Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise
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How this historic US$4.5 billion IPO was put together is shown in Figure 6.2. Simply put, a series of shell companies were created under the MPT, the most important of which was China Mobile Hong Kong (CMHK). CMHK was the company that sold its shares to international investors, listed on the New York and Hong Kong stock exchanges, and used the capital plus bank loans to buy from its own parent, China Mobile (British Virgin Islands) Ltd. (CM BVI), telecom companies operating in six provinces.
FIGURE 6.2 China Mobile’s 1997 IPO structure
The key point that stands out in this transaction is that a subsidiary raised capital to acquire from its parent certain assets by leveraging the future value of those same assets as if the entire entity—subsidiary plus parent assets—existed and operated as a real company. The value of the provincial assets, as far as the IPO goes, was based on projected estimates of their future profitability as part of a notional company that was compared to the financial performance of existing national telecoms companies operating elsewhere in the world. In other words, the estimates were based on the assumption that CMHK was already a unitary operating company comparable to international telecom companies elsewhere. This most certainly was not the case in China: prior to its IPO, CMHK was a shell holding company that existed only on the spreadsheets of Goldman’s bankers. The IPO, gave it the capital to acquire six independently operating, but as yet unmerged, subsidiaries. So even at this point, China Mobile could be said to exist only as a paper company, but with a very real bank account.
This was not the IPO of an existing company with a proven management team in place with a strategic plan to expand operations. It would be much closer to the truth to say that this was an IPO of the Ministry of Post and Telecommunications itself! But international investors loved it and two years later, in 2000, a similar transaction was carried out in which CMHK raised a total of $32.8 billion from a combination of share placement ($10.2 billion) and issuance of new shares ($22.6 billion). This massive injection of capital was used to acquire the MPT’s telecom assets in a further seven provinces. As a result of these two transactions, China Mobile had reassembled the MPT’s mobile communications business in 13 of China’s most prosperous provinces in the form of a corporation that replaced a government agency. What happened to the US$37 billion raised after CMBVI was paid is unknowable since it is a so-called private unlisted entity and is not required to make public its financial statements.
The significance of this deal ripples down to this day over a decade later. First, as was the case for the original 86 H-share companies, the government could have simply incorporated each provincial telecom authority (PTA) and sought to do an IPO for each. This would no doubt have greatly benefited local interests and ended up creating many regional companies. The amount of money to be raised in aggregate, however, would in all probability have paled in comparison with China Mobile and there was no certainty that any local firm would have developed a national network. More importantly, the new structure conceptually enabled the potential consolidation of entire industries, making possible the creation of large-scale companies that might someday be globally competitive. Today, China Mobile is the largest mobile-phone operator in the world, with over 300 million subscribers and operating a network that is the envy of operators in developed markets.
Second, and equally important, the money raised was new money, not re-circulated Chinese money from the budget, the banks, or the domestic stock markets. Third, the creation of this structure made possible the raising of further massive amounts of capital simply by injecting new PTAs (or any other “asset”). The valuation of such assets was purely a matter of China’s negotiating skills, flexible valuation methodologies employed by the investment banks and demand in the international capital market. In the case of the acquisition in 2000, foreign investors paid a premium of 40–101 times the projected future value of China Mobile Hong Kong’s earnings and cash flow. This was truly pulling capital out of the air! Fourth, this new capital was without doubt paid back into the ultimate Chinese parent, CMCC, giving it vast amounts of new funding independent of budgets or banks. More importantly, the restructuring took what were relatively independent provincial telecom agencies originally invested in by a combination of national and local budgets and allowed China Mobile to monetize them by means of an IPO priced at a huge multiple of the original value. The ability to deploy such capital at once transformed CMCC into a potent force—political as well as economic.
Why wouldn’t Beijing enthusiastically embrace these Western financial techniques when the foreigners were making the Party rich and China seem omnipotent? In the ensuing years, China’s “National Team” was rapidly assembled (see Table 6.6) and a similar approach was used to restructure and recapitalize China’s major banks, as described earlier. It need hardly be said that this list includes only central government-controlled companies: Beijing kept the goodies for itself.
TABLE 6.6 The National Team: Overseas IPOs, 1997–2006
Source: Wind Information
Note: * denotes company parent Chairman is on the central nomenklatura list of the Organization Department of the Communist Party of China.
None of this would have been possible if it had not been for international, particularly American, investment bankers. Over the period 1997–2006, bankers and professionals from a small number of international legal and accounting companies played major roles in the creation of entire new companies. These companies were created out of industries that were fragmented, lacking economies of scale, or, in the case of the banks, even publicly acknowledged as being bankrupt. The investment banks put their reputations on the line by sponsoring these companies in the global capital markets, introducing them to money managers, pension funds and a myriad of other institutional investors. Supported by global sales forces, industry analysts, equity analysts and economists, the banks sold these companies for China. Sometimes investors were so excited they didn’t even have to: for the first time, global investors had the opportunity to invest in true proxies of China’s national economy.
Simply put, international financial, legal and accounting rules provided the creative catalyst for China’s vaunted National Team. Even more important, their professional expertise and skills put Beijing and the Communist Party of China in the driver’s seat for a strategic piece of the Chinese economy for the first time ever: the central government and the Party’s Organization Department own the National Team.
ENDNOTES
1 Shares in the public offering are allocated to investors by means of a lottery process.
2 Of course, the authors are well aware that the Hong Kong Shanghai Bank and AIG are companies with deep Chinese roots, but they were not Chinese owned.
3 For more details on how the demand for capital gave rise to stock markets spontaneously in China during the early 1980s, see Walter and Howie 2006: Chapter 1.
4 See David Faure, China and Capitalism: A history of business enterprise in modern China. Hong Kong: Hong Kong University Press, 2006.
CHAPTER 7
The National Team and China’s Government
“The source of crony capitalism in China is the unrestrained power held by certain factions that lets them intervene in economic activity and allocate resources. Supporters of the old economy want to increase SOE monopoly power and strengthen government’s dictatorial power.”
Wu Jinglian, Caijing
September 28, 2009
There can be little doubt that the Chinese government’s initial policy objective was to create a group of companies that could compete globally. However, the National Team created by government policy was, from its inception, more politically than economically competitive and, as a consequence, these oligopolies came to own the government. At the same time, that bankers were creating National Champions, Zhu Rongji was, perhaps inadvertently, making it possible for these huge corporations to displace the government. In 1998, Premier Zhu forcefully carried out a major streamlining of central government ag
encies that reduced their staffing by over 50 percent and eliminated the great industrial ministries that had been created to support the Soviet-inspired planned economy. These included the Ministry of Coal Industry, the Ministry of Machine-Building, the Ministry of Metallurgy, the Ministry of Petroleum, the Ministry of Chemicals, and the Ministry of Power, all of which became small bureaus that were meant to regulate the newly created companies in their sectors. The new companies and the bureaus were collected under the now long-forgotten State Economic and Trade Commission (SETC).1
The ministries disappeared, the SETC was again reorganized, but the companies remained. Then, in 2004, the State-owned Assets Supervision and Administration Commission (SASAC) was created to bring order to the ownership of state enterprises. The SASAC was meant to be the owner of the major central SOEs on behalf of the state, and was endorsed as such by the State Council. But it has largely been a failure precisely because it was based on Soviet-inspired, top-down, organizational principles. Because of the stock markets, China in the twenty-first century has progressed far beyond this to the point where Western notions of enterprise ownership are used to trump the interests of the state. To illustrate this point, the SASAC’s relationship with its collection of central SOEs is contrasted to Central Huijin’s investments in China’s major financial institutions.
ZHU RONGJI’S GIFT: ORGANIZATIONAL STREAMLINING, 1998
The regulatory bureaus with which Zhu replaced the great ministries had far fewer staff than their predecessors. Even worse, their heads were not ministers, and lacked the seniority to speak directly to the chairmen and CEOs of the major corporations, who were, in many cases, the former ministry bosses of those left behind in the bureaus. In other words, by eliminating the industrial ministries and at the same time promoting the creation of the huge National Champions, Zhu Rongji effectively changed the ministries into Western-style corporations that were staffed by the same people at the top. However, he did not, or was unable to, change the substance.
That may have been because the former ministry officials now in charge of the new corporations successfully fought for the right to remain on the critical staffing hierarchy of the Chinese Communist Party. This would seem entirely natural given the Party’s desire to ensure its control over the economy. However, had these new corporations been staffed by men who were outside of the Party’s nomenklatura, things might have turned out differently and the political independence of the Party and government might have been preserved.
There was one crucial exception: in spite of all the financial clout they seem to wield, the Big 4 banks remain classified as only vice-ministerial entities. An entity is placed in the state organizational hierarchy based on the rank of its highest official; the chairmen/CEOs of these banks carry only a rank of vice-minister. The reason for this exception appears to be straightforward: the Party seems to have wanted to ensure that the banks remained subordinate entities, and not just to the State Council, but to the major SOEs as well. Banks were a mechanical financial facilitator in the Soviet system; the main focus of economic effort then was on the enterprises. Little has changed.
When transferring to these central SOEs (yangqi ) the former ministry officials were able to retain their positions on the Party list controlled by the central Organization Department. Today, 54 of the 100-plus central SOEs nominally managed by the SASAC are on what is called the central nomenklatura list. The chairmen/CEOs of these companies hold ministerial rank and are appointed directly by the Organization Department.2 These men rank equally with provincial governors and all ministers on China’s State Council, and many are members or alternates of the powerful Central Committee of the Communist Party of China (see Table 7.1). What would the chairman of China’s largest bank do if the chairman of PetroChina asked for a loan? He would say: “Thank you very much, how much, and for how long?”
TABLE 7.1 The National Team: Representation on the Central Committee (2009)
Source: Kjeld Erik Brodsgaard, “Politics and business group formation in China,” unpublished manuscript, April 2010
What then of the SASAC, the current entity charged with overseeing the central SOEs? The SASAC was established by the State Council in 2003 and had been created out of the SETC (see Endnote 1) and an agglomeration of other commissions and bureaus which previously had oversight of the central SOEs. It was created as a quasi-governmental entity (shiye danwei ) rather than a government ministry because such a powerful government entity would have attracted discussion at China’s “highest organ of state power,” the National People’s Congress (NPC). This was particularly so since there was a line of argument in support of the NPC as the proper entity to own state assets. This argument held that since the NPC was, in fact, the legal representative of “the whole people” under the Constitution, it was better placed than the State Council to play this role. As a result, the entire process establishing the SASAC was rushed through just before the NPC convened in March 2003.
One of the greatest considerations surrounded the issue of the new commission’s classification (guige ). For a moment it appeared that it would be similar to the Central Work Committee for Large Enterprises (daqi gongwei ), the other of the SASAC’s two principal components, which was headed by a Party member at vice-premier level. The other choice was the arrangement at the SETC, with a ministry-level leader at the top. The final choice of the latter was a decision that weakened the SASAC almost fatally from the very beginning. Why should a major corporation owned by the Chinese central government be subject to the authority of what in the Chinese context is tantamount to a non-government organization (NGO) even if it was run by a minister? A vice-premier might have made the key difference.
Despite its weak position in the state hierarchy, the SASAC was charged by the State Council with very significant responsibilities: 1) representing the state as owner of those central SOEs that together constitute the “socialist pillars” of the economy; 2) carrying out a human-resource function for SOE senior management; and 3) deciding where to invest dividends received from the SOEs. In each of these areas, the SASAC has had great difficulty exercising its authority, not simply because it is a sort of NGO, but also because its organizational relationship to its nominal charges was inappropriate.
First of all, SASAC has been unable to address the simple fact that it was not the owner of these SOEs (see Figure 7.1). Previously, the industrial ministries could make such a claim since they were a component part of the government and, in fact, oversaw the investment process in their subordinate enterprises. After the strategic assets of these enterprise groups were spun off into listed companies, the remaining SOE group companies became, in fact, the direct state investors in the National Champions. In contrast, SASAC was tacked on after the old ministry systems were eliminated. Secondly, while SASAC could oversee the appointment of management at the vice-president and CFO levels, the Party’s all-powerful Organization Department appoints the chairmen/CEOs. How can even a governmental entity exercise authority over enterprises whose senior management has been appointed by the Organization Department? These chairmen/CEOs do not report to a government minister; they report directly on a solid line into the Party system.
FIGURE 7.1 SASAC’s “ownership” and supervisory lines over the National Team
Finally, the delicacy of the SASAC’s position is well demonstrated by the fact that its “invested” companies have successfully resisted the payment of significant dividends, whether to the SASAC or the Ministry of Finance, despite a protracted struggle over the past few years. Even with a three-year “trial” compromise in place, reached in 2007 after years of wrangling, payments will be in the 5–10 percent range of post-tax profit, all of which has been used for projects that are equivalent to reinvesting into the SOEs. The profit made by these nominally state-owned enterprises is not small and in recent years has reached almost to 20 percent of China’s national budget expenditures (see Figure 7.2). This is a vast amount of money that would be better redirected a
t the country’s burgeoning budget deficit. Instead, because of their political and economic power, coupled with the ingenuous argument that they continue to bear the burden of the state’s social-welfare programs, the National Champions are able to retain the vast bulk of their earnings. The fact that the government is unable to access this capital is the best illustration of the power of these oligopolies.
FIGURE 7.2 Central SOE profit as a percentage of national budget expenditures
Source: 21st Century Business Herald 21 , August 9, 2010: 11
The architecture of the entire SASAC arrangement bears the hallmarks of the Soviet-style ministry system abolished by Zhu Rongji in 1998. In that system, SOEs reported directly to their respective ministries and were administratively managed by them (guikouguanli ); the Party organization was their nerve system. The relationship between ministry and enterprise was all-encompassing, including investment, human resources and the deployment of capital and other assets. When the ministries were abolished, the line to the past was broken. The SASAC could not take their place, even though its structure was predicated on the thought that the old administrative management methods still worked. At best, the SASAC as presently constituted is rather like the State Council’s Department of Compliance. China in the twenty-first century is no longer built on the Soviet model.