In Doha, a historical chapter for Greater China began in
November 2001. Both China and Taiwan were admitted as members of
the World Trade Organization (WTO). While rejoicing over China's
elevated commercial position, Long Yongtu, the country's chief
negotiator of WTO membership, cautioned his compatriots against
being too arrogant. He further warned that "the work ahead of us
shall be much greater than what has just been achieved".
With a majority of the businesses in both China and Taiwan
(which also gained membership at the WTO's Doha conference in
November 2001) lacking international expertise, Long's remarks are
acutely relevant today. The recent class action lawsuits filed
against China's Netease and Taiwan's Clarent Corporation exposed
the vast difference in interpretation of corporate governance codes
that exists between Asian enterprises and international investors.
They unveiled the unilateral penalties applied to those who attempt
to ignore such rules.
TAIWAN STAR
Among the five greater China technology companies that gained
listing status on Nasdaq, Clarent's performance dwarfed that of its
peers by far. Based in Silicon Valley, Clarent was co-founded in
1996 by Jerry Chang and Michael Vargo. Its principal activities
were internet protocol systems, which allowed the simultaneous
transmission of voice, fax and data over internet networks. Among
its client list were AT&T Worldnet, China Telecom, Telstra,
Japan Telecom and Korea Telecom. Prior to its initial public
offering (IPO) in early 1999, Clarent was placed by the Silicon
Valley-based Upside Magazine among the "Hot 100 Privately Held
Companies".
Although Clarent's headquarters are in the US, it is largely
regarded as a Taiwanese company. Over 34% of its shareholding is
held by two investment vehicles subscribed to by the island's
investors, WK Technology Funds and the1988 Wang/Chang Family
Revocable Trust (fig.1). In addition, its founder, Jerry Chang, is
a Taiwanese national.
Between 1997 and 1998, WK Technology, Taiwan's largest venture
capital firm, and Goldman Sachs, respectively, took up substantial
positions in Clarent, with the former having a 22.74% and the
latter a 9.54% stake. Both Wen Chang Ko, chairman of WK Technology
and Shirley Lin, a Goldman Sachs managing director, served on the
Clarent board.
SHINING ON NASDAQ
On July 1 1999 at the height of the dotcom bubble, Clarent
listed on Nasdaq with an offer price of $15 per share. Its IPO was
underwritten by a group led by Credit Suisse First Boston and
co-managed by Robertson Stephens and two other firms. It was an
auspicious beginning. On its listing debut, Clarent's share price
closed at $25.50 a share, an ascent of 61.3%. Bolstered by the
market's enthusiastic response to its stock, on November 22, four
months after it was listed, Clarent offered an additional four
million shares, with each priced at $85 a share. They were offered
by the same party of listing underwriters.
THE GOOD YEAR
Flushed with capital, Clarent embarked on an acquisition trail
in the following year. In the month of August alone it deployed a
total of $202 million for two companies. Colorado-based Peak
Software was acquired for $60 million on August 1 2000, while
California-based ACT Networks came under Clarent's umbrella at the
end of the same month when $142 million was committed to it. The
third day of October proved to be an historic 24 hours for Clarent
when its share price peaked at $169.75 a share, 11-fold its $15
listing price. No greater China technology company had ever enjoyed
such a meteoric rise in its share price on Nasdaq.
Clarent's sales figures testified to its solid position in the
internet telephony market, where it ranked third behind Cisco
Systems and Lucent Technologies. In the fiscal year ending December
2000, Clarent reported a turnover of $151.58 million, representing
a 217% increase compared with $47.82 million in 1999. The
performance from the first two quarters of 2001 also assured
investors that it would be another bonus year. Its net revenue
stood at $124.3 million, an increase of 135% from the first six
months of the previous year. By then, a Synergy Report placed
Clarent as the market share leader in Asia Pacific for the first
quarter of the year. No spell could break Clarent magic.
WINTER IN SUMMER
But when July arrived, a dramatic change in Clarent's fortunes
began to unfold. On July 18, the first of many class action
lawsuits was filed against Clarent Corporation. It opened the
floodgate to a long list of legal disputes claimed against Clarent
in subsequent months. Among the defendants being named were
representatives of the two private equity investors, Ko of WK
Technology and Lin of Goldman Sachs. The suits alleged that
Clarent's listing prospectus was false and misleading. It had
failed to disclose the underwriters' agreement with certain
investors to provide them with significant amounts of restricted
Clarent shares in exchange for exorbitant and undisclosed
commissions. Furthermore, the suits also claimed that the
underwriters had entered an agreement with these investors to
purchase Clarent's shares in the after-market at pre-determined
prices.
Clarent responded immediately and announced that Jerry Chang,
its chief executive officer, would step down. On July 19 Chang's
previous responsibilities were taken over by Vargo, Clarent's other
co-founder, on a temporary basis. Chang's new role in the
corporation would be as chairman of the company's board and chief
strategist.
But the actions taken by Clarent failed to stop its largest
shareholder, WK Technology, from frantically disposing of its
shares. In the three days between August 28 and 30 2001, WK
Technology sold over two million Clarent shares — 40% of its
holdings. Although WK Technology began its divestment of Clarent
shares in September 2000, it had sold only 300,000 shares on two
other occasions.
DAMAGE CONTROL
Coincidentally, less than a week after WK Technology so
significantly reduced its holdings in Clarent, the latter publicly
acknowledged that previously reported revenues for the first half
of 2001 were "potentially materially overstated" while losses were
potentially underestimated. Upon release of these statements by
Clarent on September 4, its shares were suspended from trading with
immediate effect. Jerry Chang, Mathew Chiang, president of
Clarent's Asia Pacific operations, and Kevin Chang, general manager
of Clarent's north Asia operations, were put on administrative
leave. The action appeared to have come too late. On September 28,
with then 10 class action suits filed against Clarent, Jerry Chang
resigned while Chiang and Kevin Chang were dismissed. Clarent
revised its revenue forecast for the third quarter from the
previous $40-43 million to $17-18 million. It also revealed a
reduction of 50% of its workforce, or around 350 employees.
THE COMPATRIOT
Clarent was soon joined on Nasdaq by China's Netease, which
became the second Nasdaq-listed greater China technology company to
face class action lawsuits in the US. Both Clarent and Netease were
suspended from trading on Nasdaq on September 4.
Like Clarent, Netease had been successful in
securing funding from private equity investors. According to
sources, the three private equity investors, Baring Private
Equity Partners, Goldman Sachs and Softbank China Venture
Investments paid $5 per share for a total of an 18% stake.
Each of them had secured a board seat in the company
(fig.2).
On June 30 last year, Netease advanced onto the global platform
when it became a listed company on Nasdaq. Its offer price, at
$15.50, was in the same price range as that issued by Clarent. But
investors' appetite for technology stocks had already been
significantly deflated following Nasdaq's meltdown a few months
earlier. Netease's lacklustre listing debut was an ominous
beginning on a 15-month journey plagued by financial losses and a
long saga of senior management turnover.
CHANGING OF THE GUARDS
Netease became a subject of intense scrutiny when Hong Kong's
iCable Communications decided, after a month-long discussion, to
withdraw from its $85 million offer to acquire the whole of Netease
in June. While iCable was still undertaking due diligence, King
Lai, Netease's chief executive officer and Susan Chen, the chief
operations officer, both abruptly left the company. They had been
appointed between April and July last year. To restore investors'
confidence William Lei Ding, the founder of Netease, returned to
take over the helm after an absence of 15 months. But he failed to
stem the senior management haemorrhage. On August 28, Helen Haiwen
He, its chief financial officer since July 1999, resigned. Two
weeks later Ding himself vacated his desk, after having held the
position as the chief executive for the second time for only two
months. His responsibilities were taken over by Ted Sun on a
temporary basis. Sun had been one of the longest serving directors
in Netease. His tenure had begun in November 1996 and ended in May
2000, a month before Netease was listed.
INVESTORS' VERDICT
Netease's convoluted senior management movements mirrored deep
structural and financial problems in a company that was once the
best-known website in China. Less than a month after the deal with
iCable was aborted, Netease received its first warning from Nasdaq
that it would face delisting for its failure to follow procedure
and to submit its annual report. Although it vowed to appeal
against the decision, on September 4, the inevitable took place.
From then on, Netease shared a similar fate to Clarent.
In the class action lawsuit filed against Netease, private
equity investors' representatives were not named as defendants.
They were confined to Ding, Lai and He, and the underwriters of its
IPO. The complaints cited misleading financial information in the
listing prospectus, in which the results for the first quarter of
2000 were artificially inflated. Between the period of July 3 2000
and August 31 2001, Netease made three different announcements
which finally revealed an over-statement of a $4.3 million revenue.
As a result, the new net loss for 2000 was, in fact, $20.4 million,
18% higher than what had been previously reported (fig.3).
OBSERVATION
In failing to abide by the governance standards promulgated by
international regulatory bodies, both Clarent and Netease have paid
a heavy price. Their prestigious public listing status on Nasdaq is
in limbo. The vaccum created by the departure of the founders and
senior managers in both these two companies will ultimately dim
their future prospects.
WTO negotiator Long described China's admission to the WTO as "a
historical necessity". Along with this necessity comes the
prerequisite of understanding the expectations of the global
playing field. Within the next five years, both China and Taiwan
will have to implement extensive reforms to measure up to the
standards of WTO members. There is very little time for such a
formidable task.
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