China recently launched a plan to take 112 of its massive, state-owned enterprises (SOEs) and merge them into 40 even bigger companies that they hope can be more competitive internationally.
Are Chinese companies getting too big?
But critics worry the plans for companies with assets that total about $6 trillion will just end up creating huge monopolies that do not perform any better than the current businesses.
China’s state-owned enterprises have long held a commanding position in the country’s still tightly controlled economy, dominating telecommunications, banking, oil and other key strategic sectors.
The companies have an advantage over private enterprises because of easy access to credit and links to government agencies, but their rate of return on investment has been poor, at about 2.5 percent. That’s even less than returns on bank deposits.
“One reason why the government wants to merge the SOEs is to make them more capable for international competition,” said Xu Dingbo, associate dean at the China Europe International Business School (CEIBS).
“There is also the problem of excess capacity and extremely low returns on investments in the SOE business, which the government wants to tackle through mergers.”
Creating monsters
The government has not released many details about the merger plans, but it remains unlikely that authorities will completely privatize state-owned enterprises.
Media reports have suggested that the firms could be consolidated by sector, and have their links with state regulating agencies removed. Their ownership could be transferred to asset-investment firms, helping them run as more purely commercial enterprises.
But they will likely continue to have links to state control, through measures like allowing the government to continue to retain the right to appoint top managers. What seems certain is that the mergers will make the businesses dominant players in their respective industry segments.
Rail monster
The ongoing merger between China’s two railway track and equipment makers for example, is likely to create a new entity capable of challenging foreign players like Siemens and Bombardier.
According to estimates, the market capitalization of the two railway companies, or value of their shares on the stock market, following the merger will be significantly higher than that of German giant Siemens.
“The merger plan may be useful. But it may be creating greater monsters in some sections of industry,” Xu said.
“I worry about a monopolistic trend. Monopolistic tendencies will become stronger after the mergers. I hope foreign companies will strike harder to reduce the monopolistic tendencies. China is a big market and they cannot walk away from it,” he said.
Mixed signals
Although the plans have been talked about for months now, and a general picture is becoming clearer, there are signs the merger plan is undergoing some changes, and the government has been reluctant to release its full details.
One possible reason for this is the deep vested interests and influence that China’s state-owned enterprises have, with some arguably more powerful than government ministries.
Industry sources said two shipbuilding giants, China Shipbuilding, CSSC Holdings Ltd and Guangzhou Shipyard International Co Ltd., are next in line for mergers. But there has been no official confirmation. An earlier report about the planned merger between oil giants China Petroleum & Chemical and PetroChina has been denied by official agencies.
Economists say the release of such stories, and their subsequent denials, are meant to test the market’s response, and help officials time their merger moves.
That is also giving investors an opportunity to make incredible returns on the stock market and the government a chance to mop up funds as the shares of listed state-owned enterprises rise sharply.
Shares of China South Railway and China North Railway shot up dramatically prior to the merger, with CSR rising 510 percent between December 31, 2014 and April 20. China North rose by 483 percent during that same period.
Foreign company fears
The merger plans come at a time when foreign companies operating in China are already feeling vulnerable, following a string of crackdowns by authorities on unfair pricing and intellectual property licensing. Foreign companies have complained of being unfairly targeted, but authorities say they have also targeted Chinese firms.
“Foreign companies have reasons to be worried because mergers can make Chinese companies stronger in international competition. But if the government is not able to manage the merger properly, it will result in weaker competition from them,” Xu said.
Some analysts say the merger program is unlikely to affect the government’s control over major industries and do little to make progress on market liberalization.
“Major central SOEs tend to be in sectors that the Communist Party regards as "lifelines" for the economy and national security, such as energy. So I suspect that the basic ownership structure of these companies is not really going to change,” said Andrew Batson, China Research Director of consulting firm, Gavekal Dragonomics.
