Big is beautiful

"We've just been consolidated. It feels great"

If you are trying to understand the direction of Chinese industrial policy, there are clues in the success of a long-departed Glaswegian tea merchant.

Sir Thomas Lipton first blended his Yellow Label tea in 1890. Today Lipton enjoys leading market share in China – a country that has been drinking tea since 2737 BC.

Earlier this year (see WiC33) Beijing newspapers asked how Lipton tea could enjoy local sales volumes exceeding the combined sales of China’s top 100 producers.

The answer: a fragmented marketplace. There are 70,000 tea manufacturers in China, and none with major economies of scale. Few enjoy pricing power and there is no internationally famous China tea brand. That’s pretty amazing when you consider the country’s association with the product (“Not for all the tea in China” etcetera).

The lesson drawn by policymakers is simple enough: China has too many producers.

And not just in the tea industry. Four overseas firms dominate international cement – so why does China have 5,500 cement producers? A few companies in the US, Japan and Europe rule the pharmaceutical roost. China has over 5,000 pharma firms – not a single one of which competes globally.

The government has concluded that, if China is to have internationally competitive companies, it must engineer industry consolidation.

That’s a big task and so far the focus has been on a few key industries.

Exhibit one: the car industry. Last week a landmark deal was announced to create the country’s third largest carmaker, with Chang’an Automotive absorbing the two carmaking subsidiaries of aircraft builder, Aviation Industry Corporation of China (AVIC). In exchange AVIC got a 23% stake in Chang’an.

Chang’an’s output of 1.5 million vehicles per year will be boosted by the restructuring. AVIC’s Harbin Hafei and Jiangxi Changhe make 700,000 vehicles – mostly minivans – as well as 600,000 engines.

The China Daily points out that “Chang’an has successfully fulfilled the government’s consolidation plan of having two or three auto conglomerates with annual outputs of more than 2 million vehicles each.” The newspaper adds this is a “milestone” in the government’s plan to consolidate China’s 130 automakers into a ‘big four and a small four’ in the hope of “making the industry more competitive with international rivals and in the global market.”

The Automotive News website likewise called the Chang’an move a “happy reshuffle” and predicts the deal will be a “catalyst” for a forthcoming “merger season”.

The second industry up for consolidation is steel. Li Yizhong, the minister of industry and information technology, estimates that China has nearly 1,000 iron and steel smelting enterprises. The stated goal is to reduce this to five internationally-competitive firms and, back in February, the country’s biggest steel firm, Baosteel acquired Ningbo Iron and Steel and Baotou Iron and Steel.

Somewhat more controversially Shandong Steel recently acquired privately-owned Rizhao Steel. As reported in WiC30 the deal was financed with large state loans, and saw the loss making Shandong (also known as Shangang) take control of a profitable private firm. Rizhao’s owner Du Shuanghua did not seem to have too much say in the matter.

More recently, two Shangang subsidiaries hit the headlines. Securities Daily reports that Jinan Iron and Steel and Laiwu Steel are on the verge of being merged with Rizhao and the company’s other assets into a single listed firm. Post-merger, the enlarged Shangang Group will become the nation’s third biggest, with 31.6 million tonnes of annual capacity.

Securities Daily predicts the deal will set the template for future restructurings in the industry, where many small firms are listed. It quotes Wang Zhenqian, a fund manager with China AMC, as saying the move is long overdue. First, it will rationalise production and help Chinese steelmakers close backward facilities and upgrade to higher margin products – such as steel plate for cars. Just as crucially, Wang reckons it will improve steelmakers bargaining power in negotiations with international iron ore miners such as BHP Billiton.

So why has consolidation taken so long to happen? The central government’s efforts have been slowed by local authorities – who fear loss of control of local enterprises, and the taxes they pay.

Additionally, and far less defensibly, these enterprises have been a source of graft for provincial bureaucrats. They are loathe to see them consolidated beyond their sweaty grasp.

Then again, one provincial government – Shanxi – is now at the vanguard of the consolidation trend. In what might be termed ‘consolidation by sledgehammer’, Shanxi aims to reorganise 2,000 privately-owned coal mines into around eight state-owned firms. It has said that no mine can stay private if its production is less than 3 million tonnes per year, and (as described as far back as WiC1) has been squaring up to recalcitrant local coal barons. This ‘struggle’ is ongoing. Last month CBN Weekly characterised the option given to local mine owners as “You have no choice but to sell”.

The Weekly says that so far only 1% of mine owners have buckled. It also warns that this is consolidation at too high a price. The coal barons may not have the best reputation – the province has suffered a series of mining disasters – but they do have property rights. “In a market-oriented system,” the Weekly opines, “a corporate merger contract should be established on the basis of compliance with the common interests of party A and party B instead of being enforced by executive power.”

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