

It appears unlikely that the Chinese government will find it necessary or desirable that Du's maneuverings are further exposed in open court. China's motives behind the Rio Tinto case might entail bringing Du to heel economically - not legally - and that objective has already been achieved.

Beyond the thunder and fire of the behemoths that produce and shape the metal that is building China, the Chinese steel business has always revolved around access: to capital, for the hundreds of millions of yuan needed to build the immense plants; to import permits, for the millions of tonnes of iron ore to feed the furnaces; and to the patronage of the powerful for opportunities and, if necessary, impunity.

Du began his career as a staffer at a subsidiary of Capital Iron & Steel Corporation, known as Shougang: the steel company that taught China's state-run enterprises how to bend - and perhaps break - the rules.

At the same time that Deng Xiaoping reformed agriculture and gave birth in Shenzhen to China's decentralized export model, he unleashed Shougang to demonstrate the potential latent in China's ossified state-owned industries.

Obligated only to return an agreed yearly profit to the state, freed from traditional restrictions on its scope of operations, and fueled with immense retained profits and easily available credit, Shougang stormed through North China and the world. Shougang expanded upstream, downstream, overseas, and into areas totally unrelated to steelmaking, such as ownership of an investment bank and Beijing's flagship semiconductor factory.

Shougang displayed an early and aggressive interest in financial engineering, partnering with Hong Kong tycoon Li Ka-shing to attain the Holy Grail of entrepreneurial minded Chinese enterprises: a backdoor Hong Kong stock exchange listing that gave the enterprise added independence, access to capital, and the visibility and opportunities that accrued to a "red chip" stock.

Shougang's partner in the brave new world of industrial production was the village of Daqiuzhuang, in Tianjin municipality near Beijing. Under its tough-talking village headman, Yu Zuomin (and allegedly with the assistance of powerful friends and possibly the preferential supply of steel from Shougang and other mills), Daqiuzhuang's numerous factories established a near national monopoly over the production of welded steel pipe. As a result, the village was flooded with money and Mercedes cars, and provided China's reformist leadership with a widely publicized exemplar of the nimble, successful, and profitable township enterprises that were desperately needed to employ the millions of farmers driven off the land by agricultural reforms.

Shougang and Daqiuzhuang's buccaneering ways attracted the fear and envy of their competitors and the concern of state planners watching the enterprises defiantly slip the macroeconomic and capital control leash again and again.

Even as Deng Xiaoping lay on his deathbed, Shougang received its political and legal comeuppance. The executive director of the Hong Kong company (which listed Deng's son, Deng Zhifang, as a director) was arrested for economic crimes; his father, the chairman of Shougang, quickly resigned. A year later, after a standoff concerning the murder of an investigating official, PLA troops invested Daqiuzhuang and carted Yu Zuomin to jail.

However, as a detailed 2008 investigative report at China MBA Net reveals [1], it appears that Du Shenghua carried on the legacy of Shougang and Daqiuzhuang in their swashbuckling business model, methods, and even personnel.

Du left Shougang in 1991 and entered the field of steel processing. In the mid-1990s, he established a key alliance with Liu Fengqi, an experienced and extremely capable veteran of Daqiuzhuang. Together they set up and ran a network of pipe factories in Hebei, Shandong and Guangdong provinces that claimed 50% of the national market and rode China's construction boom to reported profits of 445 million yuan (US$65 million) in 2003.

In 2004, Du made the fateful decision to move upstream into the capital-intensive process of iron and steel production and realize a dream long-held by Shougang but never achieved: the construction of a major facility in coastal Shandong relying on Shandong coal and imported iron ore.

Du found a willing partner in Shandong's Rizhao city, a prime location that had long been earmarked by the central government as the site for a world-scale greenfield plant - and served as the subject of perpetual sparring between the central government, the province, and the city government.

In an impressive display of financial and political leverage, Du was able to build the plant as a 100% private venture despite the misgivings of the central government and a crackdown on wildcat steelmaking projects. He put down a little less than 10% of the construction costs - 200 million yuan - in cash, and financed the 2 billion yuan balance with loans from a plethora of local banks, secured by guarantees from his profitable pipe operations.

Du fast-tracked the startup, ramped up production and the Rizhao Iron & Steel Corporation began earning significant profits: 600 million yuan in 2005, soaring to 5.8 billion yuan in 2007 on an output of over 7 million tonnes per year (tpy).

However, Du Shuanghua had to worry about two key problems.

The first was the jealousy of the national and provincial metallurgical establishment, which resented his pre-emption of the prime Rizhao location. Shandong province was saddled with two inefficient and undesirably located plants at Jinan and Laiwu, and yearned to consolidate production in a 20 million tpy megaplant at Rizhao.

In 2008, an unwilling Du received a team of accountants and lawyers charged with valuing the company for a merger. In November that year, the parties concluded a letter of intent for the merger.

However, it transpired that Du had other plans. In early 2009, he torpedoed the deal by selling roughly 25% of his Rizhao stake to Hong Kong's Kai Yuan Holdings, thereby following the trail to a backdoor Hong Kong listing blazed by Shougang. Two of Kai Yuan's key figures are Hu Yishi - the chairman of the board - and his father, Hu Jinxing, a non-executive director and cousin of Hu Jintao.

Du's poison-pill strategy succeeded in scuttling the Shandong deal but immediately raised eyebrows among Hong Kong's hyperactive and hyperanalytic stock punters.

In return for his interest, Du Shuanghua received no cash. He accepted 200 million shares of Kai Yuan stock at a vastly inflated price of HK$2.60 per share - at least 12 times their trading price. When these shares were added to another 100 million that Du had previously accumulated, he became Kai Yuan's largest shareholder, with around 30% of the stock.

However, Rizhao contributes the majority of Kai Yuan's profits. It would appear that Du sacrificed 70% of the profits on the stake he injected in Kai Yuan - amounting to tens of millions of dollars - to Kai Yuan's other stockholders in return for the dubious privilege of holding another 20% of Kai Yuan's stock.

Hong Kong punters immediately leapt to the conclusion that Du was either currying favor with Hu Jintao's family for leverage in his tussle with the Shandong provincial metallurgical establishment, or ultimately had plans to inject the entire Rizhao operation into the Kai Yuan shell on favorable terms, and reap the benefits of a public listing for his mill in a global financial center - or both.

President Hu's extended family is apparently active in business and government [2]. Aggrieved posters have seized upon a kickback scandal in Namibia involving Nuctech, a company headed by his son, Hu Haifeng, to raise the specter of corruption close to the president [3].

The Chinese informational apparatus is apparently extremely sensitive regarding challenges to Hu Jintao's integrity, and it was reported that it blocked Internet searches with the keywords "Hu Haifeng", "Nuctech", and "Namibia".

Hu Yixia, a young man in his early thirties who collects yearly compensation of about HK$1.5 million (US$193,000) from Kai Yuan, recently cobbled together the wherewithal to exercise an option to purchase 200 million additional shares in Kai Yuan for HK$35.4 million, bringing his share of the company to close to 10% [4].

The Rizhao matter might have remained the subject of unwelcome innuendo in the Hong Kong financial markets if not for the damaging revelations concerning Du's business practices that emerged at the Rio Tinto trial.

Rio Tinto is the largest iron ore supplier to China, itself the world's largest importer of commercial iron ore, bringing in a staggering 600 million tons per year.

In theory, China's 1,000 mills are supposed to present a united front to the three main suppliers - Rio Tinto and BHP Billiton for Australian ore, and Vale of Brazil - through the China Iron & Steel Association, under the leadership of Baoshan Iron & Steel. In practice, more than 100 Chinese mills and traders are licensed to import ore and exploit their advantage by assembling speculative inventory and compelling unlicensed mills to buy from them at double the original price. In a seller's market, the producers have ample opportunity to play divide-and-conquer and undercut the government negotiators.

Negotiations this year are especially acrimonious, with the producers taking advantage of a tightening in supply to demand a price increase of almost 100% as payback for what they saw as China's insistence on excessive price-cuts in 2009, a lean year when Chinese buyers eschewed long-term contract commitments and switched to buying less-expensive spot cargoes.