The story behind the Wahaha Danone JV dispute

After reading China Law Blogs post on the Danone and Wahaha Joint Venture dispute, I just had to translate this 21st Century Business Herald article which ran over the weekend. Its details surpass anything reported so far in the western media, and explains in stunning detail how the Wahaha group and its CEO Zong Qinghou went about setting up mirror companies to steer profits away from the JV and into his pocket. Continue reading for the gory details:

[Rushed translation from Chinese]

21st Century Business Herald
Reporter Chen Xiaoying
2007-04-13

When Wahaha went under reorganization, Zong Qinghou had to find help, but while Danone became his best partner, it also sowed the seeds of today’s conflict.

Why does Danone all of a sudden want to buy these “Non-Joint Venture Enterprises” (NJVEs)? Why does Zong Qinghou not hesitate to at all costs resist this move? How were these NVJVE’s formed? And how did they become the cake that both sides are fighting over?

On the 11th of April, after both sides refused to budge and a tit-for-tat war of words, Danone finally decided to hold a press conference and open their mouth in defense. At the news conference, Danone President of Asia Area Fan Yimou not only produced evidence and stressed that the Wahaha brand was part of the Joint-Venture, he also criticised Zong Qinghou for “using public opinion to obtain personal interests.”If you look a little deeper past the ruckus and track down the interests and their origins, you can see very clearly how things developed. The fuse that ignited the bomb between the two is not about trademarks, but rather Wahaha’s non-Joint venture enterprises, and Danone’s demand that they be bought for a price of 4 billion RMB in a forced buy-out.

61 “Non-Joint Venture Enterprises” became the cake.

Wahaha’s shareholder structure is extremely complicated, according to this newspapers investigation, there are only over 100 companies that have the three letter name “Wa Ha Ha”. According to Zong Qinghou, among them are: the post-restructuring Hangzhou Wahaha Group Co, 39 subsidiary JV companies with Danone, and there are even more employee (management) stock held “NJVEs”

These NJVE’s began to grow in strength after the 2000 reorganization, Danone’s President for Asia Fan Yimou stated: “Especially in the last 18 months” the NJVEs have had explosive growth. Until present, the total sum of these companies has reached 61 with total assets reaching 5.6 billion yuan, and in 2006 only, total profits reached 1.04 Billion Yuan.

The NJVE’s made Danone furious and they put forward the demand of buying 51% of shareholders rights for a price of 4 Billion yuan.

Why have these enterprises made Danone uneasy and move with such quick action? This newspapers reporter was able to find that the products produced by the NJVE’s and the JV’s are nearly identical, with the only difference being in how and where the products were sold. The products made by the JV are mostly distributed in the coastal areas, and the NJVE products are distributed in the mid and western regions of China. Zong Qinghou’s explanation was that these moves were in order to answer the call of the nation and finish the distribution of their products in the mid and western regions of China.

“The Decision makers at Wahaha wanted to participate in the opening up of the west, hand in hand with the state revitalize impoverished areas including the Three Gorge’s Damn reservoir construction project. But Danone had misgivings about the consumption ability of these areas and didn’t want to carry out investment” Zong Qinghou said in his explanation of the formation of these NJVE’s. Furthermore, according to Zong, the profit margins of the NJVE’s clearly exceeds those of the Joint Venture.

According to an industry insiders explanation:”Actually, the biggest costs in the beverage industry lie in sales costs, especially advertising. Because the products made by both companies are the same, the NJVE’s obviously don’t have to pay for any advertising fee’s, so their profit margins are also a little higher.” Danone and Wahaha were both clearly aware of this point, and both parties talked over profit sharing, but in the end were unable to reach an agreement.

Failing to reach an agreement, starting in the second half of last year both sides started to quietly make their moves

In the past, there have been reporters in the media who have seen copies of the contract Wahaha would give to their dealers. The contract stated, that from November of 2006 they not only have to continue to sign the contract with the JV companies, but they also have to sign a contract with a company named Hangzhou Wahaha Beverage Sales Ltd. Company. Furthermore, besides handling the JV sales companies Gold Card account, the Hangzhou Wahaha Beverage Sales company required them to put the payments for goods into a Gold card account created under the new company. This kind of financial operation is clearly aimed at separating the operation of the JVE’s and NJVE’s and individually settle the sales accounts of the NJVE’s.

In order to resolve the problem of JV companies competing with their NJVE counterparts, Danone decided to take steps on their own and put up 4 billion yuan in capital and buy 51% of Wahaha. But Zong Qinghou and Wahaha were unwilling, and facing Danone’s pressure he angrily rejected this “low price forced buyout.”

Who’s “Non- Joint Venture Companies”?

Now that they are to be included in the buyout, this drags in the problem of ownership with regards to the NJVEs. Now, how exactly did these NJVE’s come about and who after all are the owners?

According to records, the Hangzhou Wahaha Beverage Sales Company was founded on December of last year, with the main stock holder being Zong Qinghou. There are no connections with the Wahaha Group and its Labor Union.

The sole financier of the Hangzhou Wahaha Beverage Sales Company was Hangzhou Hongsheng Beverage Company(杭州宏胜饮料有限公司), which on march of this year changed its name to Wahaha Hongsheng Beverage Group Ltd. Co (娃哈哈宏胜饮料集团有限公司)and put up 3 million RMB in capital. The legal representative of the Hongsheng group is Zong Qinghou’s daughter, Zong Fuli 宗馥莉. Hongsheng’s registered capital is 80 Million RMB and has two shareholders.

One of the shareholders naturally is Shi Youzhen(Zong’s wife)施幼珍, who owns 10% of the company, and the corporate shareholder representative (法人股东)Hengfeng Trade Ltd. Company (恒枫贸易有限公司) holds the remaining 90%. Furthermore, Shi Youzhen is also the number two shareholder of the Wahaha Group. Hengfeng trading was registered in the British Virgin Islands and its legal representative also is Zong Fuli (Zong’s daughter).

The Hongsheng factory was set up inside the Wahaha Xiaoshan(萧山) #2 production base. It produces fruit-vegetable and bottled water beverages. Since its formation in 2003, within a short time Hongsheng’s account accumulated over a billion RMB in profits that were not shared with Danone, and in 2005 it was number 30 on Hangzhou’s list of highest profit earning foreign invested enterprises.

Zong Qinghou in his explanation of these companies, said that Danone acquired similar beverage companies in China and had control over the JV’s commercial secrets. “It brought harm to us.”

Besides NJVE’s producing Wahaha’s traditional beverages, another important component among these NJVE’s is the Hangzhou Wahaha Child’s Wear LItd. Co. (杭州娃哈哈童装有限公司) One of China’s biggest youth clothing companies. Zong Qinghou has previously stated that Hangzhou Wahaha Child’s Wear and the JVE do not have any relation and were exclusively or jointly financed by the Wahaha Group and its Labor Union. From material the newspaper was able to obtain, the shareholders of Hangzhou Wahaha Child’s Wear have been through numerous changes, ultimately ending up in the hands of three shareholders. One is a foreign enterprise named Platinum Net Limited and the other two are Zong Qinghou and his wife. Zong Qinghou holds 65%, his wife 10% and Platinum Net Limited holds 25% whose financier is unidentified.

The helper becomes the competitor

Why did Wahaha hatch out such huge “None-Joint venture Companies” and become the the focus of the conflict? In reality, it is related to Wahaha’s path of reorganization.
Starting in 2000, reorganization led the Wahaha Group down the road of privatization.

At that time, Wahaha and Danone had already set up many joint venture subsidiary companies. For the parent company Wahaha, reform was unavoidable which has become connected to the JV subsidiary companies. According to a document titled “Document 1999 #32”; at that time the net assets of the Wahaha Group were about 700 million RMB. After excluding company housing, real estate projects and awards given for scientific achievements, actual net assets were 500 million RMB.

In an asset evaluation report that was made at the time of Wahaha’s reform, the assessor, Zhejiang Assessment Company clearly noted that in the assessment of the groups assets, Wahaha’s trademark, business reputation, production technology, and liquid assets were not included. Thus at that time, Wahaha’s trademark was not put in the assessment report.

“Because at the time of the JV, Wahaha’s trademark was covertly put into the joint venture, this was not only the premise of the JV but also to decrease the difficulty of the restructuring” A legal professional who was familiar with the restructuring stated. If it wasn’t carried out in this way, Wahaha’s restructuring total of sum of money would have been much bigger, and if the managing level wanted to retain the same shareholding proportion they would have had to put up more capital.

The restructuring documents requested that the groups original sole owner, Hangzhou Shangcheng District Government transfer 49% of the net assets to Zong Qinghou who was to be the leading manager and employee. Zong himself put up about 150 Million RMB which accounted for 29.4% of the shares and the workers and staff members(management) put up 19.6% in capital or 100 million RMB. The actual financing was based upon 81% of the original value. Furthermore, already among the peeled off assets, the awards for achievement in science(“科技成果转化奖) became the source of capital for the companies management. The total sum of these awards totaled 70 Million RMB, of which 80% was given to Zong Qinghou and the remaining 20% was turned into the collective shares of the workers and staff.(management). Although during the restructuring in 2000, Zong Qinghou individually had to pay 60 Million RMB to purchase stock rights which was not permitted to be a bank loan.

Whether it was coincidence or sedulously planned out, at that time it was a win-win for the management of both Wahaha and Danone. Now solely in the hands of Zong Qinghou, shortly afterwards Wahaha was able to get rid of former competitor company Robust (乐百氏) and enter a period of super-speed development.

In may of last year, Zong Qinghou held discussions with the Hangzhou City Bureau of Asset Management to give up their 45% stake in ownership. At that time Zong stated that there wasn’t a timetable, nor would there be any difficulty(in obtaining investment) but in no way was he going to consider foreign investment.

But from the beginning of this year, due to Danone putting forward the plans for purchase of the NJVEs, these negotiations have already stopped.

Some of the opinion has said that when Wahaha went under reorganization, Zong Qinghou had to find help, but while Danone became his best partner, it also sowed the seeds of today’s conflict.

—————-
Original article (Chinese) http://www.nanfangdaily.com.cn/southnews/sjjj/sjgs/200704130533.asp
“Danone’s China Deal Goes Sour: French Food Firm Accuses A Leading Businessman Of Undermining Venture,” – Wall Street Journal
宗庆后的转折点：掌控娃哈哈 － Xinhua