FINA 6092 Advanced Financial Management Harvard Business School Case Study ! Shenzhen Development Bank Case Report Section A: Group 6 Name CATALOGUE PART 1: BACKGROUND INTRODUCTION   1 PART 2: THE INVESTMENT VALUE OF SHENZHEN DEVELOPMENT BANK   1 PART 3: RISK ANALYSIS  2 PART 4: RISK CONTROL   PART 5: ADVANTAGES POSSESSED BY NEWBRIDGE IN THE SDB INVESTMENT  4 PART 6: THE VALUE-ADDED FROM NEWBRIDGE AS A PRIVATE EQUITY 6 PART 7: VALUATION OF SDB   8 1. THE PRICE OF SDB’S TRADABLE SHARES   9 2. PEER COMPANY TRANSACTION 0 3. PRICE TO BOOK RATIO (P/B RATIO)   13 4. PRICE TO PPP   14 5. CONCLUSION   15 PART 8: REASON FOR NEWBRIDGE FAILURE   17 PART 9: KEY LESSONS FROM THE FAILURE   9 PART 10: REACTION OF NEWBRIDGE   19 1. IMMEDIATE REACTIONS   20 2. POST INVESTMENT RESTRUCTURING  22 Part 1: Background Introduction Shenzhen Development Bank, which was a stated-owned bank, enjoyed it popularity in coastal provinces. In 2002, it was at a crossroad and faced with the negotiation with Newbridge, which was an institutional investor, for selling its legal person shares. However, the whole investment process was not smooth for Newbridge. Several problems and risks emerged, including the valuation of SDB and the related risk analysis, etc. In our case report, we will cover these issues in detail and offer our approaches and analysis. Part 2: The Investment Value of Shenzhen Development Bank Shenzhen Development Bank (SDB) attracts investors for several reasons. Generally speaking, the dual-track system in China leads to heavy reliance on bank loans as the capital resources, resulting in the popularity and profitability of banking system. On the other hand, Shenzhen Development Bank, as the first commercial bank going public, has already enjoyed favors from investors. The following factors contribute to the investment value of Shenzhen Development Bank. To begin with, the SDB possesses a promising future in the banking industry. It is the fifteenth largest commercial bank and has a nationwide banking license. It has the right to run a large scale of business without limitation. Although it is faced with poor governance and capital structure, its development potential is huge if proper foreign management mode can be brought in. Secondly, SDB is involved in traditional commercial and retail banking businesses ! 1! mostly in more developed coastal regions of China. At the same time, it takes the leading role in the Pearl River Delta region of Guangdong province, arguably the most dynamic regional economy in China. In these areas, a large number of wealthy offers a huge market for banks. SDB has experienced fast loan growth driven by the region’s economic growth. In addition, SDB has already gone public thus it enjoys the advantage of smooth financing. Public offering gives opportunities of business expansion and flexibility of capital turnover. Last but not least, investors are easy to get the control of SDB due to its dispersed ownership. According to the case, investors only need to obtain roughly 18% of total shares (which are legal person shares) to become the biggest shareholder of SDB. Therefore, it does not cost so much to get the real control of SDB. Taking the huge development potential, geographic advantage and low acquiring cost into consideration, there is no doubt that SDB is a valuable investment for investors. Part 3: Risk Analysis On one hand, SDB is an attractive target for investment. On the other hand, investors should pay attention of risks involved in the investment. Firstly, the credit risk management of SDB is poor. The lack of a systematic credit policy and a well-defined authorization and approval mechanism, coupled with a poor organizational design of the credit functions, have resulted in ineffectiveness in credit monitoring and slow responsiveness to the market conditions. Several data are extracted from exhibit 9 to reflect the poor asset structure and risk control. ! 2! 2000A 2001A 2002A NPL/Gross Loans 22. 7% 15. 3% 11. 6% LLR/Gross Loans 7. 1% 4. 7% 3. 9% LLR/NPL 1. 0% 30. 9% 33. 2% Asset Quality Judging from these ratios, the non-performing loan accounted a large proportion of total loans, which posed extremely credit risks on SDB. The default loans results in great loss of SDB and such a risky asset structure seems to be continuous. Secondly, the risk lies in the special relationship with local government. SDB is under the control of Shenzhen government and it is often obligated to provide financing for a range of municipal projects. The special relationship with local government leads to that the major shareholders of SDB are also its own borrowers. These conflicts of interests further hampers independent management and exacerbate asset quality problems. Furthermore, as a state-owned bank, the compensation of the management team is not closely tied to performance and most board members do not have the incentive to perform fiduciary duty to push forward changes in the interest of the dispersed shareholders. Thirdly, the potential investment risk can be attributed to the distrust of foreign institution from local investor. Such a control transfer from local government to foreign institution may lose several existing clients and the business scale may shirk as well. How to maintain current investors and exploit the market are important issues that Newbridge should take into consideration. ! 3! Part 4: Risk Control To ensure the investment in SDB is successful and profitable, Newbridge should take measures to control those risks and alleviate existing problems. For the credit risk management, a sound monitoring system and a strict approval system are required to be established. With a solid risk management and control system, the large proportion of NPLs can be driven down, so is the default risk. At the same time, it is very important to obtain a good relationship with Shenzhen government. A close relationship with government is a key determinant of the success for foreign investors in China. Besides, a big change of the board members is essential for combating interest conflicts, as well as building up a more efficient and responsible management. Part 5: Advantages Possessed by Newbridge in the SDB Investment 1. Good Timing Shenzhen developing band was a government-controlled bank and therefore had the same legacy issues as other state-owned banks. In fact, the bank was mismanaged by government officers and encumbered by massive low-quality loans which results in high NPLs, an under-capitalized balance sheet, and disappointing profitability. Actually, SDB had fallen into operational difficult position. In order to reform the bank, the govt. decided to incorporate foreign capital and professional management. Then Newbridge has its change to invest SDB. If not, how high the price Newbridge offer, the deal cannot be done. 2. Rich Experience In the past, Newbridge started a series of investment in the more traditional industries ! ! in China, gaining partial control of North Dragon Iran & Steel Group, Xuzhou VV Food & Beverage, and Guan Sheng Yuan, a candy-maker. These full show the Newbridge is experienced in dealing with Chinese Company, and know the local context. What’s more, as the end of 1999, Newbridge purchased a 51% stake in Korea First Bank and become the first foreign owner of a South Korean bank. After this acquisition, Newbridge reshuffled KFB’s management team, restructured its balance sheet, and significantly improved the quality of its loan portfolio and its operating performance. For SBD who first introduce private investors, rich experience is basic standard to choose. And Newbridge exactly meets this requirement, which bring huge advantage. SDB believes that Newbridge could bring professional management and operational expertise. 3. Special Advantages 1) Executives Starting in 1999, Shan led the acquisition and turnaround of KFB. The success of the KFB investment, as well as Shan’s extensive business experience and connections among the local business community, policymakers, and academics, earned him an international reputation as one of the leading experts in banking and private equity investing in Asia. What’s more, Shan is a local Chinese who know China situation well. All factors make Shan a perfect executive for Newbridge to compete the SDB acquisition deal. 2) No threat Unlike foreign commercial banks which might have had a conflict of interests between their potential stake in SDB and their future franchise development in China, ! 5! Newbridge did not pose any competitive threats to SDB. This is a special advantage of Newbridge comparing to others competitors. 3) Location Advantage Newbridge Hong Kong office is close to Shenzhen, comparing to foreign competitors. And communications and any feedbacks could easily transported between two parties. Though because of the advanced communication technology, the geographical district cannot be the limitation, the Newbridge still have kind of location advantage here. 4. Competitive Price Actually, the Newbridge offered about 1. 6 times premium on book value, which is competitive price comparing to recent similar acquisition deals. Since the SDB was in bad operation situation, there is high risk for such high premium offer. And the specific price valuation will be proposed in the following part. Part 6: The value-added from Newbridge as a private equity 1. Operational Efficiency The lack of a systematic credit policy and a well-defined authorization and approval mechanism, coupled with a poor organizational design of the credit functions, had resulted in ineffectiveness in credit monitoring and control and slow responsiveness to the market conditions. In addition, SDB’s affiliation with the Shenzhen govt. meant that SDB was often obligated to provide financing for a range of municipal projects, and many of SDB’s major shareholders were also its own borrowers (Which partly explain the high bad debt rate). These conflicts of interests further hampered ! 6! independent management and decision-making, and exacerbated asset quality problems at SDB. If Newbridge becomes the private investor in SDB, the above problems could be solved in some degree. Like the debt management, the Newbridge won’t agree the bank lend someone who are not qualified but have petticoat influence. Also, Newbridge as the biggest shareholder can improve the SDB’s operating mechanism and corresponding marketing, stuff motivation, risk management, service, etc. All of them can bring operational efficiency. 2. Efficient Management As a state-owned bank, SDB also suffered from governance problems that plagued the state-owned banks in China at the time. The compensation of the management team was not closely tied to performance, and most board members were ex-government officers or existing management executives at the bank, who did not have much incentive to discipline the current management team or perform fiduciary duty to push forward changes in the interest of the dispersed shareholders. Private ownership here can largely improve the management level. Both the CEO and board member could be changed to the experienced professionals. As we can see in the initial announcement, the Newbridge already identified Jeffrey Williams, who was CEO of Standard Chartered Bank in Taiwan and had over twenty years of professional experience in financial services within greater China, for the CEO position. And Frank Newman as well as Newbridge associates will be the potential board members. Such excellent management team will bring new look to SDB. 3. ! Good Market Response 7! There is an announcement effect here. After announced the Newbridge as potential private equity, the market response was very good, the share price increasing largely. In other words, SDB enjoyed the rising equity value. 4. Agent Costs Saving Before the Newbridge enter, SDB had very dispersive equity structure, which the management and ownership were strictly separated. In fact, this structure would bring huge agent cost: the managers of SDB may sacrifice shareholder wealth for personal benefits. However, if the Newbridge as a private equity also the biggest shareholder, it have majority control on the SDB. And Newbridge will of course put shareholder interest first. Original agent costs can be saved then. Part 7: Valuation of SDB On December31, 2002, SDB had a per share price of RMB10. 32 and market capital of US$2465MM. So the exchange rate between RMB and US dollar at the end of 2002 was equal to: 10. 32? 1,945,822,149 ? 2,465,000,000 = 8. 15 About 72. 4% of SDB’s shares outstanding were traded shares held by the public and the remaining 27. 6% were legal person shares, which cannot be traded on the exchange. According to the material, in order to buy 17. 89% of legal person shares of SDB, Newbridge will pay 1. 6 times book value based on latest internationally audited financial statement, which is equal to 8! 521? 1. 6? 17. 89% = 149. 1(US$MM). Divided by the total number of shares of SDB, we get offered price per share: 149,100,000? 8. 15 ? 1,945,822,149? 17. 89% = RMB3. 49 So Newbridge will pay RMB3. 49 per share. We decide to use four methods to evaluate the value of SDB. 1. The Price of SDB’s Tradable Shares The first method is to use the price of SDB’s tradable shares in the public stock market. But Newbridge need to take a lot of factors into consideration before the price of tradable shares can be a benchmark for the valuation. ) The Chinese stock market was an immature emerging market, compared with stock markets in developed countries. Stock valuations in China on a growth-adjusted basis were in general significantly higher than those in the same sector in more mature markets, largely because the limited investors who were eager to switch their bank savings to the stock market for higher returns. 2) The SDB stake from the four sellers consisted of non-tradable legal person shares, which did not have a liquid public market for share transfer. The government planned to permit the conversion of legal person shares into tradable shares but did not launch any timetable for the conversion plan yet. At exit, Newbridge would have to sell its legal person stake to a buyer through the private market, subject to the government approval. ! 9! 3) Newbridge agreed with the Shenzhen government for a five-year lock-up period after the purchase of the stake. 4) The 18% stake on sale can make Newbridge the single largest shareholder of SDB and provide Newbridge effective control of the bank. Newbridge can appoint 8 out of the 15 board seats and install new management team. A significant control premium in the valuation would be justified because it was almost impossible for any foreign investor to own over 20% stake in a Chinese bank. 5) However, since the Capital Adequacy Ratio (CAR) of SDB fell from 10. 6% in December 2001 to 9. 5% in December 2002, just above the 8% level required by China Banking Regulatory Commission, it was probable that SDB would have to raise a large amount of capital to improve its CAR if the China Banking Regulatory Commission raised the requirement. As a result, the percentage of stocks held by Newbridge might be diluted by large capital infusions and end up with losing with its big shareholder status. In conclusion, four negative factors and one positive factor need to consider before using the price of SDB’s tradable shares in the public stock market as the valuation in this case. On December31, 2002, SDB had a per share price of RMB10. 32, while multiplying the price-to-book ratio of SDB in 2002 by the book value per share of SDB in 2002, we get average per share price for 2002: !. ?!. !! = ! "#$%. !" 2. ! Peer Company Transaction 10! The valuations in the precedent transactions could serve as another good reference point. There are four precedent peer company transactions: 1) In September of 1999, International Finance Corporation (IFC) made a $22 million equity investment in Bank of Shanghai, acquiring a 5% stake at a price-to-book ratio of 1. 5. 2) In November 2001, IFC became the third largest shareholder of Nanjing City Commercial Bank by investing $27 million for a 15% stake at a price-to-book ratio of 1. 2. ) At the end of 2001, 11% stake in Bank of Shanghai was acquired by HSBC (8%) and Shanghai Commercial Bank (3%), for a total of $86 million at a price-to-book ratio of 1. 2, making it the first foreign investment in the Chinese banking sector since China’s entry to WTO in December 2001. 4) In December 2002, Citibank agreed to purchase a 5% stake in Pudong Development Bank at a price-to-book ratio of approximately 1. 4 to 1. 5 for a total estimated amount of $73 million. So according to precedent peer company transactions, the average price-to-book ratio is (1. +1. 2+1. 2+1. 45)/4=1. 34. The price paid at 1. 6 times book value is a little higher than average. Note that here we use the arithmetic average ratio instead of weighted average ratio by book value of each bank because weighted average by book value means that the price-to-book ratio is linear correlated to the book value of each bank, which is unreasonable in this case. ! 11! Though we have no further information regarding to the first three transactions, we can still get detail information on Pudong Development Bank and make a further comparison with SDB. Comparison of Operating and Financial Statistics of SPDB and SDB Bank Assets($ Gross Corporate Deposits NO. of NO. of Market Market Name MM) Loans Loans (%) ($ MM) Branches Staff Share of Share of Total Total Loans Deposits ($ M) SPDB 33,785 21,170 90. 50% 29,656 284 6,698 1. 10% 1. 30% SDB 19,900 10,159 96. 90% 13,674 198 5,030 0. 50% 0. 60% As we can see from the graph above, all of the operating and financial statistics of SDB were worse than those of SPDB. SDB is only about half of the size of SPDB in the sense of assets, gross loans, deposits and market share of total loans and total deposits. Comparison of Financial Ratios of SPDB and SDB NPL/Loans LLR/NPL ROA ROE Loans/Deposits SPDB 4. 40% 64% 0. 60% 15. 90% 66. 60% Average 7. 30% 55. 30% 0. 60% 26. 80% 64. 60% 33. 20% 0. 30% 74. 30% SDB 11. 60% 9. 10% NPL/Loans is the percentage of non-performing loans in total loans, which measures the quality of the loans. A lower NPL Ratio indicates a better quality of the loan portfolio, while LLR/NPL is the loan loss reserve as a percentage of non-performing loans. A higher NPL Coverage Ratio suggests more conservative provisioning for potential credit losses. As it is indicated in the graph above, both NPL/Loans ratio and LLR/NPL ratio of ! 12! SDB were worse than that of SPDB and the industry average, signaling loans of lower quality and more aggressive reserve recognition policy. The reserve for the non-performing loans was inadequate. Probably the profit of SDB was exaggerated by setting such a low NPL coverage ratio. As for ROA ratio and ROE ratio, SDB also underperformed the industry average and SPDB due to large amount of inferior loans. Furthermore, the Loans/Deposits ratio of SDB has reached 74. %, which was not only higher than the industry average and SPDB, but also nearly reached the limit of 75% set by the China Banking Regulatory Commission. This meant that SDB could hardly expand its profit by making more loans without more deposits. In conclusion, the operating and financial ratios of SPDB were much better than those of SDB. The price-to-book ratio of approximately 1. 4 to 1. 5 for SPDB suggested that the 1. 6 times price-to-book ratio of SDB was a little too high. Based on the average price-to-book ratio 1. 34, the price per share Newbridge should offer would be: 21,000,000? 1. 34? 17. 89%? 8. 15 ? 1,945,822,149? 17. 89% = RMB2. 92 3. Price to Book Ratio (P/B Ratio) Price to Book Bank CMB 2. 3 1. 8 Minsheng 2. 2 1. 2 SPDB 4. 9 3. 6 Average 3. 1 2. 2 SDB ! 2002A 2003E 5. 5 5. 9 13! The third method is to use the P/B ratio. In the valuation of stocks of banks in the China, we suggest to use the P/B ratio rather than the more commonly used P/E ratio. Because the NPL coverage ratios of banks in China were mainly set by the banks themselves, the loan loss reserve varies, which influenced the net income directly. As a result, comparing the net income of each bank is not so meaningful and the P/E ratio is not a good ratio for valuation in this case. As we can find from the graph above, the P/B ratio of SDB was almost twice as high as the industry average in both 2002 and 2003, which could be seen as another evidence for the conclusion that the market price of tradable shares of SDB were over-estimated. We can calculate the price per share of SDB in 2002 by multiplying the industry average P/B ratio in 2002 by the book value per share of SDB in 2002: 3. 1? 2. 22 = RMB6. 88 Similarly, we get the price per share of SDB in 2003: 2. 2? 2. 06 = RMB4. 53 The average is (6. 88 + 4. 53) ? 2 = RMB5. 71 per share. In conclusion, using the P/B ratio method, the price per share Newbridge should offer would be RMB5. 71 per share. 4. ! Price to PPP 14! The final method is to use the Price to PPP ratio. The Pre-Provision Profit is the profit before deducting the loan loss reserve. Since the NPL coverage ratios of banks in China were mainly set by the banks themselves, the loan loss reserve varies from bank to bank, which influenced the net income directly. Therefore, the Pre-Provision Profit, which ruled out the influence of distinct differences in the loan loss reserve policy of each bank, may turn out to be a better indicator. We can calculate the total value of SDB by multiplying the industry average Price to PPP ratio in 2002 by the Pre-Provision Profit of SDB in 2002: 17. 8? 184 = 3275. 2(US! $MM) 3,275,200,000? 8. 15 ? 1,945,822,149 = RMB13. 72 In conclusion, using Price to PPP method, Newbridge should pay RMB13. 72 for each share of the 17. 89% of legal person shares of SDB. 5. Conclusion Price(RMB) Current Newbridge Offer Price . 49 The Current Price of Tradable Shares at the End of 2002 10. 32 The Average Price of Tradable Shares in 2002 12. 21 Peer Company Transaction Method 2. 92 P/B Ratio Method 5. 71 Price to PPP Ratio Method ! 13. 72 15! We can see that valuation of SDB varies a lot by using different methods. This is mainly because the Chinese stock market was an immature emerging market, compared with stock markets in developed countries. Stock valuations in China on a growth-adjusted basis were in general significantly higher than those in the same sector in more mature markets. Price to Book (P/B) 2002A 2003E CMB 2. 3 1. 8 Minsheng 2. 2 1. 2 SPDB 4. 9 3. 6 Average 3. 1 2. 2 SDB 5. 5 5. 9 Especially, as we can see from the graph above, the P/B Ratio of SDB were 5. 5 and 5. 9 in 2002 and 2003 respectively while the industry average were 3. 1 and 2. 2. This was the main reason why the current price of tradable shares at the end 2002, the average price of tradable shares in 2002 and the valuation based on Price to PPP Ratio Method were significantly higher than the valuations based on Peer Company Transaction Method and P/B Ratio Method. And we can find that in the precedent peer company transactions, the P/B Ratio were 1. 5, 1. 2, 1. 2 and 1. 45 respectively, much lower than the industry average of 3. 1 in 2002. And as for SPDB, though the P/B Ratio was 4. 9 in 2002, the transaction took place in December 2002 with Citibank ended up with a price-to-book ratio of approximately 1. 4 to 1. 5, which can be a special good reference point. ! 16! In conclusion, the offer price between RMB2. 92 per share and RMB5. 71 per share will be appropriate. And the current offer price of RMB3. 49 was suitable in this case. Part 8: Reason for Newbridge Failure 1. Potential competitors The existing potential competitors offer an excuse for initial shareholders of SDB to break their promise. Since SBD has unique attraction to foreign investors (less than 20% holding is the already the biggest holding), the potential competitors always existing before the deal has done. After announcement about the acquisition between Newbridge and SDB in near future, other investors who want to enter Chinese bank industry feel jealous about the deal. And this situation offers a perfect excuse to refuse Newbridge. . Management replacement There was rumor that the top government officials who were key backers of the deal might have been replaced, adding to the uncertainty on the deal. As we know, whether the deal success or fail is in few leaders’ control. And the replacement of government officials is a concern. 3. Damage to Private interests The potential state-stake sell-down would be a highly politicized transaction with ! 17! inherent conflicts of interest between the owner, the Shenzhen government, and the existing managing team consisting of government-appointed officers. On one hand, the Shenzhen government was deeply concerned with the deteriorating performance of SDB, a banking franchise regarded as critical for the development of local economy. On the other hand, the existing management team was deeply entrenched in the bank. Besides, the senior executives came from different departments of the Shenzhen government or local state-owned companies. They had intricate and powerful political connections within the Shenzhen government, and gave greater considerations to job security than would foreign investors that would provide capital infusions and operational assistance. However, the acquisition by Newbridge might damage some parties’ interest indirectly, for instance the borrowers, original managers, employees. The rejection from these damaged parties can be a huge obstacle. 4. Immature counterparty After the deal was announced in September 2002, the transitional management committee was soon established and started working with the existing management team at SDB. But eight months later, SDB, in a surprise move, unilaterally renounced the management contract and dissolved the management committee. Someone said that it was suggested that since SDB’s share price had gone up significantly after the Newbridge deal was announced, the current management team argued that SDB was highly willing to pay more. Through the whole deal, we can see the negotiations ability and experience of SDB is lacking. At first, the SDB had an agreement with Newbridge quickly, and then they suddenly pull back. We cannot find out the accurately and true reasons here, since the China's national conditions make her a special and complex eco-political entity and so do the bank acquisition issue. But we can deduce the counterparty SDB is still immature to handle such deal wisely and professional. ! 18! Part 9: Key lessons from the failure Based on the reasons mentioned above, the key lessons from the failure we can conclude to three main aspects: 1. Done as soon as possible First, the deal was delaying too long. Since the announcement about the acquisition, there were eight months before the SDB unilaterally regretted. But “a long delay may cause trouble”, the failure here exactly showed this concern. Hence, if decided, the deal should be done as soon as possible, in case of any unexpected things. . Do in Rome as Rome does Since the specialist of China’s national conditions and powerful government right, dealing with govt. should be careful and wisely. Any stakeholders need to be considered and balanced. “Do in Rome as Rome does”is very crucial in China. Part 10: Reaction of Newbridge The Newbridge should not have quit the business in such a stage, mainly because there are still profitability in the business and methods to turn it over. The following points are all supports that Newbridge should stand on its position: ! The contract remains legal: the binding framework agreement signed in June 2002 was still binding, there were no reasons the agreement became invalid ! 19! ! Political issues are not extremely decisive: Since the government once agreed with the deal and no other competitors seem have better connection with the government, it is not a decisive reason to give it up ! Potential competitors are not powerful enough: Newbridge once defeated all foreign competitors in the bidding, the new competitor in Taiwan is much weaker than the previous ones, and the hostile bidder was just in the stage of showing interest Opportunity cost had not become sunk cost: The efforts Newbridge paid was not in vain until then; the negotiations and agreements achieved still counted, which were opportunity cost not sunk cost ! Profitability remains high in the deal: as discussed above, the profitability of acquiring SDB was huge; all fundamental conditions did not change, the potential gain from the transaction did not gone away 1. Immediate reactions The key point here is to block other competitors out and remain the only business counterparty with the Shenzhen government. Since given the government the condition that Newbridge is the only investor that it could talk about, all complicated issues could be discussed later. 1) Raise bidding price Newbridge could raise the bidding price immediately. The main reason the stakeholders dissatisfied with the deal was because the heating market reaction of the SDB share price. According to the calculation of bidding price range above, there was room to raise the transaction price and make the deal more attractive; compared with the potential gain in the future raise the price is acceptable. 2) International law suit The hostile bidding from Taiwan’s Chinatrust Commercial Bank was the direct ! 20! trigger of the failing of transitional management committee. According to the previous agreement made with the local government, the transaction was already on the move even not closed. With these conditions, it is illegal for the outside bidders to launch hostile acquisitions and force the ongoing deal canceled. Related legal structures in mainland China is not complete so it is not a good idea to sue Chinatrust Commercial Bank in the mainland; in Taiwan the “country” whose “sovereignty” China does not admit is helpless. Since the Taiwan bank must abide the international law, sue the bank or make no-talk clause in international legal system is a good way; if the law and judgment does not binding in China, Chinatrust Commercial Bank could not bear the reputation loss in the deal. 3) Comfort the stakeholders The stakeholders, including the government and the state-owned-enterprises, wished to get more compensation from the transaction viewing the soaring market price of the shares in the exchange. There are three important issues they did not consider clearly in this expectation: first, the rise in price was because of the transaction took place; second, their shares as the legal person shares were not allowed to be traded in the market; third, the Chinese stock market in those days was like a casino instead of financing platform and manipulated by speculators, the price in the market was significantly over valued. Due to these features, their shares should not have been priced as the outstanding floating shares in the market in any aspects. In these occasions, their expectation of a much higher surrendering price was irrational. Newbridge must convince the stakeholders that their offering price was high enough in the situation; if there was room to increase the offer, the extent was rather limited. What was more, waiting for other bidders was not a good way, since the regulation change in China was coming soon, and the government could not wait another long period to make SDB a capable bank viable under the new regulation while suffering potential total failure of the deal. ! 21! 4) Launch golden parachute Another good approach in this deal is to please the key losers in the deal a great compensation personally. China was very special as resources and power were controlled in key persons’ hands; as long as received reasonable compensation, the door of success was opened. It was legal to pay considerable compensation forcing management member to leave in terms of “Mai Duan Gong Ling” or other titles to dismiss the present management team member who are key stakeholders handicapped the deal; by doing this the opposition will decrease a lot. 2. Post investment restructuring To make the deal successful, there are many aspects should be mended in SDB to improve it into a world-class bank. 1) Replace the management team The previous management team was lack of knowledge and interest of building up a modern world-class bank because they were generally representatives of large state-owned-enterprises and government whose primary goal was not makes profit in the bank but finance the local companies at any expense. In this sense, Newbridge organized a new team of top management to run the bank with brand new theory. This is a must since the change of the bank must be thoroughly and painful, the previous stakeholders are not qualified in these positions 2) Employee replacement and training The same as the replacement of the management team, the employees should also be changed significantly. Previous staff in the bank basically knew nothing about credit rating, risk management or banking at all. There are two ways to do this: replace the employees or train them into capable staff. One important criterion is not to lay off ! 22! oo many staff to upset the local government which wished to make the transaction safely and harmlessly. For old staffs, the better way is to retire them earlier than normally do. In this case the bank’s payment was reduced and no chaos would be caused. For young staffs, further training was needed to make them understand the requirement of being eligible bankers. As the bank would development, more staff would be hired, and the employee quality would be improved by new staff joining in. 3) Implement performance incentive The key in motivating the staff to work in accordance with the general goal of the bank is to implement performance incentive mechanism. The better one does, the more contribution one makes, the higher payment one receives. When the performance of staff is related to the salary, the process of restructuring could go much faster since everyone could work for him or herself. 4) Build modern credit rating system The key in making SDB into a profitable and healthy bank is to strengthen its balance sheet. To achieve this goal only by injecting more capital is not enough; preventing the assets of SDB going worse is the key. By making loans wisely, the NPL will increase by a much slower speed; with the enlargement of the balance sheet the existing NPL would be written off by profit and diluted by healthy assets in the future, the goal of strengthen the assets of SDB could be done 5) Build internal risk management mechanism China’s banks always lack of this kind of mechanism to prevent bad results happen, because banks consider themselves a division of the government which will never bankrupt. However it was not true. By build a good internal risk management, SDB could oversee itself clearly and thoroughly to discover and avoid potential risks. 23! 6) Maintain good relationship with previous stakeholders Even previous stakeholders are not direct beneficiaries of the bank; SDB still had to keep good relationship with them since they are either big clients or local authorities which could provide them political benefits. These large state-owned-enterprises would still be the key clients of SDB for a long time, offending their interest in the short-term is not wise, let alone the government. This is a big challenge for the new management team within which foreign bankers are the majority. !