China Mulls Major Industry Mergers

An analysis by Michael Lelyveld
2015-05-11
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china-oil-refinery-2011.jpg A worker rides a bicycle at a Sinopec oil refinery in Wuhan, Hubei province, in a file photo.
AFP

Some of China's giant state-owned enterprises may get even bigger as the government considers a merger and acquisition plan to reorganize its vast holdings.

But whether the state-held conglomerates known as SOEs will become more efficient or profitable remains to be seen.

Reports suggest that the government will reshuffle its many industrial interests, which vary from oil companies to arms manufacturers and makers of products ranging from salt to silk.

On April 27, share prices of some listed SOE subsidiaries soared after the official Xinhua news agency cited a "massive" plan to consolidate holdings under control of the State-owned Assets Supervision and Administration Commission (SASAC).

An internal SASAC document called for slashing the number of centrally administered SOEs from 112 to 40, Xinhua said in an exclusive report.

But six hours later, the news agency cast doubt on its own story following a SASAC disclaimer of the report by Xinhua's Economic Information Daily.

"Investigations have found that the news story was written without interviewing or verifying with us," SASAC said.

Conflicting reports


Listed shares of the monopoly China National Petroleum Corp. (CNPC) and state-owned refiner Sinopec jumped by the maximum allowed 10 percent on the earlier reporting, but closed 6 percent off their highs the next day after the apparent denial.

Both CNPC PetroChina and Sinopec said they had no information about a planned merger.

The flap marked at least the fourth time that the merger story has surfaced, only to be knocked down.

On Feb. 17, The Wall Street Journal first reported that officials were studying a possible CNPC-Sinopec merger, aimed at creating a "national champion" to compete with international oil companies.

Nine days later, a Sinopec spokesperson doused that report, saying the company had "never heard" of such a plan.

On March 11, The Wall Street Journal broadened the story, citing a plan "to radically consolidate" the entire state sector, restructuring over 100,000 enterprises and merging assets in fields including energy, resources, and telecommunications.

On May 4, analysts rekindled speculation as CNPC, Sinopec, and China National Offshore Oil Corp. (CNOOC) all announced replacements of their company chairmen, marking the petroleum industry's biggest executive reshuffle in years.

Growing expectations


With the latest emergence of the merger story, expectations are growing that a reorganization plan for the sprawling but heavily indebted sector is in the works, sparking debates about the merits.

The rationale for mergers is at the heart of the controversy.

According to Xinhua, "... many SOEs compete with each other, causing overlapping business, fierce infighting and even malicious competition, especially when two companies eye the same international target."

"The government wants to avoid senseless competition as it strives to make companies more competitive in the global market," the news agency said.

Such reasoning strikes critics as anti-competitive.

Foreign press reactions have been largely negative with regard to a CNPC-Sinopec combination, arguing it would preserve all the drawbacks of state ownership while gaining none of the advantages of privatization.

"Critics say a merged oil group would be a more bloated and less efficient version of the current duopoly," the Financial Times said.

But by airing overhaul plans for the entire state sector, the government seems to be seeking new remedies for stagnation as economic growth slows.

Bid to boost growth


On Sunday, the People's Bank of China (PBOC) voiced concern for "relatively high downward pressure" on the economy as it announced its third cut in benchmark interest rates since November.

The monetary easing is the latest sign that the government is accelerating steps to halt the growth slide, raising prospects for plans to reinvigorate the laggard SOEs.

Last year, the government pushed a "mixed ownership" plan to encourage private investment in SOEs, hoping to pump life into the sector with new capital and management practices, but response has been cool.

In this year's first quarter, SOE profits fell 8 percent to 499.7 billion yuan (U.S. $80.5 billion) after showing a 3.3 gain in the year-earlier period, the Ministry of Finance said.

The sector's total assets stood at 105.5 trillion yuan (U.S. $17 trillion) with liabilities of 68.6 trillion yuan (U.S. $11 trillion), both up by about 12 percent from a year before.

The government has claimed success for the merger formula after approving a union between the top bullet train manufacturers, China CNR Corp. and China CSR Corp., in early March.

Officials argued that the firms were competing against each other for foreign contracts, undermining China's national interests.

The State Council, or cabinet, has also considered consolidating the two major nuclear development firms, China Power Investment Corp. and State Nuclear Power Technology Corp., for the past year. But the companies are resisting a merger for the domestic market, the Financial Times said.

Concerns unclear


A fundamental question is whether a grand merger plan for the entire sector represents a step forward for China or a step back that will restrain competition among inefficient industries and neglect more productive private enterprises.

Economists are divided on the implications of the reported plans.

"If you put two giant companies together, you're probably going to reduce competition in the domestic market," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.

The push for larger national companies may raise doubts about whether profitability is the main priority.

"You would think that if they're anxious for better performance that privatization would be higher on the list than mergers," said Hufbauer.

He also noted that the merger plans appear to disregard China's anti-monopoly law, which has been enforced with heavy fines on foreign firms since last year.

The proposals for strengthening SOEs through mergers also seem to ignore calls for greater access to the Chinese market for foreign companies that could act as a check on monopoly practices.

"It doesn't sound like any of those concerns are getting much play," Hufbauer said.

'The right direction'

But Harvard University economics professor Dale Jorgenson argued that China is moving in "the right direction," given that state-controlled industries are far from prepared for privatization.

"This idea of consolidating these enterprises, I think, is the right step for them to take at the moment," said Jorgenson. "Having a smaller number of these firms is a good idea."

Many of the SOEs are already uncompetitive and unable to withstand further pressures.

"The basic point is that they're not making a lot of money. Some of them are losing a lot of money," Jorgenson said. "These are basically weak businesses."

"We're not talking about people that are world-class, trying to take down Apple or something like that," he said.

The implication is that the merger plan is more defensive than offensive as China struggles with industrial overcapacity.

The series of reports and denials on the merger issue may be a measure of the political resistance to change in the state sector.

Although he sees the merger proposals as positive, Jorgenson discounted the idea that consolidation of SOEs would represent a government step toward radical reform.

"They have a lot on their plates, but economic reform doesn't seem to be at the top of the list," he said.

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