19 February 2019
Many investors are disappointed by the restructuring of China Cosco Group and China Shipping Development. Photos:, Xinhua
Many investors are disappointed by the restructuring of China Cosco Group and China Shipping Development. Photos:, Xinhua

China SOE reform: Three strikes and you’re out

What do you call a group of stocks that fell more than 20 percent upon trading after a four-month suspension?

Answer: Chinese state-owned enterprises reform.

Pity the investor who fancied a hefty Christmas present upon hearing the news that China Cosco Group and China Shipping Development would be restructured.

Aimed at achieving efficiency by delineating clear and separate lines of business, the reform would have China Cosco (01919.HK) focusing on container shipping and Cosco Pacific (01199.HK) on container terminals.

On the other hand, China Shipping Container Lines (CSCL, 02866.HK) would become a financial container leasing company while China Shipping Development (01138.HK) would concentrate on oil transport and sell back its loss-making dry bulk cargo unit to Cosco Group.

Both China Cosco and CSCL fell more than 26 percent, suffering their worst-ever decline, while former blue-chip Cosco Pacific fell 17 percent. China Shipping Development was lucky; it recorded an 8.2 percent share gain.

The message was clear: Investors voted against the deal because it was not a full merger in which they could cash out. Also, the change in the business nature of the four flagships gave fund managers no choice but to dump the stocks.

One negative consequence was that the whole restructuring exercise might have a good chance of being vetoed – as the fate of these companies is now closely interlinked – meaning opposition to one would spoil another and then the whole deal.

More importantly, this Chinese style of restructuring, or value destruction – as it has come to be known – underscored the enormous challenges of reforming state-owned enterprises. It began last year with the railway and mining sectors and is now turning to shipping.

The failure of two out of three mergers does not look good for deals still in the pipeline.

Just last week, the proposed merger between China Minmetals Corporation and China Metallurgical Group Corporation (CMCC), which would free the latter from direct supervision of the State-Owned Assets Supervision and Administration Commission (SASAC), met chilly response from the market. CMCC dropped 20 percent from its price before suspension.

The merger between China South Locomotive and Rolling Stock and China CNR into CRRC Corporation (01766.HK) was simply magical. Their share prices jumped over 50 percent right after the transaction was proposed, spurring hopes for more similar deals to come.

Nothing as auspicious followed.

The SOE reform is fueled by a burning desire to inject efficiency into those mammoth enterprises. The number of state-owned firms under SASAC fell to 107 from 196 in 2003, but mergers only highlight the problem with scale. As the company grows bigger, so do its problems.

In the first 10 months, SOE profits fell 11 percent not just because of macroeconomic headwinds, but also because many of these firms have been undertaking ambitious expansion programs which only resulted in excess capacity and worsening operating environment.

There is a lot to learn from Corporate America about handling mergers, specifically the need to communicate better with institutional investors as to what lies ahead.

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EJ Insight writer

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