China prepares fresh round of state-orchestrated megamergers
Energy, heavy machinery and steel focus of drive to scale up state-owned enterprises
China is preparing a fresh round of megamergers between state-owned behemoths in the energy, heavy machinery and steel sectors, as hopes fade for a more fundamental overhaul of the state sector.
State-owned enterprises account for more than a third of total investment and receive almost 30 per cent of bank loans but generate less than a tenth of total gross domestic product, according to Gavekal-Dragonomics, a Beijing-based research provider.
In a landmark economic reform blueprint approved in late 2013, top Communist party leaders pledged to “raise corporate efficiency” at SOEs while also ensuring that they “undertake social responsibility”. Analysts say the inherent tension between these two goals has never been resolved.
Since then, government-orchestrated mergers have emerged as the primary focus of SOE reform, while progress has been slow in implementing other changes that could boost efficiency, including privatisation and increased competition.
“The ongoing wave of megamergers has both domestic and international aims,” says Wendy Leutert, a PhD candidate in government at Cornell University who is completing a dissertation on SOE reform. “At home, the Xi administration hopes mergers will enable state firms to co-ordinate excess capacity cuts and boost pricing power. Abroad, the goal is to increase national champions’ market share, eliminate price wars, and integrate upstream and downstream industries.”
The official Xinhua news agency reported last month that the government’s focus for SOE mergers is coal and electricity, heavy machinery and steel.
Coal producer Shenhua Group is reportedly in merger talks with China Guodian Corp, part of a broader effort to consolidate the power sector. If approved, the combined group would have $262bn in assets. In March, the listed arms of China National Nuclear Corp and China Nuclear Engineering & Construction Corp said their unlisted parent companies would merge, creating an $80bn group.
China National Machinery Industry Corp won approval last month to absorb textile machinery producer China Hi-Tech Group, a combination worth $52bn in assets. China National Machinery acquired another central government-owned machinery group, China National Erzhong, in 2013.
Following the tie-up of Shanghai Baosteel with Wuhan Iron & Steel last year, which created the world’s second-largest producer, local media is rife with rumours about the next steel merger.
Some experts believe the ultimate goal is for the enlarged Baosteel to form the core of a “southern steel” conglomerate, while Beijing-based Shougang Group will merge with other rivals to form “northern steel”.
“Some of the mergers are mostly about combining similar companies to generate scale and reduce competition. Others are intended to integrate upstream and downstream portions of the industry value chain,” says Li Jin, chief researcher with the China Enterprise Research Institute.
Mr Li also notes that some recent tie-ups are intended to prepare SOEs to win projects related to President Xi Jinping’s Belt and Road initiative, which is focused on infrastructure investment in developing companies. These mergers include the combination in late 2014 of the country’s two main train producers and last year’s merger between its two biggest shipping groups.
ChemChina and Sinochem are planning a merger next year, the Financial Times reported in May. Bankers say the deal is intended to boost ChemChina’s financial strength so it can successfully absorb Swiss agrochemicals group Syngenta.
Defenders of the government reject the claim that mergers are the only tool the leadership is willing to deploy.
“Mergers are just the most visible actions, so people say it’s the only thing happening. This is wrong,” says a recently retired executive at a large state group. “Mergers create the foundation. Once you have created the groups you want, then you can move on to other reforms.”
In fact, the mergers have been a key feature of SOE reform efforts for more than a decade. The central government owns 101 groups, down from 189 when Sasac was set up in 2003. Such continuity is why many critics doubt that mergers can address the root problems that have plagued SOEs for years.
They say the SOEs need to be subjected to more competition by reducing barriers to entry in sectors such as energy, telecommunications and heavy machinery that are largely closed to private firms. They also argue that SOEs’ preferential access to bank credit and the expectation of government bailouts make SOEs complacent about week profitability or even outright losses.
“Rather than allowing the market to enforce survival of the fittest, the government-guided mergers typically force stronger SOEs to absorb their weaker rivals,” says Yanmei Xie, an analyst at Gavekal Dragonomics.
Many experts say the goal of SOE reform has never been clearly defined. For some, the campaign means pushing state groups to act more like private companies. For others, it’s mostly about strengthening the Communist party’s grip on SOEs, in part by enforcing greater political discipline.
The latter approach seems to be winning out. In an article in a Communist party newspaper last month, Sasac chairman Xiao Yaqing emphasised the importance of SOEs as a tool for the government to guide the economy and achieve political objectives.
“We must resolutely resist ‘privatisation’, ‘de-state-ification,’ ‘de-main guidance-ication’,” he wrote.