"Hello Boss" was the theme of the ad campaign for the MTRC IPO. Webb-site.com finds that far from making you the boss, this company has massive waivers from normal corporate governance rules on disclosure and connected transactions. You might as well hold non-voting shares in a blind trust.

You're no Boss
8 October 2000

MTR Corporation (MTRC) hit the market with a bang last week (as well as a flurry of duplicate share certificates) as a lot of short-term punters got their kicks from stock sixty-six. The offer's popularity was no surprise after a lengthy publicity campaign and a public which perceives an implicit guarantee from the government. The offer followed on the heels of still-positive returns from last year's government offering of the Tracker Fund of Hong Kong.

Enough has been written in the media about the fact that MTRC is essentially a property company, the income from which subsidises the railway, so we won't analyse that in depth here.

Instead, we ask exactly how much truth there is to the notion that public shareholders are now the "boss" of MTRC, as the ad campaign, which featured gracious MTRC staff in various states of obsequiousness, suggested. We will show you that the veil of secrecy over its property operations and an exceptional set of waivers effectively leaves you in the dark and with non-voting shares.

Secrecy over Property Projects

MTRC currently has a HK monopoly in underground railways and a duopoly on railways in general with the Kowloon-Canton Railway Corporation (KCRC) which is Government-owned. Like most municipal railways worldwide, it would not be profitable on its own, but has become a vital piece of public transport infrastructure.

It has funded the railway developments mainly by receiving land grants from the Government (in excess of operational requirements) and then tendering the development rights to that land. Outside developers undertake to pay the land premium to the Government, the construction costs, and in addition pay certain amounts up both up-front and as an agreed profit share to MTRC in return for the development rights. They are willing to pay these amounts to MTRC because the land premium is set on the basis that the railway does not exist, when in fact its existence adds a great deal to the value of the site.

So what are the up-front payments and the agreed percentage share of profits? That's a good question, and the MTRC prospectus sheds little light on it. The company has obtained an exemption from the Securities and Futures Commission under Section 38A of the Companies Ordinance from the normal requirement to file copies of all material contracts in the last 2 years, while the Stock Exchange has granted an exemption from the requirement to put those contracts on display.

The exemptions were granted on the grounds that the contracts are "commercially sensitive". This exemption is so rare that we cannot recall one ever being granted. In fact, Section 38A only contemplates exemption if the requirement is "irrelevant or unduly burdensome". We find it questionable whether "burdensome" extends to commercial sensitivities or was intended to refers to the physical workload in the filing, which would have been low.

The two contracts in question were the development agreement for Kowloon Station Package 3, with Sun Hung Kai Properties, and the Package 4 agreement with Amoy Properties. We are left with a description in the prospectus which fails to disclose the profit-sharing split on the projects between MTRC and the developers. A similar agreement is in the works on the mammoth combined Package 5,6, and 7, again with Sun Hung Kai Properties. After a development deal has been struck, we see no reason why the public, and shareholders, should not know. Indeed, keeping all bids sealed after a tender is finished favours the participants of that tender in future tenders. You can't know what the "going rate" is unless you have won before. Such secrecy is not in the public interest.

No other company in HK would get away with announcing a major joint venture (unless it was with MTRC or KCRC) and not disclosing what the percentage interests are. Is this the degree of transparency we can expect in the future? If analysts do not know what share the MTRC has in a project then it will be impossible for them to assess how much profit the MTRC will make on it. On the other hand, if MTRC tips off the analysts on what the profit split is, then that is selective disclosure, which is fundamentally wrong - all stock market participants should have equal access to information. Developers' bankers will often also be told what the detailed terms are before they agree to finance a project.

Your Non-Voting Shares

First of all, recognise that even after the "greenshoe" over-allocation in the IPO, the Government still owns 77% of MTRC. That gives them control over the board and the ability to pass or reject both ordinary resolutions (which require a 50% majority) and special resolutions (which require a 75% majority) in General Meetings.

OK, fair enough, there are plenty of HK companies in that situation, with a controlling shareholder holding more than 50% or as much as 75% of the votes. That's why we have a section in the listing rules about "Connected Transactions" which requires shareholders who own 10% or more of a company to abstain from voting, and to seek public shareholder approval, when they have an interest in that transaction. For example, if a listed company buys a property from its parent, then such a vote is required, and the public can decide whether the terms are fair.

Having understood the property subsidy of MTRC's rail operations, you will appreciate how important the Government is to the company's future profitability. Not only that, but as Hong Kong's infrastructure expands, MTRC will be asked to take on new rail projects, and be given new land grants in compensation. So the pricing of such land, and the viability of the rail projects, are crucial to future investment returns.

But wait - the Government has committed to hold at least 50% of MTRC for 20 years from the listing date. So any such deals will be between the company and its controlling shareholder. In other words, they are "Connected Transactions" under the Listing Rules. Public shareholders might therefore expect the right to approve such transactions, based on independent financial advice, right? Wrong. The Stock Exchange has granted a blanket waiver of these rules. The best you can expect is a press release announcing a done-deal. No independent opinions, and no votes.

The prospectus states that this waiver is due to the "unique circumstances". It then lists a set of circumstances that no longer exist:

These "unique circumstances" no longer exist and are a feeble attempt to justify a simple fact - you have no control over this Company. The Government is the boss, and your company will build the railways it wants you to, and take the land it is granted. They are not going to take the risk that public shareholders may reject a transaction on financial grounds and thereby affect the development of railway infrastructure.

Sure, you can hope that the management of MTRC do a decent job in fighting for the best terms, but there's nothing you can do about it if they fail.

The Board

Since you don't get to vote on deals with the Government, the only line of protection is at the Board level. But there's no salvation there, because as the prospectus states, "All of the Members of the Board... have been appointed by the Government".

There are 10 directors, of which 9 are non-executive and the other is the Chairman and CEO Mr Jack So (who, incidentally, worked until 1995 for Sun Hung Kai Properties group and is a director of Hongkong Bank).

Of the 9 non-executives, 3 are civil servants appointed by the Chief Executive of the SAR under the MTR Ordinance. They are the Transport Secretary, Transport Commissioner and Treasury Secretary. They would abstain from voting on any deal where there is a "material interest which arises as a result of the Government office which he holds". That seems open to interpretation as to whether they can vote on a property deal with the Lands Department rather than the Treasury or Transport Departments.

The other 6 non-executive directors are described as "independent". But as we've explained before, that doesn't mean the public shareholders get to choose them. No, they are nominated by a "Nominations Committee", then appointed by the Board (which was appointed by the Government), and then the Government gets to vote on their re-election at the Annual General Meeting. You can vote at the meeting if you want, but as the Government has 51%, it would be pointless.

Even the 3-man Nominations Committee comprises the Secretary for Transport, the Chairman of Hongkong Bank and the Deputy General Manager of Bank of China's Hong Kong branch, both banks being Principal Bankers to MTRC and one (HSBC) being a sponsor of the IPO and a regular adviser to the Government.

The 6 so-called independent directors comprise the usual cross-section of respectable people from government and industry, but again, these are not people you can appoint or remove. One of them is an Executive Councillor to the Government and so is hardly independent. Another sits on the HKMA's Exchange Fund Advisory Committee and the Trade Development Council, and a third is a director of Exchange Fund Investment Ltd, which oversees the Government's stock market intervention portfolio. 

No less than half of the independent directors are directors of Hongkong Bank, including the bank's Chairman.

A Blind Trust

A lot of public investors are relying on the goodwill of the Government in buying this deal. With over 10% of the adult population having bought it, the stock is almost in the "politically too big to fail" category. The Government needs to ensure good investment returns as long as it plans future privatisations such as the Airport and KCRC. There are no promises, but we get the following words in the prospectus:

"the Government has acknowledged... that the Company will require an appropriate commercial rate of return on its investment in any new railway project and that... financial and other support for those new railway projects from the Government may be required... The Company will require these returns to be at a suitable commercial margin over its cost of capital. In this connection, the Government has recognised that this would ordinarily be between 1% and 3% above the estimated weighted average cost of capital of the Company."

However, the lack of transparency in its property operations and the fact that public shareholders have no control over transactions with the Government or the appointment of independent directors, means that shareholders should recognise that they essentially own non-voting equity in a blind trust, and trust is the operative word.

© Webb-site.com, 2000

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