We urge minority shareholders to veto CNOOC's proposal to continue lending up to RMB6,800m (US$821m) to its parent's subsidiary. We also question why such loans over the last 2 years have not been subject to minority shareholders' approval, apparently breaching the Listing Rules. The Stock Exchange has yet to take any public action. CNOOC should get its money back.

Veto CNOOC Loans to Parent Group
19 April 2004

Company: CNOOC Limited (CNOOC)
Stock code: 0883
Meeting type: Extraordinary
Date of meeting: 28-Apr-04
Time of meeting: 11:30
Advice date:  19-Apr-04
CCASS voting cut-off 23-Apr-04. VOTE NOW
Circular and Notice of Meeting: Click here
Proxy form: Click here
Voting method: A poll is required by the Listing Rules. All proxies will be counted. CNOOC Parent must abstain.
How to vote: See our voting guide

Note to journalists:
We have up to 8 proxy seats available inside this AGM. Please contact us if you want one.

Item Description Vote
1 To approve the Framework Agreement, including loans of up to RMB6,800m to a subsidiary of the parent of CNOOC AGAINST

Background

In an announcement filed at 17:32 on 8-Apr-04, the eve of the 4-day Easter weekend, CNOOC said it would seek minority shareholders' approval (the parent cannot vote) for a bunch of "continuing connected transactions" with a company called CNOOC Finance Corp Ltd (CNOOC Finance), a non-bank PRC finance company which is a 62.9% subsidiary of China National Offshore Oil Corporation (CNOOC Parent).

CNOOC Finance was established in Jun-02. On 5-Sep-03, CNOOC bought 31.80% of CNOOC Finance from its parent for RMB450m cash in a connected transaction which, because it cost less than 3% of CNOOC's net assets, did not require minority shareholders' approval. The reason given in the announcement of the acquisition was to "enable the Group to participate in the financial services industry in the PRC", but then in a masterpiece of inconsistency, the oil producer said "The Company has no current intention to expand into the financial services industry other than the acquisition." So they were participating in financial services but not expanding into it. Go figure! The announcement made no mention of any transactions between CNOOC and CNOOC Finance.

However, buried in the footnotes of the 2002 and 2003 annual reports, it was disclosed that CNOOC had lent RMB2,740m to CNOOC Finance at 31-Dec-02, and RMB3.9m at 31-Dec-03. And according to the Easter-eve announcement, the maximum outstanding loan between the creation of CNOOC Finance in Jun-02 and Mar-04, was a whopping RMB6,600m.

Of course, you won't see it described as a "loan" - CNOOC prefers to call it a "deposit" with CNOOC Finance, but it is in fact an unsecured loan. While CNOOC Finance is regulated by the People's Bank of China, that hardly fills us with confidence, and no credit information has been published on CNOOC Finance, which also invests in "marketable securities" and equities, including equity of CNOOC group companies. Incidentally, the "deposits" which CNOOC Finance takes are "over 3 months" - presumably because any shorter duration would require a full banking licence which it does not have.

Breaking a Golden Rule of Governance

It is a golden rule of good governance that listed companies should not lend money to their controlling shareholders. If you want to make a loan (or call it a deposit), then go and lend the money to an independent bank, or preferably several. If you lend money to your controlling shareholder, then you run a huge conflict of interest. There have been numerous cases in the past of this kind of arrangement causing major problems when the parent is unable to repay the loans. If CNOOC Finance gets into trouble, is CNOOC really going to demand its money back, given that both are controlled by the same entity and Chaired by the same person?

If you think these fears are unfounded, then you have forgotten about the collapse of companies like Guangdong International Trust and Investment Corp (GITIC) or the default of the government-owned parent of Guangdong Kelon Electrical Holdings Co Ltd on unapproved loans of RMB1,260m from the listed H-share company which was once the darling of institutional investors. Fans of CNOOC should bear this in mind.

Breach of Listing Rules

The most jaw-dropping part of this is not that CNOOC is now seeking approval for future loans to CNOOC Finance up to RMB6,800m which it really should not make, but that it never sought approval in the past, even though the Listing Rules would have required it, since the maximum of RMB6,600m was about 16.3% of net assets at 31-Dec-02 and 14.1% of net assets at 31-Dec-03.

Regulatory note: we reported this breach of the Listing Rules to the Stock Exchange on 9-Apr-04 but no public action has been taken, nor has the company even acknowledged that it broke the rules for almost 2 years, even though it is now seeking approval for similar transactions in future.

Shareholder Circular

CNOOC used the Easter break to its advantage. On 13-Apr-04, the day after Easter, it published a circular to shareholders dated 5 days earlier (the same date as the announcement), so this must have been in production well before the announcement of the deal was made. This included a letter from independent financial adviser Cazenove Asia Limited, signed by its Chief Executive May Tan and Head of Corporate Finance Karman Hsu, advising that the terms of loans were:

"in the interests of the Company and the Shareholders as a whole."

Well we can see why they would be in the interests of one shareholder, CNOOC Parent, which gets a handy RMB6,800m to provide loans to other group companies, but we cannot see how this is a better risk for the minority shareholders than putting the money in banks, which have much more diversified loan portfolios. Even accepting that PRC exchange controls mean CNOOC is effectively restricted to PRC banks with its RMB deposits, it would be politically difficult for one of the large government-owned banks to default, but much easier for an internal finance company like CNOOC Finance to shut down without any disruption to society.

When Webb-site.com spoke today with Cazenove's May Tan, who had signed the advice letter, she denied knowledge of the situation and said a colleague had handled it. Cazenove was unable to provide further comment before we published this article.

CNOOC is already heavily involved in previously-approved connected transactions with its parent, including the sale of oil. But there is no reason to deepen the conflict further. The company claims that the loans to CNOOC Finance:

"could help diversify the Group's risks in relation to its deposits"

but in fact what it does is increase the company's exposure to its parent group.

We are shocked that the committee of independent directors, including experienced investment banker and Vice Chairman of Goldman Sachs Asia, Dr Kenneth Courtis and former Swiss ambassador to China, Dr Erwin Schurtenberger approve of this arrangement and and regard it in the interests of CNOOC to continue with the loans. According to CNOOC's annual report, Dr Courtis is designated as the 2-member audit committee's "financial expert" under U.S. securities laws.

So we urge you to vote AGAINST these transactions. We also call on CNOOC Parent to get CNOOC Finance to give the listed company its money back, to unwind the previous unapproved loans.

We also recommend you vote AGAINST the re-election of Dr Courtis and Dr Schurtenberger as independent non-executive directors, at the AGM on the same day, 28-Apr-04. See our separate voting advice on that meeting.

© Webb-site.com, 2004


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