The default option

Poorly timed: Tianwei’s solar bid

China South Industries Group Corp (CSGC) and China National Machinery Industry Corp (Sinomach) have long been the poster boys for China’s heavy machinery industry. The direct translation of CSGC’s Chinese name would be “China Weapon Equipment Corp”, while Sinomach once prided itself as the country’s answer to General Electric.

But the question now being asked: are the state-owned arms manufacturers too big to fail? The answer could still be ‘yes’ at the parent level – at least for the time being. But recent developments in China’s bond market have seen CSGC and Sinomach sending mixed signals on whether they are prepared to let their subsidiaries go under.

In May this year electrical transformer maker Baoding Tianwei became the first state-owned borrower to default in the domestic bond market after failing to pay Rmb85.5 million ($13.5 million) in interest on a Rmb1.5 billion bond (see WiC279).

The bond’s underwriter China Construction Bank stepped in with a bridging loan for Tianwei to refinance its debts. But the short-term lifeline hasn’t proved to be sufficient. A bailout from its powerful parent CSGC hasn’t happened either. Last month Tianwei told investors that it would be filing for bankruptcy.

“The bankruptcy of Baoding Tianwei is an indication that the unbreakable golden shield of state-owned enterprises has finally shattered,” the state-run Economic Information Daily has suggested.

Tianwei was founded in 1958 to supply electrical transformers to state power firms. But as competition from foreign and local rivals grew, it decided to transform its core business. In 2000 it became the first state-owned enterprise (SOE) to branch into the new energy sector by acquiring a small Tibet-based solar power firm. In 2007 it then raised its bet significantly, inking a Rmb30 billion joint venture with CSGC to create a “solar electricity valley” in Baoding.

The problem? According to the National Business Daily, other firms were doing similar things and the solar sector was rapidly reaping the consequences of overcapacity: sliding prices and rising losses.

“Other SOEs should look at Baoding Tianwei as a mirror and reflect if they too have expanded or diversified recklessly,” the Economic Information Daily opines.

The newspaper says there is still a six-month window for Tianwei to come up with a restructuring plan (before being dissolved by receivers) and it remains possible that CSGC might step in as a white knight.

Sinomach, another Baoding-based company, has had some bad news of its own, although its unit China National Erzhong Group is in a less dire situation.

A state-owned manufacturer of smelting equipment, Erzhong had warned that it may have to stop paying interest on a Rmb1 billion note after being sued by a creditor. Such a default would be the second by a Chinese state-owned company in the interbank bond market, following that of Tianwei. But Erzhong hopes of avoiding Tianwei’s example were boosted last week with a statement which said Sinomach was planning to “take over” the bond to “protect investors”.

The default warning and potential bailout come just days after Beijing unveiled guidelines for an overhaul of SOEs aimed at improving their financial performance (see WiC296).

“Erzhong’s bailout announcement signals that authorities remain nervous about the consequences for financial stability,” the Financial Times has noted.

“The endgame is the bonds will be paid,” Ivan Chung from Moody’s in Hong Kong told Bloomberg. “The outcome of Erzhong bond repayment is in contrast to Baoding Taiwei’s restructuring. Those are two extreme outcomes and they make it difficult for investors to assess the government’s intention to get rid of moral hazards.”

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