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Shining lights brighten future of SOEs — China Daily Commentary

October 23rd, 2015 No comments

 

China Daily

Shining lights brighten future of SOEs

By PETER FUHRMAN (China Daily) Updated: 2015-10-23 07:29

Shining lights brighten future of SOEs
While the need for SOE reform is great and too many SOEs still fight to maintain the troubled status quo, there are also some Chinese SOEs leading by example.

As China’s leadership prepares its 13th Five-Year Plan (2016-20), it confronts multiple economic challenges, reform of State-owned enterprises being one of them.

Shining lights brighten future of SOEs

SOEs account for at least 30 percent of China’s total GDP. Some estimates put the share as high as 45 percent. But there are two worrying signs of the worsening situation for China’s SOEs: Their profits are dropping and indebtedness is rising sharply. According to the Ministry of Finance on Wednesday, the profits of the SOEs from January to August decreased by 8.2 percent year-on-year, while the total debt of SOEs from January to September has surpassed 77 trillion yuan, a 20 percent year-on-year increase.

Last month, the government introduced its guidelines for the next stage of SOE reform, including more outside capital. The guidelines are in the right direction, but, there is also some enormous potential within the SOE sector in China that, if unleashed, would also help contribute to the overall turnaround.

There are centers of research excellence, especially in applied engineering, on par with the best in the US and Europe. One example is the China Iron and Steel Research Institute Group in Beijing. It employs 2,000 staff with doctorates along with other experienced research scientists. Every visit, I leave impressed not only by the commitment of the large staff, but also the level of the research institute’s globally-important innovation.

If there is an area that needs improving-one not uncommon for SOE research institutes-it is in how to commercialize their many technologies and how to initiate and structure profitable licensing deals, both with other SOEs in China and global steel and new materials companies. The Institute, based in Beijing’s Haidian district, is making great strides, but, a greater focus as well as a stronger push from the government to get technologies out of the lab and into factories would be helpful.

SOEs too often focus excessively on increasing gross output rather than on pleasing customers and accumulating profits. One positive mold-breaker here is Yangzhou’s AVIC Baosheng Group, which makes steel and copper cable. Though operating in a brutally-competitive market with lots of competitors, Baosheng holds its own. Also in Yangzhou are two examples of how SOEs can take a valuable traditional brand name and rejuvenate it. Restaurant chain Yechun Teahouse and cosmetic manufacturer Xiefuchun have both been around since the Qing Dynasty (1644-1911) and became SOEs in the 1950s.

Yechun is now opening beautiful restaurants both inside and outside China that maintain consistently high quality. Xiefuchun is more of a jewel-in-the-making, with great all-natural products in tune with buying trends in China and abroad. However, Xiefuchun is not as good as it could be on branding, packaging and retail, areas where SOEs often tend to do poorly. Xiefuchun, against all commercial logic, is now stuck inside a large SOE chemicals holding company.

Meanwhile, China Huadian Corporation stands out for its success doing something few SOEs have mastered-investing to build from the ground up and then running profitable large-scale projects outside China. All SOEs know about the central government’s “Go Global” policy. Huadian is getting it right and so has much to teach other globally-ambitious SOEs.

Then there’s my choice for most exceptional high-tech SOE in China, Sichuan Aerospace Tuoxin Basalt Industrial. Though little known, it could be a model for how SOEs might develop in the future. Based in Chengdu, 90 percent of the company is owned by the giant centrally-managed SOE, China Aerospace Group. Tuoxin internally developed a revolutionary process for using ordinary quarried stone to produce a lightweight waterproof, heat-resistant material with broad applications in everything from auto parts to wind-energy. It is on track to become a billion-dollar company within the next five years. Tuoxin suggests what more SOEs could be capable of.

But to get to where it is, Tuoxin needed an owner with long-term vision and patient capital, as well as a senior management team that wants to break out of the cocoon of supplying mainly other SOEs by partnering extensively with China’s private sector companies.

While the need for SOE reform is great and too many SOEs still fight to maintain the troubled status quo, there are also some Chinese SOEs leading by example. They are blazing a path toward a more productive and profitable SOE sector all Chinese can take pride in.

The author is chairman and chief executive officer of China First Capital

http://www.chinadaily.com.cn/opinion/2015-10/23/content_22260934.htm

An insider’s view of Chinese M&A — Intralinks Deal Flow Predictor

October 22nd, 2015 No comments

intra

Intralinks Dealflow Predictor

 

Intralinks: The meltdown of China’s equity markets that began in the summer, despite measures by officials in Beijing aimed at calming investors’ nerves, has left many global investors jittery. Is this just a correction of an overheated market or the start of something more serious, and how would you describe the mood in China at the moment?

 

Peter Fuhrman: Never once have I heard of a stock market correction that was greeted with glee by the mass of investors, brokers, regulators or government officials. So too most recently in China. The dive in Chinese domestic share prices, while both overdue and in line with the sour fundamentals of most domestically quoted companies, has caused much unhappiness at home and anxiety abroad. The dour outlook persists, as more evidence surfaces that China’s real economy is indeed in some trouble. I first came to China 34 years ago, and have lived full-time here for the last six years. This is unquestionably the worst economic and financial environment I’ve encountered in China. Unlike in 2008, the Chinese government can’t and won’t light a fiscal bonfire to keep the economy percolating. The enormous state-owned sector is overall on life support, barely eking out enough cash flow to pay interest on its massive debts. Salvation this time around, if it’s to be found, will come from the country’s effervescent private sector. It’s already the source of most job creation and non-pump-primed growth in China. The energy, resourcefulness, pluck and risk-tolerance of China’s entrepreneurs knows no equal anywhere in the world. The private sector has been fully legal in China for less than two decades. It is only beginning to work its economic magic.

 

Intralinks: Much has been made of slowing economic growth in China. What are you seeing on the ground and how reliable do you view the Chinese official growth statistics?

 

Peter Fuhrman: If there’s a less productive pastime than quibbling with China’s official statistics, I don’t know of it. Look, it’s beyond peradventure, beyond guesstimation that China’s economic transformation is without parallel in human history. The transformation of this country over the 34 years since I first set foot here as a graduate student is so rapid, so total, so overwhelmingly positive that it defies numerical capture. That said, we’re at a unique juncture in China. There are more signs of economic worry down at the grassroots consumer level than I can recall ever seeing. China is in an unfamiliar state where nothing whatsoever is booming. Real estate prices? Flat or dropping. Manufacturing? Skidding. Exports? Crawling along. Stock market prices? Hammered down and staying down. The Renminbi? No longer a one-way bet.

 

Intralinks: What impact do you see a slowing Chinese economy having on other economies in the APAC region and elsewhere?

 

Peter Fuhrman: Of course there will be an impact, both regionally and globally. There’s only one certain cure for any country feeling ill effects from slowing exports to China: allow the Chinese to travel visa-free to your country. The one trade flow that is now robust and without doubt will become even more so is the Chinese flocking abroad to travel and spend. Only partly in jest do I suggest that the U.S. trade deficit with China, now running at a record high of about $1.5 billion a day, could be eliminated simply by letting the Chinese travel to the U.S. with the same ease as Taiwanese and Hong Kong residents. Manhattan store shelves would be swept clean.

 

Intralinks: With prolonged record low interest rates and low inflation in most of the advanced economies, many multinational companies have looked to China as a source of growth, including through M&A. Which sectors in China have tended to attract the majority of foreign interest? Do you see that continuing or will the focus and opportunities shift elsewhere? Is China a friendly environment for inbound M&A?

 

Peter Fuhrman: The challenges, risks and headaches remain, of course, but M&A fruit has never been riper in China. This is especially so for U.S. and European companies looking to seize a larger slice of China’s domestic consumer market. The M&A strategy that does work in China is to acquire a thriving Chinese private sector business with revenues in China of at least $25m a year, with its own-brand products, distribution, and a degree of market acceptance. The goal for a foreign acquirer is to use M&A to build out most efficiently a sales, brand and product strategy that is optimized for China, in both today’s market conditions, as well as those likely to pertain in the medium- to long-term.

The botched deals tend to get all the headlines, but almost surreptitiously, some larger Fortune 500 companies have made some stellar acquisitions in China. Among them are Nestle, General Mills, ITW, FedEx and Valspar. They bought solid, successful, entrepreneur-founded and run companies. Those acquired companies are now larger, often by orders of magnitude. The acquirer has also dramatically expanded sales of its own global products in China by utilizing the localized distribution channels it acquired. In Nestle’s case, China is now its second-largest market in revenue-terms after the U.S. Four years ago, it ranked number seven.

Chinese government policy towards M&A is broadly positive to neutral. More consequential but perhaps less well-understood are the negative IPO environment for domestic private sector companies, as well as the enormous overhang of un-exited PE invested deals in China. These have transferred pricing leverage from sellers to buyers in China. Increasingly, the most sought-after exit route for domestic Chinese entrepreneurs is through a trade sale to a large global corporation.

 

Intralinks: After years of being seen mainly as “an interested party”, rather than an actual dealmaker, Chinese players are increasingly frequently the successful bidder in international M&A transactions. What has changed in their approach to dealmaking to ensure such success?

 

Peter Fuhrman: Yes, Chinese buyers are increasingly more willing and able to close international M&A deals. But, the commonly-heard refrain that Chinese buyers will devour everything laid in front of them stands miles apart from reality. It seems like every asset for sale in every locale is seeking a Chinese buyer. The limiting factor isn’t money. Chinese acquirers’ cost of capital is lower than anywhere else, often fractionally above zero. The issue instead is too few Chinese companies have the managerial depth and experience to close global M&A deals. There are some world-class exceptions and world-class Chinese buyers. In the last year, for example, a Chinese PE fund called Hua Capital has led two milestone transactions, the proposed acquisition for a total consideration north of $2.5bn, of two U.S.-quoted semiconductor companies, Omnivision and ISSI. Hua Capital has powerful backers in China’s government, as well as outstanding senior executives. These guys are the real deal.

 

Intralinks: When it comes to doing deals, what are the differences between private/public companies and SOEs?

 

Peter Fuhrman: With rare exceptions, the SOE sector is now paralyzed. No M&A deals can be closed. Every week brings new reports of the arrest of senior SOE management for corruption. In some cases, the charges relate directly to M&A malfeasance, bribes, kickbacks and the like. SOE M&A teams will still go on international tire-kicking junkets, but getting any kind of transaction approved by the higher tiers within the SOE itself and by the government control apparatus is all but impossible for now. That leaves China’s private sector companies, especially quoted ones, as the most likely club of buyers. We work with the chairmen of quite a few of these private companies. The appetite is there, the dexterity often less so.

 

Intralinks: China has long been a fertile dealmaking environment for PE funds – both home-grown and international. In what ways does the Chinese PE model differ from what we see in other markets?

 

Peter Fuhrman: Perhaps too fertile. For all the thousands of deals done, Chinese PE’s great Achilles heel is an anemic rate of return to their limited partner investors, especially when measured by actual cash distributions. Over the last three, five, seven years, Chinese PE as a whole has underperformed U.S. PE by a gaping margin. It’s a fundamental truth too often overlooked. High GDP growth rates do not correlate, and never have, with high investment returns, especially from alternative investment classes like PE. If there is one striking disparity between PE as practiced in China as compared to the U.S. and Europe, it’s the fact that that Chinese general partners, whether they’re from the world’s largest global PE firms or pan-Asian or China-focused funds, too often think and act more like asset managers than investors. The 2 takes precedence over the 20.

Intralinks: What opportunities and challenges are private equity investors facing?

 

Peter Fuhrman: The levels of PE and venture capital (VC) investing activity in China have dropped sharply. What money is being invested is mainly chasing after a bunch of loss-making online shopping and mobile services apps. The hope here is one will emerge as China’s next Alibaba or Tencent, the two giants astride China’s private sector. PE investment in China’s “real economy,” that is manufacturing businesses that create most of the jobs and wealth in China, has all but dried up. Though out of favor, this is where the best deals are likely to be found now. Contrarianism is an investing worldview not often encountered at China-focused PE and VC firms.

 

Intralinks: As in many other markets, PE investors are having to deal with a backlog of portfolio companies ready to be exited. Do you feel that PE’s focus on minority investments in China could prove a challenge when it comes to exiting those investments? What do you see as the primary exit route?

 

Peter Fuhrman: Exits remain both few in number and overwhelmingly concentrated on a single pathway, that of IPO. M&A exits, the main source of profit for U.S. and European PE firms, remain exceedingly rare in China. In part, it’s because PE firms usually hold a minority stake in their Chinese investments. In part, though, the desire for an IPO exit is baked into the PE investment process in China. Price/Earnings (P/E) multiple arbitrage, trying to capture alpha through the observed delta in valuation multiples between private and public markets, remains a much-beloved tactic.

 

Intralinks: Finally, what is your overall outlook on China and advice for foreign companies and investors seeking opportunities to engage in M&A or invest there?

 

Peter Fuhrman: Yes, China’s economy is slowing. But the salient discussion point within boardrooms should be that even at 5% growth, China’s economy this year is getting richer faster in dollar terms than it did in 2007 when GDP growth was 14%. That’s because the economy is now so much larger. This added increment of wealth and purchasing power in China in 2015 is larger than the entire economies of Taiwan, Malaysia, Thailand, and Hong Kong. Much of the annual gain in China, likely to remain impressively large for many long years to come, filters down into increased middle class spending power. This is why China must matter to global businesses with a product or service to sell. M&A in China has a cadence and quirks all its own. But, the business case can often be compelling. The terrain can be mastered.

 

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One of China’s Best State Enterprises Shows Need for Reform — Financial Times

October 6th, 2015 No comments

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Financial Times article Peter Fuhrman

China’s ruling State Council last month released a much-anticipated plan meant to kick the country’s huge state-owned enterprise (SOE) sector into shape. No small amount of kicking is required. Not all but many of China’s 155,000 SOEs are inefficient and often loss-making. Where SOEs do make money, it’s usually because of markets and lending rules rigged by the government in their favor.

Finding a truly good SOE, one that can take on and outcompete private sector rivals in a fair fight is hard. Gong He Chun is one. Customers throng daily to buy its high-quality products, often forming long queues. The employees, unlike at so many SOEs in China, are helpful and enthusiastic and take evident pride in what they are doing. Though local private sector competitors number in their hundreds, Gong He Chun has them all beat.

Gong He Chun is a small restaurant chain, with just four shops in the ancient and Grand Canal city of Yangzhou, about 300km up the Yangtze river from Shanghai. It specializes in preparing and serving meticulously-prepared versions of dishes that have for over 1,000 years made Yangzhou synonymous with fine eating in China.

It’s a rather long and mouth-watering list, including crab and pork-stuffed xiaolongbao dumplings (below centre), potstickers (below right), steamed shrimp dumplings, shredded tofu and of course Yangzhou’s most famous culinary export, Yangzhou fried rice.

Gong Hechun

Gong He Chun was founded in 1933 as a private concern, but was then, like almost all other private businesses, expropriated in 1949. It’s been an SOE ever since, its shares owned by the Yangzhou government branch of SASAC, the government agency now responsible for holding shares and guiding the management of all SOEs. Gong He Chun somehow held on through the long dark years during Mao Zedong’s rule when most restaurants in China were shuttered, and investment in the SOE sector was directed toward Stalinist heavy industry – steel mills, coal mines, power plants, railroad rolling stock and the like.

Yangzhou, Yangzhou cuisine and places like Gong He Chun represented just about everything that Chairman Mao Zedong most detested. Since at least the Tang Dynasty (618-907), the town has had a reputation for its mercantile traditions, beautiful women and traditional culture. To eradicate such bourgeois roots, Mao and his planners crammed the city in the 1950s and 1960s with ugly sooty chemical factories and smelters.

I remember first visiting Yangzhou in 1981 and being shocked by the sight of once-splendid Ming Dynasty temples and courtyard homes converted to makeshift factories and communal dwellings. In those days, finding anything to eat, even at the few hotels where foreigners were allowed to stay, was no simple matter. All food, including dumplings, was available only with ration coupons.

Things have improved over the last twenty-five years. One not-unimportant reason for this is that Jiang Zemin, who ran China from 1989-2002 is a native son of Yangzhou while his successor, Hu Jintao, was raised in the next door town of Taizhou. Jiang still visits Yangzhou at least once a year, usually during Qingming Festival when filial Chinese return to their home to sweep the graves of their ancestors. Yangzhou this year is celebrating with pomp the 2,500th anniversary of its founding.

Gong He Chun (see photo) still hews closely to the recipes and cooking methods perfected in the 1930s by the founder Wang Xuecheng. This means cutting thin soup noodles by hand, preparing the dumplin skins in such a way as to create tiny pores and air pockets that allow flavor to seep in.

Ever wonder exactly how a properly prepared potsticker should look?

At Gong He Chun, as all its many cooks are taught, they must fulfill Wang’s precise prescription: the overall outward appearance of a sparrow’s head, with its slender sides resembling a lotus leaf and its bottom fried to the color of a gold coin. If only the management and workers at China’s huge substandard SOE oil refineries took as much care, China’s polluted skies would surely improve.

While the quality of what comes out of the kitchen is world class, there are places where the dead hand of state ownership can be detected. The toilets are primitive, plastic plates and bowls are old and chipped, and the overall décor looks like a 1950s US high school lunchroom.

Though its brand-name and reputation are known nationally, Gong He Chun has no apparent intention to expand outside Yangzhou. The three-tiered system of SOE management in China, with ownership spread among national, provincial and local branches of SASAC, makes it both rare and difficult for any local SOE like Gong He Chun to expand outside its home base.

Meantime, a Taiwan company, Din Tai Fung, has taken Yangzhou cuisine, especially the crab xiaolongbao, and built a high-end chain of global renown, with Michelin-starred restaurants across East and Southeast Asia as well as the US, Australia and Dubai. Its China outlets sell dumplings at three times the price of Gong He Chun.

I’m lucky to know the China chairman of Din Tai Fung, and have spent time with him inside Din Tai Fung restaurants. Every detail is sweated over by the chairman, from the starched white tablecloths to the polish on the bamboo steamers to the precise number of times a xiaolongbao dumpling should be pinched closed. Gong He Chun’s state owners are utterly devoid of the drive, vision and hunger for profits and expansion that only a private proprietor can bring.

A newly-announced government policy on SOE restructuring has already come in for criticism in China. Xi Jinping and his State Council – once keen to expose SOEs to more market rigor and competition – have opted for a more “softly-softly” approach, with no specific targets for improving the woeful performance of many SOEs. One reason is that a fair chunk of China’s SOE system is in chaos, thanks to a more high-priority policy of the Xi government. Every week brings new reports about bosses and senior management at China’s largest SOEs being investigated or arrested for corruption.

If there was ever an economic rationale for a small chain of traditional dumpling shops to be owned by the state, no one seems able to recall it. What profit Gong He Chun makes is not being reinvested in this rare SOE jewel, but is used instead to prop up SOE losers in Yangzhou. As China’s new SOE reform policy now begins its tentative roll-out, it looks certain Gong He Chun will for years to come remain a rare bright spot in a blighted SOE landscape.

Peter Fuhrman is Chairman & CEO China First Capital. He has no business relationship with Gong He Chun.

 

http://blogs.ft.com/beyond-brics/2015/10/05/one-of-chinas-best-state-enterprises-shows-need-for-reform/

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