After years spent working to reform its super-sized but lackluster state-owned enterprises (SOEs), China has seen positive results: banks, steel makers and other industrial conglomerates now stand among the world’s most profitable companies.
With the domestic economy emerging strongly from the global financial crisis, Beijing sees an opportunity to accelerate SOE reform, creating firms that have a competitive edge on the international stage.
The latest news is that China is close to launching an independent agency with a mandate to restructure and consolidate SOEs that require government assistance to improve their businesses and balance sheets. A draft proposal compiled by the State-owned Assets Supervision and Administration Commission and the Ministry of Finance, has been submitted to the State Council and will likely be approved in the second quarter.
The new entity, dubbed as "CIC 2.0" in reference to China Investment Corp, the country’s sovereign wealth fund, will report to SASAC and have an initial registered capital of about US$6.4 billion. Unlike CIC, which manages the country’s foreign-exchange reserves for overseas investment, CIC 2.0 will focus on consolidating domestic companies and serve as a manager of state assets.
A better comparative would be Central Huijin, an investment agency set up by the central bank in late 2003 to bail out China’s major state-owned lenders ahead of their stock market listings. Central Huijin, which retains large stakes in Industrial and Commercial Bank of China, Bank of China and China Construction Bank, is now owned by CIC.
Given that banking sector reform was largely touted as a success, it’s no surprise that the government wants to replicate the approach in other industries.
CIC 2.0 will likely take over SASAC’s shares in certain SOEs, promote mergers and acquisitions, inject capital into reformed enterprises, and eventually usher the stronger ones towards initial public offerings (IPOs). In this way it will help SASAC meet its pledge to reduce the number of SOEs under its purview from 127 to between 80 and 100 by the end of this year.
Packing a raft of smaller SOEs into one holding group is definitely a shortcut for SASAC to meet its consolidation deadline. But the challenge lies in how to rescue these laggards in an effective and efficient way.
In assuming control of SOEs, CIC 2.0 will inherit a legacy of problems, including bureaucratic organizational structures that will need be unwound and managers at all levels who are likely to resist change, whether it involves cutting budgets or adding to workloads. If media reports are correct in saying that CIC 2.0 will have to take over 20 to 30 SOEs in a one-off manner, it simply won’t have enough resources – people or capital – to fix them all.
What’s more, consolidating smaller SOEs may only be the initial test for CIC 2.0. The Chinese authorities expect the agency ultimately to play a bigger role in helping larger state enterprises in key industries revamp their shareholding structures. This could be part of a broader plan to transform these behemoths into truly commercially driven entities with a presence in the capital markets.
Success for CIC 2.0, therefore, will hinge on whether it can managing the sometimes competing interests of different state agencies, and how fast it turn to the market to dispose of state assets.
For foreign investors, including leading players in various industrial sectors as well as buyout funds, CIC 2.0 does not represent good news. Dealmakers have always regarded industrial consolidation in China as a golden opportunity, but they complain about the difficulty of buying stakes in state firms. The creation of a government-backed consolidator is a further obstacle between them and big equity-purchase deals with SOEs, at least temporarily.
The Chinese government placed a premium on foreign capital and expertise when reforming the banks, but times are changing. We are unlikely to see a repeat of the highly lucrative pre-IPO deals secured by the likes of Goldman Sachs and Bank of America. It could be even worse for foreign private equity managers, who are often regarded as sources of now unwanted capital as opposed to sources of management expertise that still has a use.
The opportunities may not have evaporated completely. As CIC 2.0 gets involved in restructuring of non-pivotal SOEs, it will likely be in a position to sell stakes to outside investors. As was seen to be the case with the banks, having a well-recognized foreign face as an investor builds confidence ahead of an IPO, especially in stock markets abroad.
CIC 2.0 will be kept away from companies involved in military manufacturing, power, oil, telecommunications, coal and aviation as these areas are considered vital in national economy. But there is still a swathe of industries – automobiles, construction, steel, electronics, to name but a few – that face overcapacity and excessive investment, and are therefore expected to bear the brunt of the revamp.
Just don’t expect a quick fix.