By staff reporters Ming Shuliang and Yu Ning

Related article: Liu Chuanzhi on Legend's New Ownership
                     Lu Zhiqiang: Bullish about Lenovo's Legend

(Caijing Magazine) Twenty-five years ago, Liu Chuanzhi and 10 colleagues accepted 200,000 yuan from the Chinese Academy of Sciences (CAS) and, from a small office, established what is today a global computer giant, Lenovo.

From these small beginnings under parent Legend Holdings Ltd., Lenovo Group (HKEX: 00992) has built a celebrated brand with quality management and nearly 10 billion yuan in assets.

Today, it's hard to imagine that, after such a dramatic rise from a humble start, Legend has yet to complete an ongoing reform process aimed at eventually shifting ownership from the state to private shareholders.

But the goal may be fast approaching. Legend Chairman Liu, who was 40 years old when the company started and turns 65 this year, is laying the groundwork for further restructuring and optimization of the Lenovo parent.

A big step came September 4 when China Oceanwide Holdings Group bought a 29 percent stake in Legend for 2.75 billion yuan, becoming its third-largest shareholder. A group of 640 company employees will still control 35 percent while CAS downsizes but retains the largest share, 36 percent.

Chances are good that several difficult issues facing Legend -- maintaining its corporate culture, designing new management incentives, and choosing a successor for Liu -- can be resolved. Shaking off the legacy of state ownership and qualifying to list on the A-share market are additional goals that appear to be reachable.

The opportunities are due largely to the fact that Legend will no longer need government approvals for internal company decisions. Increased autonomy will let managers create a long-term employee incentive system, ensuring management stability for the company and subsidiaries, as well as help pave the way for Liu's successor.

More importantly, the change provides a systematic guarantee that Legend will keep moving toward its long-term goals, regardless of personnel changes.

Oceanwide Chairman Lu Zhiqiang, 57, is an old acquaintance of Liu. In terms of economic vigor, the two men are relative equals. They also share a commitment to settling Legend's outstanding issues, even at the cost of diluting shares.

Lu told Caijing, "The issue of Legend Holding's long-term management incentives must be resolved. If we need to dilute shares to solve this problem, then we will."

Zhou Qiren, dean of Beijing University's National School of Development, told Caijing the reform puts Legend on the road to full privatization.

"This change in shareholder structure for Legend Holdings will transform the company into a normal, privatized enterprise," Zhou said. "The deal demonstrates a 'great leap' in thinking, as its implementation reflects the leadership's ability to study and weigh the whole situation."

New Shareholder

Lu said the share sale followed a "lightning" decision that came about mostly by chance. But it helped that Lu and Liu are members of the exclusive Taishan Association, a club with about 15 members from top Chinese enterprises whose president is Evertrust Holding Co. Ltd. Chairman Lin Rongqiang.

At a meeting early this year, Lin told Lu that CAS was considering selling a percentage of its Legend stake. CAS had a plan to revamp Legend's share structure, but was at an impasse. Taikang Life Insurance Ltd. had expressed interest but failed to reach a consensus with CAS due to several issues, including price.

After learning CAS was looking for new shareholders, Lu immediately hunted down Liu and asked, "Is Legend Holdings looking for new shareholders? If so, we are very interested."

Oceanwide launched negotiations with CAS over Legend in May and settled in September.

Lu established Oceanwide in 1985, a year after Liu founded Legend. Subsidiaries include listed real estate conglomerate Oceanwide Construction Group Co. Ltd. (SZSE: 000046). It's also invested in new energy, Minsheng Bank, Haitong Securities and other financial institutions focusing on capital markets. Oceanwide currently has nearly 16 billion yuan in gross assets and 10 billion yuan in net assets.

Liu and Lu are more than friends. When Lu needed money for land deals in 2004, Liu reached out to help.

Lu Zhiqiang(left)   Liu Chuanzhi(right)

In a lobby campaign, Lu invited a vice minister of the Department of the United Front Work CPCCC and All-China Federation of Industry and Commerce Secretary Quan Zhezhu to visit CAS Director Lu Yongxiang and introduce himself as well as his company as a potential Legend investor. Lu is vice chairman of the federation.
 
No one questions Lu's personal connections. But his capital clout has been subject to varying opinions within the industry.

Lu told Caijing that, from late 2008, Oceanwide substantially reduced its shares in Minsheng Bank and Haitong Securities, raising more than 12 billion yuan in cash. Currently, the company's debt-to-asset ratio is around 60 percent.

Lingering Questions

By selling its 29 percent stake in Legend, CAS will lose majority control. Oceanwide and the employees' committee will have 64 percent which, according to Liu, will transform Legend from state-owned to private enterprise.

Lawyer Wei Junxian, a leading partner at the Dacheng Law Office, told Caijing that Legend's most important task is to "take off the red hat" so that it no longer needs government approval before adjusting shares.

"Red hat" refers to the early period of China's economic reforms when private enterprises adopted strategies dependent on government agencies to win government support. It was key to survival for any private company. But commercial goals of a company with a state-owned structure often take a back seat to the desires of an administrative bureaucracy.

Since then, private enterprises with enough strength have taken off red hats. But many still face old problems such as employee incentive issues, for example, due to antiquated shareholding structures. Even a company that goes private may be unable to completely abandon a red hat.

This is one issue facing Legend as it eyes long-term development to become, according to Liu, a "family company without a family."

Liu implemented a flexible bonus system to motivate employees shortly after the company was founded. He also introduced a plan to allocate 55 percent of Lenovo's shares to the state and 45 percent to employees in 1994, the year Lenovo Group listed on the stock market, according to a book named Tales of Legend.

The 55-45 plan was rejected by the Ministry of Finance (MOF). Nevertheless, CAS decided to return 35 percent of Lenovo's shares to early employees, rewarding company pioneers.

During a company restructuring in 2001, MOF approved 35 percent profit participation rights for employees. This allowed early employees to comfortably exit, leaving room for new leaders.

Liu said the transfer of 35 percent to employees, at a time when his company share was less than 2 percent, was conducive to stability. "The decision gave Lenovo the opportunity to adjust its strategy and better adapt to new situational developments," Liu said.

Venturing Out

When Lenovo split from Legend subsidiary Digital China Holdings (HKEX: 00861) in 2000, Liu changed strategy again and entered the venture capital arena.

Zhu Linan was put in charge of managing Legend's investments. In 2003, Legend began investing in stock and established the subsidiary Hony Capital, led by Zhao Linghuan. At the same time, Legend launched Raycom Real Estate Development Co. Ltd. to invest in property. It also set up an autonomous fund for direct investments, putting Wu Yibing in charge.

Like Wu, almost all direct investment employees came from multinational corporations. In addition, more than 80 percent of Legend's workers have been with the company less than two years.

Liu worries about worker turnover and calls it a huge test for the company's culture.

Another test is tied to finding the next company chief. "If only one shareholder is ‘all powerful,'" Liu told Caijing, "it is certainly hard to guarantee that my successors will be able to stay for the long term after I retire."
　　
Critical Juncture

Liu faces challenges not only in choosing a suitable successor, but also in realizing company stability through share diversification. A departure by Liu and others who helped start the company would definitely break its close ties with CAS.
　　
Liu started speaking with CAS officials in 2004 about Legend's future after his retirement. A key question was: Who would dare take the reins unless the share structure changed?

Eventually, Liu and CAS reached a consensus on structural reform and started searching for a new shareholder. "Only after we completed this daunting step would Legend Holdings be able to carry out its long-term strategic plan," he said.

CAS and Legend agreed to strict requirements for the new shareholder. Besides bolstering capital strength, plans called for Legend to develop in the real estate, finance and energy sectors. Officials hoped the future shareholder would have a background in these sectors.

A foreign shareholder could not be considered due to restrictions on foreign investment in China. Moreover, due to CAS and Legend's plans for future development and restructuring, they could not consider another state-owned company.

Shareholder diversification and long-term incentives are typical concerns for leaders of state-owned companies looking to go private. And everything hinges on a "common understanding" reached by the majority shareholder, management and new shareholder.

Finding a private company that would accept a common understanding with CAS and Legend was a prerequisite, even though few could meet this requirement. The new shareholder would also have to back Legend's future strategic and expansion plans.

Oceanwide fit the criteria. And the new share structure won support from experts such as Beijing University professor Zhou Qiren.

Zhou told Caijing that the State-owned Assets Supervision and Administration Commission's (SASAC) thinking and policy of "one majority shareholder" is fundamentally flawed, and carries a heavy cost. "Under the state-owned ‘majority shareholder' system, resources have to be highly concentrated, and the risk and danger increases," he said.

However, Liu has said that even the new structure "will not be unchangeable" -- a statement that leaves room for imagining what the future may hold.

Daylight for Reform

"Everyone knows that, in the future, Legend Holdings will most likely bring very high returns to CAS," Liu said. "To be able to do it under these new conditions really means (CAS is) looking at issues for the country's best interests."

CAS' announcement that it would sell a Legend stake was attached to a detailed list of requirements for the new shareholder, including registered capital and profitability. Oceanwide seemed to a perfect match, leading many to suspect the deal was custom-made.

Lu has rejected these suspicions, saying CAS was looking for an investor that could generally equal its 4 billion yuan in registered capital and 10 billion yuan in net assets.

Another controversy surrounds the 2.75 billion yuan price tag, which some called too low. But officials offered an explanation.

Legend owns about 44 percent of Lenovo and roughly 18 percent of Digital China. Based on September 8 closing prices, Legend's shares in these two companies are worth more than HK$ 15 billion.
　　
Legend is also majority shareholder in Raycom and invests in funds through Hony. According to company estimates, Legend will earn about 12 billion yuan in investment returns over the next five years, prompting claims that Oceanwide got a bargain.

CAS Holding President Deng Maicun defended the price, saying market values fluctuate frequently, and that market value did not factor in the price. Instead, the price was calculated according to the estimated net asset value of state-owned assets.

Lu said the price was based on the estimated value of net assets with a "small premium," which he declined in disclose.

China United Assets Appraisal Co. Ltd. estimated Legend's net assets at 9.26 billion yuan, which means a 29 percent stake was worth 2.68 billion yuan. Oceanwide paid slightly more.

The China Beijing Equity Exchange said, based on the net asset valuation, Legend undistributed profits twice this year -- in January and June -- handing out more than 450 million yuan.

An investment bank source told Caijing that Legend's price should also factor in management costs. Three of Legend's five subsidiaries, with the exception of Lenovo and Digital China, are investment enterprises whose futures are overwhelmingly dependent on management ability. But as shareholders themselves, managers can accept a buyout. Therefore, the source said, net asset value may be the most objective price indicator.

Bright Future

Legend Executive Vice President Wu Yibing described the course of direct investment ventures on September 8, estimating the company's assets would double if not triple in five years.

When Wu joined Legend in 2008, the former Harvard professor and McKinsey executive was made responsible for direct investments. The goals were clear: Reduce Legend's dependence on Lenovo and use direct investment to boost core assets.

Wu wants the company to be in a position to invest 10 billion yuan over the next five years, with total enterprise asset investments reaching the scope of Lenovo's total assets. Capital would come from returns on Hony and Legend Capital investments.

Lu said he thinks Legend's goals are achievable, and that the company's net assets could be doubled in five years. Oceanwide's investment would also double. And if the company can land on the stock exchange, even if IPO stock price calculated at four times the price/book, Oceanwide could see an 800 percent return on investments.

Under Legend's plan, a public offering would be sought after its subsidiaries go public. Liu and Lu both expressed hope for listing on the A-shares market. If and when that happens, management would have to find a solution for the 640 employees on the shareholder committee that now controls 35 percent of company shares.

Dacheng's Wei told Caijing that Legend could qualify to list on the H-shares market but need some adjustment before listing on the A-shares exchange.

"Currently, the China Securities Regulatory Commission mandates that shareholders of listed companies include less that 200 people, either directly or indirectly," he said. "Therefore, they still have work to do to decrease the number of company shareholders."

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