China Inc’s extensive presence in Hong Kong has traditionally been muted. Its holdings include the territory’s second-largest banking group, third-largest supermarket chain and minority interests in both the de facto flag carrier, Cathay Pacific, and the container port – but it has never dominated any sector.

This status quo changed dramatically at the weekend with the announcement that state-owned China Netcom is likely to become the largest shareholder in Hong Kong’s biggest telecoms group, PCCW. If a $1.2bn sale of a 23 per cent stake, owned by controlling shareholder Richard Li, to investment banker Francis Leung, is completed, Netcom will sit atop PCCW’s share register. It could then control the leading provider of fixed-line and broadband internet services in Hong Kong.

But the way the change happened has raised concerns. “The Chinese didn’t allow a commercial outcome,” says one person close to the transaction.

Netcom acquired 20 per cent of PCCW in January 2005 and took a backseat to Mr Li, PCCW’s chairman.

But this year Australia’s Macquarie Bank and TPG/Newbridge, the US private equity group, each proposed takeovers worth up to $7bn. Netcom objected on the chauvinistic grounds that PCCW should be “owned and managed by Hong Kong people”.

The objection led to Richard Li’s decision to sell out to Mr Leung and pay minority shareholders a special dividend of HK$0.33-HK$0.38 out of his own pocket. With Mr Leung selling 12 per cent of the company to the private charitable foundation led by Mr Li’s father, Li Ka-shing, another 8 per cent to Spain’s Telefónica and retaining just 2.65 per cent himself, Netcom looms larger than any other PCCW shareholder.

Adding to Netcom’s clout, the state-owned carrier and Telefónica will place their combined 28 per cent stake – almost twice the 14.65 per cent share jointly held by Li Ka-shing and Mr Leung – in a joint venture.

Aware of the transaction’s political sensitivities, Netcom announced it did “not intend to control the board of PCCW and will not seek to do so in future”.

According to those close to PCCW’s chairman, Li Ka-shing’s involvement came as a shock to Richard, who wanted to escape his father’s shadow. He is also understood to be upset at Netcom’s intervention.

“If Richard had known who the consortium members would be, he would have dealt with it very differently,” says one person close to Richard Li.

“You cannot make up rules as you go along,” he adds. “The law says there are no restrictions on foreign investment – zero.”

The sale of the PCCW stake still has regulatory hurdles to overcome with Hong Kong’s telecoms regulator, the Office of the Telecommunications Authority.

The two holding vehicles established by Netcom, Telefónica, Mr Leung and Li Ka-shing have been constructed to avoid exceeding specific thresholds spelled out in Hong Kong’s takeover code and Telecommunications Ordinance. By coming in at just under 30 per cent, Netcom and Telefónica do not have to make a general offer to all shareholders. And, according to the letter of the Telecommunications Ordinance, Li Ka-shing, who also controls assets through Hutchison Global Communications and Hutchison Telecommunications International, should evade scrutiny because his stake in PCCW will not exceed 15 per cent.

“Legally, it looks like Li Ka-shing has not broken the 15 per cent rule. But has he broken the rule in spirit?” asks an executive at a rival Hong Kong telecoms firm. “PCCW is Hong Kong’s largest fixed-line operator and Hutchison is a close No 2 in mobile and one of the top three in fixed-line.”

For some, the deal raises questions about the motivation of the elder Li, who may have opened himself up to unwanted attention. “The tragedy for Li Ka-shing is why would you do it? [take a minority position in PCCW],” says one person close to the transaction. “Hutchison and PCCW are full-on competitors. It’s not a natural position if you know the regulator probably isn’t going to like it – it’s an insane strategy.”

Additional reporting by Justine Lau

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