Talking Point

A new state of mind

Bigger than Berkshire Hathaway, many still struggle to understand Sasac

Li Rongrong, the chairman of Sasac: China’s answer to Warren Buffett?

A Google search on “Warren Buffett’s investment strategy” returns at least 260,000 page results.

That seems rather a lot for a man who espouses simplicity in his investment style. Still, one factor that Buffett has cited himself for the enduring performance of his holding company Berkshire Hathaway is a “close to unique” spread of businesses. It’s certainly a diverse bunch: from insurance firms to jewellery shops to candy stores.

But imagine stepping up to a whole new level altogether, and to an ownership portfolio that has delivered twenty times Berkshire Hathaway’s profits in recent years. What if Buffett was waking up each day to ownership stakes in Boeing, Ford, ExxonMobil (plus ConocoPhillips and Chevron), as well as American Airlines (Delta and United too), U.S. Steel, Verizon and AT&T? Then throw in America’s power producers, its national electricity grid, a dozen or so nuclear reactors, a heavy-duty bunch of industrial firms and all of its top defence manufacturers. Oh, and make some space too for NASA.

That starts to scratch the surface of the challenge facing Li Rongrong, the head of the State-owned Assets Supervision and Administration Commission (Sasac).

With an ownership responsibility for well over a hundred of China’s largest state enterprises, Li’s portfolio truly puts Buffett in the shade.

Why was Sasac created?

In the mid-1990s, thousands of state enterprises were allowed to go bust, in a bout of economic shock therapy. But the loosening of central control made for smash-and-grab conditions. Erstwhile ministries clumped together their business interests and spun some of them off in partial listings. Well-connected officials seized state assets at knockdown prices.

Part of the sink-or-swim deal that Beijing struck with state firms at the time was that they had to pay tax but could hold on to any profits in-house. Rather remarkably for an economy famed for its centralising instincts, none of the state-owned enterprises remitted dividends to the public purse for more than a decade after 1994.

Initially, of course, many of these companies were loss-makers. But as businesses were restructured and the Chinese economy grew, the bureaucrats soon noted that many state firms were becoming profitable.

Not that the central government was sharing in much of their newfound largesse, as most of the surplus cash was heading off in other directions. Some was sent offshore by corrupt SOE officials. Much of the rest was splurged on wasteful company investments.

So a new sheriff rides into town…

In 2003, Beijing moved to reassert control, creating Sasac with “principal investor” rights for a premier league grouping of 196 ‘central’ state-owned enterprises.

At a stroke, Sasac ascended to the commanding heights of the Chinese economy. Taken together the “central SOE” list continues to contribute three-quarters of the profits generated by state firms in total. It makes up a sizeable chunk of the market cap of the Chinese and Hong Kong stock exchanges too.

With a mandate to sell off state assets?

So far, Sasac has pruned its ownership roster down to 129 firms. Expect another thirty or so to drop off the list this year, according to reports in the China Daily last week. Li Rongrong has often stated that he only intends to keep firms that are among the top three in their respective industries.

But a shorter list does not point to a diminished focus on state control: Sasac’s mission is to maximize the value of state assets, and not necessarily to sell them off to the market.

Greg Anderson, a China specialist at UCLA who focuses on state-owned enterprises and the auto industry, says that there have been few outright privatisations. Most assets end up being sold in-house to other Sasac entities (“kind of like kissing your sister”, Anderson notes).

And for a series of ‘strategic’ industries (defence, electricity, petroleum and petrochemicals, telecoms, coal, aviation and shipping) there is no thought of ceding ownership whatsoever. In fact, revenues and profits at firms under Sasac are growing – this is no rolling back of the state.

That makes for a powerful economic player…

On the face of it, Sasac enjoys a diverse mandate for its portfolio; as owner, turnaround specialist, corporate governance champion and industrial planner.

It reserves the right to block wasteful spending on non-core business by its state enterprises, for instance. It oversees consolidations too: this week it merged China Energy Conservation Corp (an SOE focusing on energy conservation techniques) with China New Era Group (a military supplier). It seems an unlikely pairing, but the state press is full of the synergies on offer.

On other occasions it has acted more as an economic development agency. China Business reported late last year that Li Rongrong had taken 82 of his “central army” of companies on a tour of Liaoning province, where they committed to Rmb400 billion ($58.4 billion) in investment.

Nonetheless, Sasac does not always get its own way, as demonstrated in its failure to secure the 20% of after-tax profits that it has said it needs to fund industrial planning and restructuring work.

Instead, Sasac’s firms resisted fiercely and now pay out significantly less. ‘Resource monopolies’ like PetroChina, China Tobacco and the State Grid Corporation contribute a 10% dividend; ‘general competition’ firms are expected to stump up 5%; and military and research-related companies have enjoyed exemption from payments altogether.

Further, when these dividends are submitted, they go first to the Ministry of Finance, which has insisted that the proceeds are paid directly into state coffers before being redistributed to Sasac.

So, although it is in nominal control of China’s most important state-owned enterprises, Sasac has no source of revenue itself, and must depend on the Finance Ministry for its own budget.

Other ownership rights are diluted too?

An obvious one is the power to appoint managers. Again, in theory Sasac has carte blanche. But although its recommendations are noted, the final say on appointments, especially for the top 50 or so largest enterprises, resides with the Communist Party’s Organisation Department. The positions are simply too influential to slip out of Party hands.

Enforcing its authority on the ground has sometimes been a struggle too, not least in unpicking the multi-level interests of the state enterprises in question (they have at least 17,000 subsidiaries between them, analysts think). Ownership rights can be difficult to enforce in “dark corners” of the economy, agrees ChinaStakes.com.

Then there are the rivalries with government agencies. Clearly, the Ministry of Finance won the battle over dividend collection. But Sasac rubs up against powerful competitors in other ministries too.

What about relations with its own companies?

Occasionally tensions spill over into public view, most spectacularly in 2007, when Air China broke ranks to oppose the sale of 24% of China Eastern to Singapore Airlines and sovereign wealth fund Temasek.

Shanghai-based airline China Eastern needed the capital, as well as Singapore Airline’s strategic support, and it signalled that the deal had Sasac’s endorsement. But Air China did not want a competing foreign airline in its backyard, and fought back against the proposals.

On paper, this was a dispute that should never have happened. As controlling shareholder of the parent companies of both Air China and China Eastern, Sasac should have been able to bash both airlines into line.

Instead Air China’s parent – China National Aviation Holdings – took the argument direct to the State Council – and won. “We were naïve,” China Eastern chief executive Li Fenghua recalled at the time, “We thought approval by the authorities would resolve all difficulties.”

So Sasac is a qualified success…

In terms of delivering on its mandate of improving SOE performance, it is still a little difficult to tell. Details on Sasac’s key management objectives are hard to come by. Performance targets aren’t too clear either, although there was talk last year of introducing “economic value added” metrics to ensure that state firms were covering their costs.

Anderson says that this seems to have been put on the back burner (perhaps trumped by official enthusiasm for accelerated spending under the provisions of the stimulus programme). He wonders too how Sasac would go about calculating a cost of capital for so many companies under its charge.

In the meantime, after a poor 2008 in which “central SOE” profits fell by 30%, the newspapers are reporting an anticipated 3.5% uptick in 2009. The Beijing Review forecasts returns of Rmb750 billion ($110 billion) for the year, on revenues of Rmb12 trillion.

Of course, such huge sums dwarf the results expected to be announced at Berkshire Hathaway’s ‘Woodstock-for-capitalists’ weekend in May. But they say a lot less about the efficiency of capital allocation under Sasac management. That is one metric in which few would bet against Buffett and Berkshire winning hands-down.


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