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Chinese business at risk from monopoly mindset
Mure Dickie and Richard McGregor, FT Syndication Service
1/3/2005
BEIJING:Trading scandals are "not unique to China", points out a manager at one of China's better-run state-owned enterprises, worried that the stunning loss of US$550m by China Aviation Oil (CAO) will tar the reputation of the country's entire public sector among investors.
"The media and public should be careful about labelling this a 'Chinese' event," he says of the losses the Singapore-listed but state-controlled company is suspected of trying to hide from investors.
The manager's reminder is not unreasonable: Britain's Barings Bank and Japan's Sumitomo have demonstrated the potential dangers of derivatives trading to corporations from any country.
But few analysts doubt that CAO's woes are an important reminder of the particular problems that plague many Chinese companies listed abroad -- and a hint that these stem in part from structural issues as much as individual failures of corporate governance.
While Chinese companies that win the chance to issue shares internationally are generally considered the cream of the state sector, their performance often reflects a ready-made market rather than entrepreneurial flair or managerial skill.
"Look at the state-owned enterprises that are highly profitable. They all enjoy 'risk-free' profits from a monopoly market position," says a Chinese expert on the management of state assets. "In competitive industries, state ventures' profits are very low."
Certainly, China's biggest listed companies abroad are oligopolies rooted in controlled markets and still seen by Beijing as important arms of the state.
Units of China's state-owned oil, gas and telecoms giants account for the lion's share of the value of mainland companies listed overseas, equal to 49 per cent of the Morgan Stanley Capital Index for China. Such companies often inherit a culture of exploiting ties with government rather than creating value, says the Chinese expert.
Beijing has been promoting overseas listings in part as a way of improving state companies' management by exposing them to oversight by international regulators and investors.
China's oil majors and the telecoms operators have not been content to exploit captive customers but are working hard to develop businesses, while competing fiercely in local markets.
But the debacle at CAO shows how pressure to produce profits has dangers for companies with a state monopoly mindset. China's domestic jet fuel price is pegged to international levels and CAO had a virtual lock on the market because it controlled domestic distribution, prompting it to seek growth in aggressive overseas investment and oil and derivatives trading.
Global investors are hardly unaware of the risks. Chinese companies are allocated risk-weightings by brokerages and fund managers to reflect their relative regulatory and political perils. The weighting builds in a discount from the returns that might be expected from a stock in a similar industry in a developed country. For China, the discount is about 13-14 per cent, about the same as Indonesia.
"Investors know there are these kinds of risks with Chinese companies and they put their money in with their eyes wide open," says a Hong Kong-based broker.
However, because of the size of the biggest state-owned ventures, fund managers investing in China who are benchmarked against the MSCI index cannot afford not to buy them. "The fund manager can be right and the market can be wrong for a long time, and probably for longer than you can hold your job," the broker says.
Despite the creation of investor relations departments and commitments to minority shareholder rights -- CAO claims "prompt disclosure" is the cornerstone of its policy -- transparency at most state enterprises remains limited.
Beijing also treats top management as officials of state, sending the head of a listed oil major to a government post in Hainan Province and rotating top leaders of listed telcos.
Bill Kaye, of the Pacific Group, a hedge fund based in Hong Kong, says the recent telecoms merry-go-round shows the government does not see these companies primarily as independent profit-making enterprises. "If you believe your next position is going to be at the head of your direct competitor, why bother trying to build a competitive company in the first place?"
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