China's SOEs: Reform agenda?

Sinopec, one of the country's three leading state-owned oil majors, revealed plans in February to restructure its marketing business and allow in "social and private investors." This was the sprawling downstream business, comprising 30,000 gasoline stations, 23,000 convenience stores, plus oil pipeline and storage facilities.

A 30% stake in the business would be sold for $17 billion. But who would get it? CICC Private Equity, Bohai Industrial Investment, RRJ Capital and Hopu Investment Management were the independent PE players chosen. Each either has direct ties to the state-owned bureaucracy or a track record of working with it. The investor roster was filled out by combination of domestic financial and strategic players.

This was a landmark transaction in that it represented an early foray in China's latest push towards state-owned enterprise (SOE) reform. By diversifying ownership and bringing in true commercial players, it is hoped that these behemoths' efficiency, productivity, corporate governance and return on assets will improve.

Given this is hardly a new topic, an oft-repeated list of questions apply. How committed is the government to bringing about significant and lasting reform? What kind of assets will be made available to what kinds of investors? And to what extent will these investors be allowed or expected to elicit real change?

According to the State-owned Assets Supervision and Administration Commission (SASAC), there are more than 140,000 SOEs in China with RMB55 trillion in assets at the end of 2012 and more than 69 million people on the payroll. Most of them are controlled by local governments, not by SASAC itself.

Using the earnings of the MSCI China Index constituents, PineBridge Investments calculated that SOEs' return on equity in the first half of 2014 was 13% compared to 25% for private companies. Their balance sheets have also weakened since the global financial crisis - when SOEs benefited from loose monetary policy intended to shore up the economy - with net gearing reaching 41% as of June 2014. Private companies' net gearing was 20%.

There is evidence that Beijing is taking reform seriously. Sinopec is one of several large SOEs that is undergoing restructuring. CITIC Pacific has acquired a huge swath of assets from its state-owned parent, while China Everbright has announced plans to switch from a SOE into a joint stock company. Furthermore, earlier this year SASAC identified six SOE parent groups to serve as pilot projects for private investment.

Answering the last two questions is more difficult. Sinopec Marketing, for example, is a plum asset and a host of private investors were interested in it. But given the nature of the asset and the number of investors, can they hope to play - indeed, will they be required to play - a meaningful role in improving performance? 

At the other end of the spectrum, there are plenty of SOEs in a far worse condition that cash-strapped local governments are desperate to offload. Will private investors be interested in these assets? It all depends on how distressed the businesses are and whether the investors are allowed to implement meaningful turnaround strategies without interference from the vested interests that percolate the SOE system.

Private equity firms have participated in successful SOE restructurings. CITIC Capital Partners and Hony Capital were early entrants into the space. Hony claims to have been involved in 31 such transactions. Most recently, the GP acquired a minority stake in hotel chain Shanghai Jin Jiang International. The GP plans to improve governance and management and then make acquisitions at home and overseas. 

These deals are not for PE firms that are too foreign or too faint-hearted. SOE credentials and the government connections that come with them help generate initial traction - Hony is sponsored by Legend Holdings, CITIC Capital has ties to CITIC Group. But bringing about better performance often requires unwinding layers of entrenched habits, micro-political power bases and perhaps blatant corruption.

It remains to be seen which assets are opened up to such potentially sensitive re-tooling, and whether they end up in the hands of investors with a genuine ability to execute.

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• Topics
• Regulation
• Greater China
• CICC
• CITIC Capital
• China
• regulation