China’s railway ambitions have travelled some distance since 1888 when the Empress Dowager Cixi grew so concerned about the poor feng shui of her new steam locomotive that she insisted her railway carriage be pulled across Beijing by eunuchs instead. This was not a welcome outcome for her chief minister, Li Hongzhang.
China’s current premier, Li Keqiang, not only shares the same surname as his nineteenth century predecessor – he is similarly enthusiastic about the benefits of railways. However, where once the Qing Dynasty bureaucrat had no option but to import equipment from Germany, Li Keqiang has become an extremely vocal advocate of selling Chinese trains abroad. He has even been referred to in the local press as China’s top railway salesman.
His ambitions to create a world-beater will be boosted too by news that the country’s two train manufacturers CSR Corp and CNR Corp are to be merged. The pair, which have dual listings in Shanghai and Hong Kong, have twice been suspended since early September, when rumours of a merger first surfaced in the domestic media.
At the time, the two were said to be as unenthusiastic about the plan as was the country’s national rail operator, China Railway Corp (CRC), which potentially faces the prospect of only one company bidding for future orders on the domestic network. But Beijing is reported to have lost patience with CNR and CSR because of the acrimonious rivalry the state-owned brethren have fostered. This has hampered China’s ability to win overseas contracts and create a national champion.
Export sales are still small, but are becoming an increasingly important component for both companies’ revenues, not to mention national prestige. Analysts forecast exports will jump from roughly 9% to 25% of sales by the end of 2016, as the two transform themselves from pure rolling stock manufacturers to turnkey providers able to build entire rail projects abroad.
What shape might the merger take?
Century Weekly first broke the news of the deal back in September and was back with a new exclusive last week suggesting the merger will take the form of a share swap at the listed company level. As we reported in WiC253, CSR initially mooted this idea, suggesting the delisted entity should be archrival CNR.
But some analysts agree with CNR’s suggestion that it makes more sense for the merger to take place at the holding company level. This would enable both companies to remain listed and would be far simpler to execute from both a regulatory and legal standpoint.
Those who argue in favour of a merger at the holding company level believe it would be relatively easy to set up a jointly owned subsidiary beneath the two listed entities, which would then be responsible for overseas contracts. They note that CSR and CNR not only have many incompatible subsidiaries, but fundamentally different technological bases since CNR learnt its trade from Siemens and CSR from Kawasaki and Bombardier.
Other commentators have mooted the idea of a share swap along the lines of Air China and Cathay Pacific’s minority stakes in each other. However, anything less than full management control at some level of both organisations seems unlikely to kill the “tragic competition” between the two that is emphasised by local media outlets such as CBN.
In a recent research report HSBC offers a further scenario. It suggests the two might merge the higher margin bits of the business – bullet trains, locomotives and subway trains – and spin-off the lower margin divisions such as freight wagons. “Keeping the high technology content products could strengthen the profitability of the companies. For example, CSR Corp has one third of its workforce involved with the freight wagon business and yet its largest subsidary making freight wagons only posted revenue of Rmb5.3 billion ($866 million) and a net profit of Rmb63 million,” the bank states.
However, HSBC adds that a plain-vanilla merger would be the most straightforward scenario and would lead to three major synergies: reductions in R&D spending and in the cost of the global sales and maintenance network (as duplication is eliminated), a greater use by CNR of CSR’s locally-made electrical components (versus more pricey imports), and lower overall financing costs thanks to a stronger balance sheet.
According to the domestic media, CICC has been appointed to advise on the restructuring process, with State Councillor, Wang Yong, in overall charge. CNR board secretary Xie Jilong told shareholders the two companies have little to say on the matter. “It is not up to us, it has become a national strategy to be determined by government,” he told CBN.
National Business Daily also reports that rail manufacturer, China Railway Construction Corporation (CRCC), has been restructuring its export arm, China Civil Engineering Company. Multiple sources tell its reporter that this entity may also become part of the new behemoth.
Earlier this week, CRCC and CSR were officially awarded the contract for a 210km high-speed rail line between Mexico City and Queretaro. The two were the only consortium to bid for the $3.75 billion project. Notably CNR did not bid this time, a rare occasion in which the state-owned rivals haven’t gone head-to-head on an overseas deal.
How has their rivalry played out?
The most oft-cited example concerns CSR and CNR’s tussle in Argentina back in 2011. This saw CSR undercut CNR in what had supposedly been demarcated as the latter’s ‘sphere of influence’. It bid $1.27 million per vehicle compared to CNR’s $2.39 million offer.
CBN says the Argentinian government was so “shocked” by this low bid that it set a maximum price of $1.27 million for phase two of the project. CNR complied with a bid of $1.26 million, only to be outdone once again by CSR, which swooped in with a winning bid of $1.21 million.
As CBN concludes, “Grabbing market share through a price war still results in profits, but a far narrower profit margin.”
Fears that a merger was about to be forced upon it, may also explain CNR’s recent public reaction to rumours that it was planning to bid against CSR to win a bullet train contract in the US. Two weeks ago, Reuters reported that CNR had teamed up with SunGroup USA to pitch for an 800-mile project linking San Francisco and Los Angeles.
The project should cut journey times from nine hours to just under three and may eventually be expanded to include San Diego and Sacramento as well. CNR subsequently squashed comments from a SunGroup spokesman about a bid, leading CBN to conclude, “How puzzling it is that two companies supposedly working with each other should express such contradictory opinions.”
CSR, meanwhile, confirmed that it had submitted a bid as part of a consortium which may also include CRCC. The first part of the project envisages the provision of 95 train units.
Official figures have yet been released, but the California project is touted to cost $68 billion (although the Chinese media believe it may eventually top $100 billion, based on an average cost of $100 million per kilometre of track, including stations, trains and maintenance charges).
Should either CSR prevail, it will not only mark China’s second big win in the US, but also a new step forward as the country wins more contracts in developed markets. Two weeks ago, CNR won a first US rail tender after securing a $567 million contract to supply 284 train units for Boston’s ailing metro system, one of the world’s oldest. As part of the deal, it also agreed to establish a plant in nearby Springfield, Massachusetts, creating at least 250 new jobs.
Reaction to that news, mind you, could not have been more different on each side of the Pacific. In China, 21CN Business Herald said the win would, “greatly enhance the international image of CNR’s brand and promote the Going Global campaign of China’s high-end equipment manufacturers.”
But try telling that to Boston’s local newspapers, which have quoted numerous critics of the deal. The Boston Herald led with the headline, “China CNR’s reputation off the rails,” offering its readers an account of the company’s forced recall of asbestos-riddled trains from New Zealand earlier this year.
Meanwhile, the Boston Globe said the plan “draws concern on human rights” issues. It cited representatives from the three losing bidders, Hyundai Rotem, Kawasaki and Bombardier, which all separately described the bidding process as “not transparent”.
The controversy forced US Transport Secretary Richard Davey to defend the decision. “We’re not buying coaches from North Korea, or Syria, or Iraq,” he told the Boston Globe. “We’re buying them from a trading partner of the US that is now the second largest economy on the planet.” For cash-strapped American cities and states, Chinese train manufacturers offer one very compelling advantage over other international competitors – cost. CNR’s winning bid was almost half Canada’s Bombardier’s, which bid $1.08 billion. It is also the main reason why so many analysts continue to maintain outperform ratings on both CNR and CSR’s stock prices, which rose 50% between the beginning of July and late October (ahead of their suspension).
On track to be a world-beater?
As Deutsche Welle recently wrote, no other sector symbolises China’s shift up the technological value chain more than the train sector. It also highlights, yet once more, the potential pitfalls foreign companies face attempting to gain a lucrative foothold in China.
That’s because in the space of one decade, China has gone from being wholly dependent on foreign technology to instead outbidding foreign train manufacturers – having imported their technology and then leveraged its lower cost base. Should anyone be surprised? After all, from the very outset, China made it clear that it planned to create a national train manufacturer through, “introduction, digestion, absorption and re-innovation”.
International rail giants including Alstom, Bombardier, Kawasaki and Siemens all signed joint-venture agreements in the mid-noughties with CSR and CNR in the hope of winning business in what was fast shaping up as the world’s largest rail market. The condition of entry was technology transfer and Japan’s Kawasaki trained hundreds of CSR engineers in the technology of its Shinkasen trains.
But by 2010, CSR was starting to build its own high-speed trains without Kawasaki. At the time, a spokesman from CSR said, “Real innovation is rare. We attained our achievements in high-speed train technology by standing on the shoulders of past pioneers.”
Kawasaki thought otherwise and threatened to sue for patent infringement before eventually backing down. One year later China won its first international order with the sale of a batch of trains to Malaysia in July 2011.
However, further contracts were stymied by a collision later that same month on China’s high-speed line between Shanghai and Wenzhou (see WiC117). This not only led to (temporary) declines in domestic passenger traffic, but also a halt on high-speed rail construction and a reduction on operating speeds at the request of the State Council.
New orders only resumed in August 2013. Since then, the government has placed the rail sector at the vanguard of efforts to restimulate the economy.
In mid-March it announced that five rail projects worth a total of Rmb142 billion ($22.7 billion) were being fast-tracked. Century Weekly recently reported that China intends to lift rail investment to Rmb800 billion, of which Rmb630 billion will cover new lines and Rmb143 billion in new equipment.
Analysts believe this strong government commitment will be one of the key factors keeping China’s high-speed rail network expanding at a fast pace over the next decade. CSR’s former chairman, Zhao Xiaogang recently said the government intends to expand the network from 103,000km at the end of 2013 to 150,000km by 2020 and 200,000km by 2030. He added that high-speed trains should account for about 10% of the total. Urbanisation is also pushing further development of mass transit systems, although margins are lower than in the long-distance, high-speed sector. According to the China Association of Urban Metros, urban track length will expand from 2,500 km in 2013 to 7,000 km by 2020.
Internationally, one of the most promising growth areas is likely to arise from China and Russia’s geopolitical alliance and a planned 7,000km high-speed link between Moscow and Beijing. The first $23.9 billion phase of the project is scheduled to begin operations in 2018.
Yet while the domestic media lauds the potential for the train sector, a number of outlets also point out that both CSR and CNR are some way from being world-beaters just yet. Economic Information Daily quotes an overseas supplier who states that foreign components still account for 50% of a train unit’s electrical components, which in turn accounts for 30% of the overall high-speed train.
Can foreign train manufacturers fight back? Earlier this year, the French government hoped to create a European train champion by “encouraging” a merger between Germany’s Siemens and France’s Alstom’s train units.
However, in an example of the limits of Western state-directed capitalism, Alstom thought otherwise and accepted instead a bid from General Electric for its power units this summer. The train equivalent to Airbus seems to have been shunted into a siding, as a consequence. Meanwhile China’s plans to merge CSR and CNR into a bullet-train-Boeing remain full steam ahead.
Keeping track: about 30 minutes after the publication of this article, news broke that the Mexican government had cancelled its bullet train contract with the Chinese consortium CRCC and CSR. Mexico’s president revoked the deal, reports the Financial Times, amid allegations the tender process was “opaque”. (Nov 8, 2014)
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