Automotive
Automotive
A couple of days ago, news surfaced that Anshan Iron and Steel, one of the largest steel manufacturers in China intends to purchase a 20 percent stake in a near-bankrupt Mississippi steel mill. I say "surfaced" because the actual decision to pursue this investment apparently came in May, but for whatever reason never made the news in the US.
As would be expected, the Congressional Steel Caucus, a group of about 50 US lawmakers who are advocates of the US steel industry, raised objections to the proposed investment. These objections are similar to those raised by CNOOC's proposed takeover of Unocal back in 2005, so there is really nothing new here. The requisite "national security" implications are raised. And there is little doubt that the Steel Caucus's "investigation" will recommend against allowing this investment to happen.
Of course, the Steel Caucus can only make a recommendation; it does not have the final word, so it is not inconceivable that the investment could happen anyway. After all, a 20 percent stake is not a controlling stake, right? And even if it were, Anshan is just like any other profit-seeking business, right?
To address the first question, the answer is that we cannot always be certain whether 20 percent is a controlling stake. That really depends on who the other shareholders are and how large their stakes are. According to the Wall Street Journal, the Mississippi plant in question is owned by a private company, the Steel Development Co., which, according to its website is owned by "institutional investment firms headquartered in the United States, as well as [its] management group." So I think it is reasonable to assume that Anshan's proposed 20 percent stake would not be a controlling stake.
As for the question of whether Anshan is a profit-seeking business, the short answer is, yes, except for when it is not.
Beijing-based lawyer and blogger, Stan Abrams, posted a funny, and partially tongue-in-cheek, article today essentially making fun of the Congressional Steel Caucus's knee-jerk commie baiting (my term, not Stan's). While I largely agree with Stan's conclusion, I have to wonder whether the fact that Anshan is a state-owned enterprise is a significant factor that deserves further scrutiny.
Stan says (again, tongue-in-cheek):
Everyone knows that the company is controlled by China’s Assets Supervision Commission of the State Council (SASAC), which means that the company is merely a tool of the Communist Party. With all of those subsidies, Anshan is definitely up to no good.
Well, let's take this apart. First of all, I think we can be sure that not "everyone knows" this. Whether they should remains to be seen. Second, yes, Anshan is indeed owned by SASAC, the arm of the State Council that holds the shares of China's largest state-owned enterprises.
Third, while Anshan isn't "merely" a tool of the Communist Party (it is also other things), it is nevertheless a tool of the Communist Party. Anshan is 67 percent owned by SASAC, which doesn't necessarily make it a tool of the Communist Party -- until you take a closer look. The senior management of SASAC-owned companies, including Anshan, are appointed, not by their Boards of Directors, not by SASAC, not by the State Council, but by the Politburo of the Chinese Communist Party. (Richard McGregor's new book documents much of this. It's also a great read. McGregor explains some of this in an interview here on the China Beat.)
I also found it interesting that Qi Xiangdong, Deputy Secretary General of the Chinese Iron and Steel Association seemed to bend over backward to try to redefine what "state-owned" means:
"A market-economy country like the U.S. shouldn't make administrative intervention to corporate behavior," Mr. Qi said. "Western countries still have a stereotype of [Chinese] state-owned enterprises. ...Anshan Iron is a listed company, and not a Chinese state-owned enterprise in the traditional sense." (WSJ, 5 July 2010)
Setting aside the irony that the king of state interventionist governments would lecture the US about what a market economy is, it is extremely disingenuous of Mr. Qi to suggest that a company that is 67 percent owned by the government is not state-owned. If I were a conspiracy theorist, which I'm not, I might begin to suspect that there is a Chinese plot to redefine English language words such as state-owned, democracy, rule-of-law, etc., so as to confuse their foreign detractors.
What about "all of those subsidies"? Well, since Anshan is indeed a state-owned enterprise, we can be certain that, at some point in the past, and probably at some point in the future, Anshan will benefit from government subsidies. Part of the reason for continued government control of major enterprises in China is fear of instability that would be caused by massive layoffs if these giant firms were to go bankrupt. As long as any company is in state hands, that's not a problem. Anshan is "blessed" with a soft budget constraint, and they know it.
Is Anshan "up to no good"? Probably not, though when it comes to the murky world of Chinese state-owned enterprises, nothing can be said with all certainty. Anshan's external shareholders, a diffuse group of individuals and institutions who collectively own only 33 percent of Anshan's shares, have no say in what the company does. Anshan is part of a large group company, and there is absolutely zero visibility into the operations or financial statements of the unlisted entities. It may also give us pause that a Chinese official stretches reason in order to declare Anshan not to be a state-owned enterprise when it clearly is.
So while Anshan is probably just looking for a good investment in a business that it already knows, without visibility into the rest of Anshan's dealings, its leadership, its true controlling owners (i.e. the Politburo), we cannot be absolutely certain.
So are we OK with this investment?
Yeah, why not? Let the folks in Mississippi take Anshan's money. When it comes to the power of the Chinese state, it pretty much stops at the borders of the United States. Once Chinese money and people enter the US, they are subject to rule-of-law. And while the Chinese may wish to redefine what that term means within their own borders, they will find US courts quite unsympathetic to any attempts to do so elsewhere.
BYD, a private, Hong Kong listed, automaker based in Shenzhen, announced Monday (17 May) it had put 40 all electric taxis into service in the city of Shenzhen.
The taxi is BYD's E6 model, a cross-over vehicle with a lithium-ion battery that, according to BYD will travel up to 300 km (186 mi) on a single charge. By comparison, Nissan's Leaf all-electric vehicle is expected to travel about 100 miles on a single charge. This is also the model with which BYD plans to make its entrance into the North American market later this year.
BYD expects to have as many as 100 E6 taxis plying the streets of Shenzhen by the end of June.
These taxis are being operated by Pengcheng Electric Taxi Company, a joint venture between BYD and the Shenzhen Bus Group (SBG).
Shenzhen Bus Group is a large operator of bus lines, taxis, and related businesses in the southern Guangdong region. Its largest shareholder (55 percent) is the Shenzhen City SASAC (State-owned Assets Supervision and Administration Commission). In other words, BYD's partner in this joint venture is none other than the city government of Shenzhen.
I recently asked a former BYD employee to describe BYD's relationship with the local government, to which he replied, "feichang, feichang, feichang hao (very, very, very good). Without local government support, it would be hard for BYD to have any success. Wang Chuanfu (BYD's CEO) devotes a lot of time to nurturing this relationship. BYD's relationships with the Xi'an government (where BYD's first auto factory is located) are also feichang, feichang, feichang zhongyao (very, very, very important)."
This blurring of the lines between public and private is not that unusual in China. In fact, no auto company would survive long outside the influence of its respective local government. Though a local state-owned automaker would be expected to have a close relationship with its owner, a privately owned automaker's relationship with the local government is nearly as close.
Because BYD's E6 costs the equivalent of about US$40,000, and because the technology is still fairly new and untested -- and because taxis drivers tend to drive their vehicles far more aggressively than the average driver -- one might guess that this joint venture between BYD and the City of Shenzhen will lose money for the foreseeable future. But this is where the public-private partnership proves to be a win-win.
BYD gets to test its vehicles in real-world conditions and gather a lot of data for improvements. Shenzhen gets publicity for its support of green technology and recognition from Beijing for supporting a company on the forefront of carrying out Beijing's policy for electric vehicles.
And this kind of partnership isn't unique to China. I recently spoke with Mark Perry, VP at Nissan USA, who told me that Nissan is also working with various local governments in the US to provide some of the infrastructure necessary to support electric vehicles in their cities.
Please note this is the final post in a series. Previous posts can be found (in order) here, here and here.
_____________
This is going to be a long post, so I apologize to those of you who will have to scroll to reach the end of this in your Google Readers.
I ended my post of March 27 by mentioning this article from China Economic Weekly that was recommended to me by a friend. The article summarizes a rich debate going on in China right now about whether the company is backsliding in its economic reforms by, in effect, re-nationalizing its economy which had ostensibly been on a path of increasing privatization since the late 1990s.
What follows is a somewhat abbreviated translation of this article with a little of my own commentary.
According to the article a relatively small number of people from academic circles began last year to raise this question of whether the state was reversing course on privatization reforms, and the concept of guo jin min tui “theory” and 与民争利论 (yu min zheng li lun – theory of officials profiting at the people’s expense) just took off from there. This “sensitive and emotional concept” of guo jin min tui “theory” has drawn attention from outside China and generated much debate.
(The term “theory” may also be a mistranslation. In this case, I think the term “theory” may be better translated as “idea” or “concept” -- words that don’t carry the assumption of having been subject to rigorous scientific inquiry.)
Prior to last month’s National People’s Congress (NPC), Professor Hu Xingdou of Beijing Institute of Technology penned an article criticizing the apparent reversal saying, “China never actually had the intention of establishing a real market economy. Rather, the intention was to establish a so-called state-led socialist market economy. In fact, (what we have is) a bureaucrat- and government official-led economy.” (The word used for “bureaucrat” is 官僚 which has negative connotations of an unproductive government employee who doesn’t do any work.)
(http://www.huxingdou.com.cn/2010suggestion.htm Article headlines in English.)
Far from being a theoretical piece, Prof. Hu’s article begins with anecdotal evidence that the state’s share of assets has been growing at the expense of private capital in the following industries: steel, chemicals, coal, petroleum, mining, electricity generation, civil aviation, highways, water, finance, brokerage, insurance, real estate, posts, etc.
On the other side of the debate are people who question the concept calling it “hype” created by academics “in support of special interest groups”. (Yes, China has special interest groups too. Who knew?) They point out 民 of 国退民进 and 与民争利 do not have the same meaning.
One change the article does point to is that, in the past, the arguments of academics were rather weak, and had little influence on economic policy. That is no longer the case, they say. In the first half of 2009, academics and journalists used the term guo jin min tui to refer to the phenomenon of “local industry and regional emergence of guo jin min tui”. In the second half of the year, people began to use the term “guo jin min tui da chao” (the tidal wave of guo jin mi tui) to describe the trend.
And the people who have noticed this trend are not only academics and journalists. The assistant director of the Enterprise Institute within the State Council’s Development Research Council (a government-owned think tank) says that the “problem of guo jin min tui has become especially critical in certain local regions and certain industries.”
In April of 2009 China Entrepreneur magazine conducted a survey among senior enterprise managers, and one of the findings was that over 72 percent believed the trend toward guo jin min tui was increasing, and that China’s four trillion yuan stimulus was disproportionately benefiting state owned enterprises.
By the end of 2009, the discourse had changed from “finding a win-win for state-owned and private enterprises to calling on (the state) to give private enterprises a just and fair market environment.” People even began to worry aloud that reforms were being reversed, and call for resumption of the original guo tui min jin reforms.
In September of 2009 a professor from the China Europe International Business School said that the trend of guo jin min tui ran counter to China’s reform and opening (改革开放), and that it was causing social inequality and crony capitalism (权贵资本主义). In November of 2009, a professor from Beijing Institute of Economics told media that state takeovers of private coal mines in Shanxi Province represented a reversal of reforms.
In the face of such overwhelming criticism, official circles began to fight back.
At an economic conference in November of 2009, the Director of China’s National Bureau of Statistics said the statistics from 2005 to 2008 do not support people’s claims of guo jin min tui. The statistics he cited were total number of enterprises, industrial output, asset values, total profits, taxes paid and numbers of employees. (This particular article did not repeat his statistics, but I will give him the benefit of the doubt for the moment. I will, however, point out that the discussion trend of guo jin min tui began to gather momentum toward the end of 2009, a period that would not have been covered in his statistics.)
One month later, this same official admitted that while, yes, the phenomenon of guo jin min tui did exist, it was only in some specific areas, but not in the economy as a whole. And he expressed his wish that people’s discussion of the phenomenon would be “vigorous and meaningful.”
While here was a central government official who had changed his mind about the existence of this phenomenon, most local officials were adamant that guo jin min tui was not an accurate description of what had been happening.
Local officials in Shanxi Province (where private coal mines had been nationalized) were at pains to describe what had happened, not as guo jin min tui but as “you jin lie tui” (优进劣退) or “the excellent enter; the inferior withdraw”. Another defense of these moves (and a far more plausible one in my view) was that it was an attempt to improve safety conditions in these mines.
The Chairman of China National Building Material Group Corporation, an SOE, explained at a press conference that the phenomenon of guo jin min tui has not happened in China. And the primary reason he gave is that, because so many formerly wholly state-owned enterprises launched public offerings, their ownership had become diversified; the people were now part owners of these enterprises.
The Bureau Chief of China’s Civil Aviation Administration said, the fact that there had been mergers and acquisitions in the aviation sector was a testament to “market behavior”. The mergers that had happened were in the best interest of the industry as a whole. (He failed to recognize, however, that most of China’s private startup airlines were acquired by state-owned airlines.) And anyway, he said, because the airlines are publicly listed, they have diversified ownership. (In other words, people were welcome to buy minority positions in publicly traded shares -- an issue I also addressed in a previous post.)
Regardless of whether people believe in the existence of guo jin min tui, the debate has served to highlight the question of its existence as an issue. The news spokesperson of the CPPCC had no choice but to face this issue when asked about it at a press conference. His response was a curt denial: “guo jin min tui does not exist in China.”
At the NPC meetings that took place last month, several local government officials were asked by journalists about the phenomenon of guo jin min tui. The governor of Shanxi Province responded to a question about nationalization of coal mines in his province with prepared statistics: the ratio of state-owned to private to mixed ownership mines in Shanxi is 2:3:5. (He apparently did not address the trend.)
(The Shanxi Governor might have also mentioned the abysmal safety record of Shanxi’s mines and that government control was considered the last straw at an attempt to reign in safety violations that have lead to thousands of needless deaths in recent years.)
The Mayor of Chongqing said that guo jin min tui is a "false concept. During the financial crisis, the government provided funds to...help enterprises during their difficulties. This is not guo jin min tui; this is a rescue. (People who are now calling our rescue) during the financial crisis guo jin min tui are Monday morning quarterbacks (事后诸葛亮).”
Also during the NPC, SASAC, the state shareholder of 127 of China’s largest central state-owned enterprises, weighed in on the issue by prominently posting on its website articles with titles such as “Analysis: Is guo jin min tui true or false?”, “Mergers and acquisitions (by SOEs) are qiang jin ruo tui (strong enter, weak withdraw) not guo jin min tui”, and “The Falsehood of SOE Monopoly Theory”.
(I found these articles on the SASAC website, and while I only took the time to skim them, what I did not see were the typically shrill name-calling and denunciations to which the state has resorted in the past. Rather, SASAC lays out a reasoned defense for the existence of a “state-led socialist market economy with Chinese characteristics” and it also addresses, point by point, every one of the arguments made by those who do believe in the reality of guo jin min tui. Whether one buys the logic or reasoning employed by either side, it is refreshing to see such a vigorous and well-mannered debate taking place regarding this issue.)
While the article does not really answer the question, it does a surprisingly good job of balancing views from both sides of the argument – for a Party-owned publication, that is. Those who would read to the end of this fairly long article would probably still find that the article’s sentiment seems to slightly favor the arguments of those who do not believe in the existence of this phenomenon. At least that is the view of this non-native speaker of Chinese.
According to a story in today's Economic Observer Online, China's SASAC (国资委) is trying to shake things up a little.
Currently, only the Finance Ministry (财政部)has the authority to compile public budgets in China. SASAC's only role when it comes to money is to collect dividends from the SOEs that it controls and hand them off to the Finance Ministry.
A few years ago, when SASAC's role of "dividend handoff" was established, it followed a bitter battle between SASAC and the Finance Ministry for control of these monies. SASAC's reasoning was that, as controlling shareholder of these SOEs, it should naturally control the dispensation of dividends to which it is entitled. In the end, the Finance Ministry was simply too powerful, and managed to relegate SASAC to its handoff role. Though it controls the shares of China's largest and most important SOEs, SASAC has no source of revenue and must depend on the Finance Ministry for its own budget.
Now SASAC is at it again. They have apparently been circulating a draft resolution among local government SASACs that would give SASAC the authority to independently draw up the budget for central state-owned enterprises (独立编制央企预算). This is not an inconsequential sum. In 2008, central SOEs submitted over 500 billion yuan ($73.5 billion) in dividends to the central government.
A Finance Ministry official who was asked for comment expressed his surprise that such an action was being considered. Apparently SASAC circulated a draft in the Finance Ministry last week, but the draft "on the whole, had no major problems" -- the implication being that it contained no such provision for SASAC to take over budget preparation for the SOEs.
Central SASAC is not just pulling this idea out of the air. Apparently some local SASACs have been doing this already. Shenzhen's SASAC has, since 1995, controlled the budgets of local SOEs, and only recently has the local finance department even been invited to take part in the budgeting process for SOEs.
This story illustrates a couple of interesting aspects about governance in China. One is the constant battle over resources that takes place at the ministerial level. Money is power, and China is no different from any other country whose various departments fight over resources. The other is the variety of policies being implemented by local governments. Foreign observers so often talk of China as if it is a monolith, but this story illustrates that, when you open the box, there are a lot of moving parts, some of which don't rub each other very well.
Only time will tell whether SASAC is successful in its attempt to increase its span of control. One thing we can be sure of is that the Finance Ministry will not let this happen without a fight -- a fight they will probably win.
This one is kind of like kissing your sister, but it qualifies as a merger nonetheless.
Hafei Auto and Changhe Auto are both owned by AVIC (Aviation Industry Corp. of China), which is, in turn, owned by Central SASAC. AVIC, which also owns Harbin Dongan Auto Engine Company, has recently announced the creation of a new umbrella entity which will combine all three of these automobile-related companies. According to the 21st Century Business Herald, the new company, China Aviation Industry Automobile Corporation (中国航空工业汽车有限公司) officially began operation last Thursday (March 12) in Beijing.
I know I need to update this chart with 2008 numbers, and I will at some point, but even with 2007 numbers it still helps to illustrate the current market share landscape of China's auto industry.
Recall if you will that China's State Council designated a "Big 4" and "Small 4" among China's top auto producers. The Big 4, SAIC, FAW, Dongfeng and Changan will be allowed to pursue nationwide acquisitions. The Small 4, Beijing, Guangzhou, Chery and China HDT will be allowed to pursue regional acquisitions.
Among the remaining firms on this list are private automakers Geely, Great Wall and BYD, and state-owned automakers Brilliance, Hafei, Jianghuai and Changhe.
The private automakers will presumably be left to fend for themselves since, theoretically, the government has no say in their existence. That remains to be seen, of course, and is an interesting topic that I shall set aside for a future post.
Among the remaining state-owned firms, Jianghuai has already been mentioned as a possible partner for Chery since both reside in Anhui Province. (And since this previous post, I have also discovered that, though Jianghuai is owned by the provincial government and Chery is owned by a city government, both were started by Anhui's provincial government.)
This leaves only Brilliance without as yet any rumor of a potential suitor.
So what is AVIC hoping to accomplish by combining its auto entities into a single company?
AVIC is pushing these companies closer together to improve efficiency and profitability. The plans are to "coordinate on R&D, purchasing and sales platforms". They want to avoid competing in the same segments, and they also want to move toward using many of the same parts. There is also the requisite vow to "take the lead in development of low-emission and alternative energy vehicles" that no Chinese auto company can afford to leave out of any press release nowadays.
Given its priorities in aviation (such as building airliners to compete with those of Boeing and Airbus) does AVIC really want to remain in the automobile business? This is hard to answer, and at the moment AVIC has given no public indication that it wishes to exit the auto business. However, even if AVIC were keen on keeping its auto businesses, the point has recently been rendered moot by the government's "Big 4, Small 4" paradigm.
If I were to hazard a guess (and I do so haphazardly) it is that AVIC is grooming its auto businesses for a sale to one of the larger players. Perhaps AVIC believes that, by creating a much larger, and presumably more profitable, automobile company, it is less likely to come under pressure to sell its smaller Hafei or Changhe companies to smaller players for smaller money.
An anonymous SASAC official has revealed to the 21st Century Business Herald that SASAC is preparing to establish a new state assets investment company along the same lines as their existing Zhongguo Chengtong Investment Group.
Early indications are that this new, as yet unnamed, investment company would buy and manage a handful of the current 141 state-owned enterprises under central SASAC. A SASAC official has indicated that this new company would most likely take over some of the smaller central SOEs, thereby decreasing the number of SOEs that are directly owned by SASAC.
The new investment company would be funded by more than 30 billion RMB that is expected to come partially from the capital budget, and partially from among the assets of the SOEs that it buys.
Based on this revelation, we can only assume that the small SOEs that would be bought by this new company must be sitting on valuable assets that are not essential to their operations. That being the case, this new company would be pulling a "Carl Icahn" (and doing the Chinese people a favor) by squeezing inefficiently allocated capital out of these SOEs -- presumably to be redeployed toward more efficient purposes (although that assumption may be a bit of a stretch).
What else might this accomplish for SASAC?
They would essentially be doing what any good manager would want to do: reduce the number of direct reports. When SASAC was established in 2003, it directly owned 196 SOEs (along with their thousands of subsidiaries). That number has now dwindled to 141 (along with their thousands of subsidiaries), but that doesn't necessarily mean that the overall size of SASAC's empire has decreased. Indeed it is now bigger than ever in terms of both assets and revenues.
The goal really isn't to have less revenue, or even less cost. (This is evident in the way that aggregate financial results of SOEs are reported. Notice that after every month-, quarter- and year-end, figures are compared to the same period in the previous year without any adjustment for changes in the number of organizations reporting to Central SASAC.) This is because very few of those organizations actually go away; they are merely subordinated to other organizations under SASAC.
This move to consolidate some of the smaller SOEs under a new investment company will not actually reduce the size of the organization; it will just make the boss' life easier. And if the new company's management are competent, it may increase SASAC's returns as well.
Today's SCMP has an interview with Liu Shaoyong, Chairman of China Eastern Airlines, the weakest among the "Big 3" central state-owned airlines. The 51-year old Liu is a former pilot and former head of China Southern Airlines, another of the "Big 3".
Some readers may remember that, five years ago, China Southern was loaded with debt and in desperate straits. Liu is credited with taking the helm then, and turning things around in two years' time. A similar feat is now expected of him at China Eastern.
Unfortunately for Liu, the bull market that drove demand for air travel as he worked his magic on China Southern has long since ended. He's performing without a net this time.
If I have any regular readers, I'm sure you have recognized by now my particular obsession with business consolidations in China. The China Eastern story presents an interesting case as highlighted in SCMP's interview with Liu Shaoyong:
Q: You have said that a merger between Shanghai Air and China Eastern would be a good thing. Is it on your agenda as one of your aims?
A: It is more complicated than it seems. China Eastern is owned by the central government, while Shanghai Airlines is owned by the Shanghai municipal government. There are no talks between the two companies. However, I do not know whether government officials have entered talks. I am not at liberty to discuss things that involve the government level.
One of the issues with which I have been fascinated is how and why mergers take place in China. Who initiates discussions? Who carries out the negotiations? Who has more influence, firms or governments?
In this instance, assuming that Liu is speaking truthfully, it would appear that Liu expects discussions to be initiated by the relevant levels of government, and that he may or may not be involved once discussions are initiated.
Presumably the companies themselves would eventually become involved so that a proper valuation of the acquiree can be reached, but that may be assuming too much. The story on last summer's consolidation in the telecom industry was that the details were arranged in high level government/Party discussions, and the companies were only notified after the decision had been made.
It is also quite likely that who the respective owners of these airlines are would determine how discussions begin. If both airlines were centrally-owned, then Li Rongrong, chief of Central SASAC, could probably wave his hand and make a merger happen. Since one of the owners is the Shanghai Government (represented by the local SASAC which reports, not to Beijing, but to the local govt), a lengthy negotiation is likely to take place.
Despite its authoritarian reputation, the government in Bejing does not always get its way. And while it may be able to force, say, the government of Sichuan Province to sell its provincial airline to Air China (as it did a few years back), Shanghai's government tends to carry more negotiating heft.
Despite Liu's denial, the SCMP interviewer presses him on the rationale for a potential merger anyway:
Q: State-owned enterprises cannot implement layoffs, but the benefits of mergers and acquisitions are mainly derived from reducing staff. So what would be the real benefit of a consolidation between Shanghai Air and China Eastern, if any?
A: This is "socialism with Chinese characteristics". Chinese enterprises are operating in a tougher environment than other companies in the world. Companies in other parts of the world can either sack people or resort to bankruptcy protection when they are not doing well. Airlines can cancel or delay aircraft where necessary. But this is not applicable in China. We solve problems by growing bigger and lowering unit costs. We aim at making profit by increasing revenue.
Q: Analysts suggest that merging two loss-making companies may not work? Do you agree?
A: Generally speaking, when a company reaches an optimal scale, all the benefits from economies of scale will come along, such as cost-effectiveness.
While profit is a good thing, and keeping people employed is even better, ultimately, the leaders of SOEs gain promotion by expanding their empires. While I have yet to see any empirical evidence that this is true across the board, everyone with whom I have discussed this issue -- and this includes many knowledgeable people both inside and outside of China -- seems certain that organizational size is among the most important factors for a leader's career.
Liu will probably not be successful in turning around China Eastern in the near term. The economic downturn will give him a perfect excuse for not succeeding, and anyway, the government has no problem pumping more money into big SOEs in order to keep them afloat. Hard budget constraints rule in the new China...until they don't.
Securities Daily reports (from Econ. Observer Online) that, beginning with 2009, China's Central State-Owned Enterprises (SOEs) will publicize their annual reports. This is big news!
Until now, central SOE results have been reported in aggregate, but the only enterprise level numbers we could see were those we could glean from the annual reports of the listed entities owned by SOEs. Now we will apparently be able to see the annual reports of all 141 group companies owned by central SASAC.
One unanswered question: who will audit these rat's nests of confusing cross-shareholdings, and how reliable will the numbers be?
The State Council and SASAC have announced a "breakthrough" in drawing boundaries between the Party and Central SOE Boards of Directors that will reportedly result in greater "scope of authority and independence" for enterprise boards.
According to this article in the Economic Observer, for the past four years, SASAC has been conducting a "trial" of sorts with boards of directors -- which seems surprising since China's Company Law (公司法) already prescribes the purpose and functions of the Board of Directors, Supervisory Board and the Shareholders Meeting.
Perhaps the need for the "trial" has been that things weren't working out as planned. According to an anonymous outside board member interviewed for the article, "the gap between the trial board of directors and a 'real board of directors' is huge." Boards simply do not have the authority to "hire and fire, conduct performance evaluations, and set compensation" as is prescribed under the company law.
However, according to a document released late last year, 《关于董事会试点中央企业董事会选聘高级管理人员工作的指导意见》, the power to appoint each firm's general manager, deputy general manager, chief accountant and board secretary will now fall to the board of directors.
Until now, this duty was handled in combination by SASAC and the Party's Organization Department (i.e. Personnel Department). From this point, the only apparent involvement of the Party will be when the Board of Directors "reports" such appointments to the Party Committee of SASAC.
The document does acknowledge that, while the company law has required that these powers be vested with the Board of Directors in the past, this has not been the case, and it will change. In other words, "we've been breaking the law, but we're gonna stop now".
Once upon a time (ca. 2000) a term was popularized in China: 国退民进, which can be roughly translated as "the government withdraws, the people enter". Foreigners with Chinese-English dictionaries rejoiced at the apparent meaning of this important phrase: the government was preparing to step aside and let the private sector take over.
Over the years, we have certainly seen evidence of 国退民进 at work, but occasionally we see quite the opposite.
A securities brokerage located in Shanghai's Pudong District, Aijian Securities, was originally majority controlled by Huiyin Investment, itself a privately-held firm. Aijian had been planning to undertake an equity restructuring and an injection of additional capital that would have left Huiyin as the controlling shareholder, or so they thought.
Once all was said and done, Aijian Securities found that its controlling shareholder was no longer Huiyin. Its new ultimate controlling shareholder was none other than the Pudong District SASAC -- in other words, the State.
How could this have happened?
Apparently the Shanghai City Government had this intention in mind all along.
One of Aijian Securities' original shareholders was Shanghai Aijian Corporation (hereafter, Shanghai AJ), a listed firm (SH600643) whose ultimate controlling shareholder is the City of Shanghai. While Shanghai AJ originally either directly or indirectly controlled 20.4% of Aijian Securities, it was not the controlling shareholder. As mentioned above, Huiyin Investment, a private firm, originally controlled 54% of Aijian Securities.
According to the Economic Observer, the Party Secretary of one of Shanghai's districts, Chen Zhenhong, was transferred to the post of Vice-Chairman of Shanghai AJ in 2006. While there, Chen organized and arranged the restructuring of Aijian Securities both to draw in private capital and to land himself in the position of Chairman of the Board of Aijian Securities.
Also around 2006, Aijian Securities' controlling shareholder, Huiyin began to experience financial difficulties, and as a result Aijian's balance sheet became increasingly more leveraged with debt that was convertible into equity. While it is not known for certain who the holder of such convertible debt was, we can surmise that it was Shanghai AJ since Shanghai AJ (which, don't forget, is controlled by the City of Shanghai) became the majority owner of Aijian Securities after the restructuring.
In a clear case of 国进民退 (the government enters, the people withdraw) Aijian Securities is now a part of the Pudong District Government's plan to ensure that Shanghai (not Tianjin, not Beijing, not Hong Kong) becomes the Financial Capital of Greater China. This plan also includes increased stakes in insurance companies, banks and fund management firms.
When I consulted a reference guide* to determine the origin of 国退民进, I discovered that its very invention was surrounded with weasel words that resulted in a concept so broad one could drive a maglev train through it. Like the phrase "with Chinese characteristics" it was intended to mean whatever the leaders want it to mean.No one is suggesting that there was any kind of conspiracy or underhanded dealing that resulted in the nationalization of Aijian Securities, merely that, when governments in China set their minds to a task, there is little that stands in their way, least of all meaningless catchphrases.
__________________
* 章迪诚，著，中国国有企业改革编年史，（北京：中国工人出版社，2006） pp.556-7.
Having fielded a handful of emails on this topic (covered in a previous post), and having discussed it with a Chinese friend who is knowledgeable on the topic, I think a few more details are in order.
Again, the central topic is that SASAC, the "owner" of the Central Government's enterprises, is preparing to release a list of SOE subsidiaries in which it intends to consolidate its ownership indefinitely. These subsidiaries are all two to three levels removed from the SOEs that are directly owned by SASAC, and they are all in what are considered to be the country's seven most important industries: military, electricity generation and transmission, petroleum and petrochemical, telecommunications, coal, civil aviation and shipping.
The rough process by which these subsidiaries would make it onto the list is, first of all, to be owned by one of approximately 40 "mother enterprises" in these seven industries that are directly owned by the Central Government. Then, each of these subsidiaries whose assets and/or profits constitute more than 60 percent of the mother enterprise's assets and/or profits will be singled out for further scrutiny.
In other words, some of these "mother enterprises" are in fact no more than holding companies or shell companies whose sole purpose is to own one or more subsidiaries where the actual operations take place. The purpose behind SASAC's move is to strengthen its hold over, not just the holding companies, but also the subsidiaries where the money is made (or lost).
So what will SASAC do with these subsidiaries? There are a number of realistic possibilities:
- They could be merged into the mother enterprises.
- Those that have already been listed may be de-listed. (In other words, the State may choose to become a 100% shareholder.)
- The state may simply to decide to increase its ownership percentage in these subs.
- Also, even subsidiaries that constitute less than the 60 percent threshold may be merged with other subsidiaries to create a larger entity that would then be absorbed by the "mother enterprise".
What will SASAC do with the subsidiaries it does not want?
- As alluded to above, some may be merged into the subsidiaries that the State does want.
- Or, according to one SASAC insider, subs without prospects will be sold: "没有前途的企业则退股".
So does this mean that private firms are not welcome in those seven key industries?
- Strangely enough, no. But it does mean that private firms in those industries will begin to find themselves completely overwhelmed by SOEs that are expected by the state to dominate the industry. Only those small firms that are willing to confine themselves to a niche will continue to exist outside of state control.
The article to which I refer also mentions a further set of "pillar" industries in which the State, while not intending to exercise direct control, will still attempt to strengthen its controlling position. These are machine tools, autos, electronic information, construction, steel, and non-ferrous metals.
According to a knowledgeable friend, even private firms in these "second-tier" industries will continually find themselves at a disadvantage vis-a-vis their state-owned counterparts.
A few takeaways here:
- First, the 40 central state-owned firms (and their subsidiaries) that fall among the seven key industries account for 79 percent of SASAC's profits, so this is not an insignificant chunk of assets over which the State is increasing its control. This is a clear continuation of the "zhua da, fang xiao" policy begun in 1995.
- Second, I don't think this bodes well for the shareholders of listed firms in the seven key industries, and maybe not in the six pillar industries either.
- Third, (and this is good news, I think) it still leaves a lot of ground from which the state has all but announced that it intends to withdraw.
A SASAC insider has reportedly told Jingji Guancha that, sometime during 2009, SASAC will publish a list of subsidiary enterprises that must indefinitely remain in the hands of central SOEs. (Jingji Guancha Wang, 19 Jan 2009)
Though the Central Government (via SASAC) as of today owns only 141 enterprises, many of the important operating assets of these enterprises are buried in subsidiaries two or three levels down. (These 141 enterprises directly owned by the Central Government control some 22,000 subsidiaries.*) In essence, the Central Government has decided (or is in the process of deciding) that there are subsidiaries in certain industries that they have no intention of selling in the foreseeable future.
The industries most likely to be covered by this "list" were actually named in a document released by SASAC in December of 2006: military, electricity generation and transmission, petroleum and petrochemical, telecommunications, coal, civil aviation and shipping.
Some analysts see this as an attempt by SASAC to extend the depth of its control from the "mother companies" (母企业) down into the subsidiaries (子企业). However, it is also possible that this list will remove a lot of suspense as to what the state intends to control in perpetuity.
What isn't clear at this point is what is to be done with the subsidiaries that don't make the list. Will they be privatized, or absorbed into those firms that do make the cut?
* Update/correction: While the Central Government owns enterprises that control 22,582 subsidiaries, SASAC's 141 SOEs only control 16,373 of that number. (2007 SASAC Yearbook, p. 585)
Due to increasing discoveries of losses on derivative instruments (金融衍生品) among state-owned enterprises (SOEs), SASAC and the State Audit Administration are teaming up to conduct an investigation of the financial derivatives activities of large SOEs. (Caijing 14 Jan 2009)- China COSCO lost 4 billion RMB on a Freight Forward Agreement.
- China Eastern Airlines lost 6.2 billion RMB on fuel futures.
- China Air International lost 3.1 billion RMB on fuel futures.
- China Railway lost 1.9 billion RMB on currency futures.
Suddenly there is concern that SOEs are using derivatives for purposes other than to mitigate an existing risk. Auditors will be looking for:- the extent of derivatives losses on SOE books
- the impact of derivatives losses on last year's profits
- the existence of wrongdoing and whether procedures were properly followed.
There was no word on whether those whose derivatives bets paid off would be rewarded.
(And they really mean it this time.)
SASAC's Assistant Director in charge of performance assessment announced that SASAC is preparing to look harder at SOE performance beginning in 2010. They had been planning to implement tougher measures in 2009, but apparently the financial crisis, any number of natural disasters, the Olympics (feel free to throw in any other excuse you can think of) have necessitated a relaxation of the rules.
But they really are planning to judge SOEs based on "economic value added" (EVA) starting next year. Honest, they really are serious this time.
All cynicism aside, EVA is a pretty rigorous financial calculation based on the idea that a business must cover both its operating costs and its capital costs. It is calculated by subtracting the opportunity cost of capital from a firm's net operating profit after tax.
Part of the reason for choosing this calculation is a concern that SOEs have traditionally engaged in unproductive investment without regard to the cost of capital. According to aggregate statistics from China's Statistical Yearbook, there is a pretty significant gap between private and state-owned industrial firms in terms of asset productivity. (These stats compare only state-owned enterprises with private enterprises. These stats for state-controlled enterprises were not available.)
Part of the reason for this is that a lot of these SOEs are probably still saddled with old, unproductive assets. Another reason is that the leaders of these SOEs have often been motivated, not by profitability, but by size. Traditionally, anything they could do to make their respective enterprises larger before moving on to their next political appointment was considered to be a good thing.
SASAC has been expressing its concern about this over-investment for years, and according to the article, they plan to establish a threshold above which investment must get approval from SASAC. Furthermore, the EVA measure, which some enterprises have reportedly adopted voluntarily, will become a part of the annual evaluation.
However, I can imagine a few difficulties as SASAC attempts to implement these measures. I cannot imagine how they will begin to calculate the cost of capital for these firms given that SASAC's 142 SOEs collectively control about 22,000 subsidiaries (see SASAC 2007 Annual Yearbook in your local university East Asian Library)． SASAC lacks the small army necessary to oversee this process.
Also, they will need to decide on some sort of benchmarks against which to measure performance. But against what kind of firm would you benchmark a sprawling state-owned industrial firm? Other state-owned firms?
Finally, SASAC will need to put some teeth in its rules and mete out punishment if it expects these standards to be followed. However, I'm not certain whether SASAC even has the power to enforce such standards. The leaders of these SOEs, while some may be recommended by SASAC, are generally appointed by the Party with approvals from other relevant organizations.
It sounds like a nice idea though.
I saw a story in today's South China Morning Post saying that Jiangsu Shagang, China's largest private steelmaker (and second largest overall, I think ... behind Baogang) is looking for an outside investor or possibly an overseas listing. (I won't bother posting a link to SCMP stories since they disappear after about a week.)
Anyway, this reminded me of a conversation I had last month with a journalist friend of mine who is based in Bejing. We were discussing the apparent trend away from privatization, and the consolidation of state ownership over China's most important industries. We pretty much agreed that Li Rongrong, head of SASAC, rather than gradually privatizing SASAC assets, appears to be moving full steam ahead with plans for long-term state ownership.
Not long after this conversation, I came across this article in the 21st Century Business Herald that seemed at first to refute what my friend and I had discussed.
According to the story, the aforementioned Jiangsu Shagang (hereafter "Shagang") are apparently buying the shares of Zhangtong Gongsi, a listed firm (currently "ST" status*) whose controlling stockholder is Gaoxin Investment Group (中国高新投资集团公司), a Central SASAC wholly-owned enterprise (中国高新为国务院国有资产监督管理委员会下属的国有独资企业). (Those interested may search for that Chinese phrase in the pdf file on this page to see the explanation of controlling ownership.)
There are a couple of interesting observations here. First, Shagang, because it is private, has been struggling to raise capital until now, but by buying Zhangtong (its "ST" status notwithstanding) it now gets a back-door listing. In other words, rather than going through the major bureaucratic hassle of filing for its own listing (and risk getting shot down), Shagang gets a listing simply by buying another listed company and injecting its assets. Frankly, I'm surprised that the authorities are allowing a private firm to get listed at this time, especially through a back-door listing.
Second, and on the other hand, I guess I'm not surprised that an ST company owned by a Central SASAC firm is being cut loose since Li Rongrong has made it clear numerous times before that SASAC only intends to keep firms that are among the top three in their respective industries. The general managers of these SASAC firms are probably under pressure to dump under-performing assets -- even if that means giving them to the private sector. On yet another hand, this may, in a roundabout way, support the trend away from privatization my journalist friend and I had discussed, in that only the junk assets are being privatized, which ultimately results in a stronger public sector and a weaker private sector.
*Note: "ST" stands for "special treatment". It is appended to the ticker symbols for all Chinese firms that have lost money for two or more years in a row, and/or that have negative equity. It's sort of a warning to unsophisticated investors that this company may not be a good investment.
