It began as a cut-rate film-developing service launched by four brothers in the remote northwestern province of Xinjiang. Through pluck and aggressive leveraging, it grew into one of the largest private enterprises in China, a $5 billion-a-year empire with interests in ketchup paste, jet engines, trendy nightclubs and more than 100 other concerns.
Now, D'Long International Strategic Investment Co. is on the verge of attaining a historic yet unwanted distinction: It is about to become the first private company to be bailed out by the Communist Party government, concluding a scandal that has led to the arrest of its founder and deepened unease about the solidity of China's financial system.
According to reports this week in two state-supervised newspapers, China's central bank is preparing loans worth roughly $1.8 billion to prevent the company's collapse. D'Long is to be restructured and run by a government entity set up to oversee the management of failed state firms. Both the asset management company and the central bank declined to comment.
China's decision to rescue D'Long is the latest milestone in the economic transformation of a country that only a generation ago persecuted capitalists as counterrevolutionaries. Private firms now play a central role in the economy, so much so that the prospect of D'Long's collapse brought Chinese authorities face to face with a familiar paradox of capitalism: Despite a country's commitment to marketplace logic, some firms are simply too big and too entangled to be allowed to fold.
D'Long had grown so vast and its finances had become so intertwined with other firms that its failure raised the risk of a larger unraveling of banks and major companies with which it was involved. The company's patchwork of holdings included investments in several banks and controlling stakes in five companies that trade on Chinese stock exchanges. Ten listed companies have served as guarantors of D'Long's debts, which have been estimated by state media to exceed $2.5 billion. Questions about D'Long's finances have reinforced the view that China's stock markets are rife with manipulation and hidden liabilities, and not to be trusted.
"D'Long is so big, involved in so many different industries, and so deeply involved in the financial system," said Yin Zhongli, a finance expert at the Chinese Academy of Social Sciences in Beijing. "If D'Long died, it would cause a chain effect. Banks would be hit. The stock market would be damaged. It would harm the overall confidence in the markets. The government cannot allow that to happen."
Analysts contend the bailout is at least in part prompted by government efforts to safeguard the image of China's banks as it readies plans to sell shares in some of the largest lenders on stock exchanges in Hong Kong and New York. China's banks are choked with as much as $500 billion in bad debt, according to private economists. Cleaning up their books has long been one of the government's primary goals, and foreign capital is cast as a central fix. The collapse of D'Long threatened to add to the tally of bad debt.
Only a year ago, D'Long was often touted as a synonym for the sort of seat-of-the-pants entrepreneurialism thought to define the emerging private sector, which has become China's biggest source of new jobs. It was the brainchild of Tang Wanxin and his three brothers, who in 1986 came up with a clever way to make money in the impoverished hinterland of Xinjiang. They took film and shipped it hundreds of miles south to processing factories in the booming province of Guangdong, where development costs were much cheaper.
They folded their winnings into a dramatic expansion, taking stakes in companies that made trucks, noodles and machinery. They entered mining, textiles and tourism. Four years ago, D'Long boldly -- some said foolishly -- bought Murray Inc., a Tennessee maker of lawn mowers and bicycles, borrowing more than $300 million from General Electric Capital Corp. to finance it. Last year, D'Long acquired assets from a bankrupt German aircraft manufacturer, Fairchild Dornier. The group seemed a symbol of China's new aspirations: The sleeping giant had not merely awoken, but was looking for opportunities beyond its borders. By last year, the Tang brothers enjoyed personal wealth exceeding $250 million, according to China Money magazine.
But along the way, talk intensified that D'Long was spreading itself too thin, essentially underwriting long-term investments and acquisitions with what proved to be short-term strategies. According to three sources familiar with the company's operations, one of whom directly facilitated an investment deal involving the firm, D'Long used its stock holdings as collateral for bank loans, then applied the cash from these loans to purchase more shares in order to prop up their value. The company then borrowed more funds against the increased value of the stock, these sources said.
Though state media have reported that owner Tang Wanxin is now under house arrest in Beijing, analysts say this seems to say less about corporate corruption than it does about the lengths to which private companies must go in China to finance their businesses. Analysts note that private companies in China are routinely discriminated against by banks, and often test the limits of the law to find the funding needed to grow.
"The view that seems to present itself is that these guys were not simply crooks," said Arthur Kroeber, managing editor of China Economic Quarterly. "They were running actual businesses with actual cash flow. There was an authentic business strategy at work. It wasn't just a Ponzi scheme."
The leverage D'Long employed produced an upward spiral of cash, one that could keep working as long as its share price climbed. Banks were happy to supply loans, eager for new business to help clean up balance sheets choked with years of bad debts owed by money-losing state firms.
But as investors began selling their shares this year, the falling value of D'Long's holdings made banks reluctant to extend new credit. Some demanded immediate repayment. This coincided with a central government clampdown on bank lending to slow China's potentially overheating economy. D'Long found itself in a pinch.
The company worked feverishly to find new investors, seeking infusions from foreign firms such as Goldman Sachs, said sources close to D'Long. Prospective investors fretted over the financial tangle that confronted them. No takers emerged.
In July, the Shanghai stock exchange limited trading of one of D'Long's listed companies, the ketchup maker Xinjiang Tunhe Investment Co. Ltd., citing questions about $600 million in dubious assets. Later that month, one of D'Long's core holdings, Torch Automobile Group Co., announced it was selling controlling stakes in eight machine manufacturing companies to U.S.-based Midwest Air Technologies Inc. for nearly $24 million to raise cash.
By then, D'Long's troubles were spilling into other institutions. In late July, rare public protests broke out in Shanghai after an investment firm, Jinsin Trust Co., failed to pay back 200 local investors who had bought into a $10.4 million deal. Jinsin's default was triggered by the demise of another transaction in which D'Long had planned to buy its assets. Some of the investors staged sit-ins at the offices of the Bank of Communications in Shanghai, which had recommended that they buy the trust investments.
Yin, the Beijing finance expert, said the bailout now runs the risk of encouraging future reckless investments. "Market principles say this company should die," he said. "This creates a bad example."
But fear of instability appears to have trumped other considerations. According to Chinese media reports, Xinjiang provincial officials lobbied the central government to deliver the bailout, and economists warned of shocks to the financial system. Last week, China's ruling State Council sent an order to the central bank for the rescue package.
"The government should take the blame," said David Chen, former China-based chief of the Hartcourt Cos. investment firm. "It's time for policymakers to consider why this has happened -- lack of transparency for investors and lack of scrutiny into bank lending."
Special correspondent Jason Cai contributed to this report.