Changing Media, Changing China
Oxford UniversityPress, 2011
US$19.95 

At first glance, Changing Media, Changing China is cut straight out of the standard China scholar anthology mold. Edited by Susan Shirk, well-known political scientist and former US diplomat, it adopts the popular academic naming convention of One Headline, Single Comma and abides by the generous definition of timeliness common in the ivory tower.

Can one take a book about Chinese media seriously if it doesn’t discuss the rise of Weibo or Beijing’s reaction to the Arab Spring? Is it worth examining graphs of newspaper print runs dated 1993-2004? What to make of an essay by Caijing magazine founder Hu Shuli about her publication’s hard-hitting reportage and its influence on the political landscape? Hu left Caijing in 2009. Oh, to be on the tenure track. 

Two masters

Qian Dang and David Bandurski lead off the volume with an essay on the effect President Hu Jintao’s “Three Closenesses” policy (that media coverage should be “closer to reality, to people and to life”) has had on the government’s relationship with the press. “The media now [has] two masters, the party and the public,” they argue.

While the government still has powerful leverage over individuals within the media, the incentive structure has changed for the institution. Beijing can fire this editor or that one, but the public – and advertisers – now have much stronger influence over what gets covered, and how it gets covered. Editors and TV producers are rewarded with ratings and the ad revenues that follow them when they diverge from the monotonous party line, and they are increasingly able to get away with it.

Bandurski and Qian’s description of the general incentive system, while wide in scope, puts the media reforms in their proper historical context. It also helps the reader understand the more focused essays that follow, which explore this dynamic tension between party and media as expressed on different platforms, including the financial media, the military press, television, and of course the internet.

Refreshingly, the collection generally avoids a simplistic portrait of the commercial Chinese press as a heroic resister against autocratic censors. Several essays point out areas where private media exerts negative influence. 

Rooster or the egg

Benjamin Liebman, for example, argues that the popular press and local television stations frequently push the government to take actions that are popular with agitators but ignore due legal process. For every case in which the media exposes official malfeasance, there is another in which it serves as the voice of mob justice.

On the business front, in some cases the financial press has been bribed or suborned by companies who use pliant reporters to slime competitors. And then of course there is the rising wave of tabloid-style sensationalism – a model already familiar in the West for its advancement of prurient and commercial interests at the expense of everything else.

There are international ramifications to media liberalization as well: Shirk argues in her concluding essay that Chinese nationalists’ influence in the press and online has the effect of pushing Beijing into being more confrontational than it wants to be.

The ultimate picture is one of competing and often incompatible demands. “Television today is like a double-gendered rooster,” writes Miao Di in an essay about broadcast journalism in China. “Propaganda departments want it to crow while finance departments want it to lay eggs.”

This is undoubtedly true of other platforms besides television, and the contradiction actually has three facets, not two. The government relies on the media to keep the leadership apprised of the situation on the ground. The Party wants the media to persuade the population to accept its dominance. And the Chinese economy needs a vibrant, profitable media industry that serves as a credible source of business, social and political information and provides a platform for Chinese brands to promote themselves.

As Changing Media, Changing China shows, Chinese journalists, web sites and TV stations can sometimes serve two of the three purposes at the same time, but rarely – if ever – can they simultaneously serve all three. 

Pete Sweeney

China’s local governments are facing an unpleasant liquidity crunch. Subjected to many an unfunded mandate to improve infrastructure and social services, and at the same time prone to relentless banqueting, the outflow of cash has been substantial.

This has become the banking system’s problem. Local governments have borrowed heavily to cover their stimulus obligations, and the banks have moved some of these loans off their balance sheets by selling them to trust companies. In turn, trusts have bundled and securitized the loans – obscuring the actual condition of outstanding loans.

There has been much attention paid to exploring alternatives for local governments to earn revenues, most notably pilot projects experimenting with property taxes that would relieve fiscal dependence on land sales. But others are looking at the borrowing side. What if, instead of borrowing from state banks, China’s local governments issued bonds to pay for special projects?

The advantages of such a policy are myriad. Bonds for popular projects could be sold to private investors, and would provide a flexible alternative source of credit for local governments. They would help develop the national bond market and provide a welcome investment alternative to property and stocks. Such bonds could ultimately be sold abroad to foreign firms, giving foreign investors exposure to the renminbi and deepening the internationalization of China’s financial system.

But for now the suggestion remains entirely hypothetical. The central government can still restructure local government debt. There is no pressing need to facilitate new borrowing through bonds, and the need to slow unnecessary spending is greater than the need for financial innovation. 

Second, Beijing has already jailed officials for insider trading related to central government bonds, and a prior experiment with municipal debt in the 1990s resulted in a saturnalia of local graft. This concern is particularly acute given the immaturity of the domestic risk assessment and ratings industry.

The final issue is the legalization process itself. The outgoing set of leaders cannot feasibly make such a fundamental change to China’s budget law on their way out the door; they’ll leave it to the next generation to consider in 2012. Municipal bonds are coming, but they remain several years over the horizon.

“This is the Shanxi red sea apple. It only grows in this small area. It is the future of the beverage industry.”

It was 2008, and my first week on the job doing financial consulting for Chinese companies seeking foreign investors. I had been flown to Hohhot, the capital of Inner Mongolia, and then driven four hours through coal country to meet with a company on the Yellow River that grew crab apples, crushed them, added equal parts sugar, canned the stuff and marketed it as a branded health drink. It tasted as one would expect crab apple juice to taste. They wanted to do a reverse takeover (RTO).

For me, that taste of juice toasted the beginning of two years touring China, visiting factories churning out concrete, plastics, chemicals, shoes, agriculture, aquaculture, auto parts and pharmaceuticals. I met with managers at internet gaming companies, mines, telecom operators, discount card vendors, logistics operators, high stakes gambling organizers and even an operation that extracted protein from dead flies and put it into gel caps.

For lack of better options

All were interested in reverse mergers on the over-the-counter bulletin boards, with the aim of raising growth capital and eventually up-listing to NASDAQ. In the end, I worked with about a dozen companies that at some point or another executed a reverse merger.

 As anyone reading this issue probably knows, the words “reverse merger” are Wall Street poison these days. They weren’t always that way, but still the natural question to ask is why any Chinese entrepreneur in their right mind, after spending years building a multimillion-dollar asset, would decide to merge it with a failing company traded over the counter in the US?

The simple answer is that there really wasn’t a better option for most Chinese enterprises looking for a listing, and there is tremendous political pressure from the top down to increase not only foreign direct investment but also the net number of listed Chinese companies. Often the motivation for a foreign listing has more to do with increasing the standing of local politicians than it does with raising capital.

Let’s take a step back for some macroeconomic perspective: As emerging markets have outperformed over the past 10 years, there has been huge demand from investors for China exposure. Likewise, on the Chinese side, there are tens of thousands of companies with material earnings and breakneck growth histories that need capital to fund their expansion.

However, due to the regulatory environment, renminbi capital controls, lack of investment banking resources, and cultural and language hurdles, it can be very difficult to match the demand with supply.

Furthermore, domestic IPOs on the mainland are not an option for most companies; they are notoriously hard to come by and require years of waiting even if one has the relationships needed to get on the list. Investment banks get paid as a percentage of capital raised, so most of them aren’t interested in underwriting an IPO abroad or in China that is looking to raise less than US$80 million.

Left behind

That leaves a huge segment of the middle market with limited options for raising money. For example, the current poster child of the Chinese telecommunications equipment industry, Huawei, was once so short on funding channels it was forced to borrow from loan sharks in Hong Kong at exhorbitant rates to maintain growth.

And then there is the issue of exit for investors. There are dozens of hedge funds and institutional investors interested in small- and medium-sized companies in China. There’s lots of talk about how an IPO is only an option, not a requirement, but in fact most investors still require a structure in which they are comfortable investing. This is usually a tradable equity.

All of these factors came together around the turn of the century, when Chinese reverse mergers grew legs and took off. Entrepreneurs got their money and a listing, and institutional investors got China stock at deep discount in a US-listed equity that fit the bill of their investment charter. Everybody won. While it may seem odd from the outside, when I worked with a Chinese steel products manufacturer with nearly US$20 million in earnings that merged with a bulletin-board-quoted company whose principal business was the ownership of a few vending machines in New Jersey strip clubs, it was par for the course at the time.

After the boom years leading up to 2010, Chinese reverse mergers have imploded in a most spectacular fashion.  It seems that anybody with an internet connection can take a China stock down 20% by posting a negative article on seekingalpha.com from the comfort of their grandmother’s basement.

See ya, sucker

Should anyone be surprised? Not really: Reverse-merger stock promoters, “shell guys” and penny stock pushers are a notoriously shady lot. Most of them probably never dreamed of promoting companies that actually made money before the Chinese RTO phenomenon.

But this crew nevertheless managed to do plenty of damage to what were, in many cases, legitimate Chinese firms with real products, satisfied customers and no clue what they were getting into. Many  were “orphaned” by their backers, bankers and advisors after the transaction and didn’t have the resources or wherewithal to effectively prevent or defend against a short attack.

Other companies are indeed committing some degree of fraud and deserve to be exposed. To be sure, some of the fraud I’ve encountered in China has been stunning. I once met with a CEO in central China who illegally sold millions of dollars in private stock in a fake company to the local police pension fund and needed to get the company on the bulletin board before they found out.

As we’re seeing lately, some of this fraud has weaseled its way onto US exchanges. That said, most of the exchange-listed, reverse-merged China assets on the market have at some point filed registration statements, meaning that they have withstood the same amount of diligence and scrutiny from the Securities and Exchange Commission (SEC) that a full-fledged IPO would receive.

Small fry

In the grand scheme of things, Chinese reverse mergers a
re probably getting far more attention from regulators than they deserve. Your average private placement by these companies is usually around US$10 million, and is made by professional institutional investors who ostensibly know what they’re doing. Valuations are rock bottom (low single-digit price-to-earnings multiples) indicating that fraud risk is already priced into the deals.

Compare this to Renren.com, which just closed a traditional IPO offering of more than US$700 million at an astronomically bloated price-to-earnings multiple of 500.

The company is backed by brand-name venture capital and bulge-bracket investment bankers. Prior to the offering, the company revised the number of users claimed in its registration statement down by nearly 30%. That’s an astounding oversight for a supposedly top-shelf deal. The SEC, rather than investigating reverse-merger fraud, should be looking at how to treat China-based US-listed equities as a whole, addressing problems with disclosure and cross-border audit standards.

Short-sellers as well appear to be blatantly manipulating the market with impunity, deliberately issuing misleading “research” reports to destroy shareholder value for their own profit. They are not subject to regulatory scrutiny.

There’s no place like Shanxi

Taking an honest assessment, many Chinese companies should never gone public in the US to begin with. China has a business environment where tax evasion, bribery and obfuscation are often, but not always, the necessary evils of being competitive. Being listed in the US brings a set of responsibilities including timely financial reporting, investor communications, Sarbanes-Oxley and Foreign Corrupt Practices Act compliance, which many Chinese management teams are completely unprepared for.

These days, if you have a Chinese crab apple farm, it’s probably best to stay at home.

A report issued by the United Nations Environmental Program (UNEP) says that China should serve as a test case for how to curb soaring consumption of natural resources, Reuters reported. The study measured consumption of a variety of popular raw materials from gold to sand used in construction and aggregated them all by weight: It found that humans currently use between 47 and 59 billion tons of natural resources a year, and will use 140 billion tons by 2050 if growth is not restricted. “China is, in many ways, the test case for the global economy,” the report said. It said the success or failure of Beijing’s attempts to reconcile economic growth with environmental preservation will be of “crucial significance” for other developing countries experiencing similar spikes in demand for natural resources as they emerge from poverty. The study suggested that natural resource consumption per capita should decline to between five and six tones per year by 2050. Per capita consumption in developed countries like the US, Canada and Australia is currently over 20 tons.

China Mass Media (CMM.NYSE) is essentially a middle man, reliant on a few key relationships: with state TV provider China Central Television, from which it buys advertising slots; and the clients it sells the slots to, including Samsung, McDonald’s and China Mobile.

China Mass Media generates more than 90% of its revenue from swaps of this ad space; the remainder comes from producing programs, CCTV public service announcements, for example.

In the past few years, China Mass Media’s net income has dropped off sharply. Meanwhile, competitors SinoMedia Holding (no relation to China Economic Review’s publisher) and Charm Communications posted fairly steady growth in net income since 2007 – excluding a downturn in 2009 during the financial crisis.

The cause of China Mass Media’s dwindling profits was once the company’s greatest strength: its relationship with media behemoth CCTV. China Mass Media’s CEO, Wang Shengchang, was previously employed at CCTV, and his personal contacts generate most of the company’s business. But these connections have become less vital as CCTV has systematized some of its ad business.

From 2008, for example, CCTV started selling China Mass Media ad slots in blocks at a fixed rate, rather than based on client demand. The company began recording the purchase of these slots as a cost of revenue, causing its annual profit to plunge.

In 2009, CCTV then switched to an auction-based sales system that left its former favorite China Mass Media scrambling to compete. The next year, China Mass Media was outbid for the 2010 New Year Gala program, the country’s most-viewed program, for which it had been the exclusive ad agency from 2004 to 2009. This single contract had previously accounted for almost 10% of its annual revenue.

China Mass Media has also seen an increase in prices for ad slots – in 2009, the media fees for CCTV4 programs rose by over 40%. However, intense competition among agencies means they are unable to pass on all of these costs to clients.

SinoMedia Holdings and Charm Communications were able to keep growing their profits in this new world order. So why not China Mass Media?

One major factor has been the company’s failure to diversify its business. Charm Communications has gained footholds into satellite TV, internet and outdoor advertising, while SinoMedia Holding recently announced an agreement to sell ad space for MediaCorp, Singapore’s largest media company.

China Mass Media benefits from a healthy balance sheet – it currently holds just over US$100 million in cash and short-term investments, with little or no debt. To boost revenues, the company should reconsolidate and diversify its business.