Monday, March 30, 2009

Parts of Delphi on the Block? / Thoughts on Chinese Purchase of Foreign Automakers

With all the rumors of acquisitions in the global auto industry that have been floating around recently, I hesitate to report the following. According to a report in today's Caijing, Beijing's city government is putting together a group to buy portions of the assets of Delphi, the US-based auto pars supplier spun off from GM in 1999.

According to the ubiquitous "knowledgeable person" (知情人士) who seems to be the source of all these rumors, Beijing Auto (北汽) is expected to take part, but its participation is not yet confirmed. The only participant that has been revealed thus far is Tian Bao Group (天宝集团), a private auto parts firm controlled by Zhou Tianbao who, according to Hurun, is the 821st richest person in China.

Caijing's "knowledgeable person" pointed out that it is not yet clear which of Delphi's assets Beijing's group intends to buy. (I should also point out that Delphi itself has made no such announcement.)

As would be expected, Delphi's recent fortunes reflect those of the US auto industry as a whole; however, Delphi has had a rough go of it since being spun off from GM, having declared bankruptcy in 2005.

The list of rumors of potential Chinese takeovers of foreign automakers or auto parts suppliers grows longer by the day. Aside from Geely's announcement that it will buy bankrupt Aussie parts supplier DSI, there has been little real news in this space.

I am beginning to wonder, were the Chinese ever truly interested in acquistions of foreign automakers? Or did foreign automakers plant these rumors to pressure the Chinese or appeal to their egos?

I ask these questions because I see little reason for the major Chinese automakers to buy one of these foreign firms. All of the major Chinese players are pouring tons of money into R&D to develop their own technologies. Most of them have also absorbed much technology and knowhow from their foreign joint-venture partners. And some of GM's and Chrysler's best engineers, many of whom immigrated from China, will probably be looking for work soon.

While many Chinese-made auto brands may currently be lacking in terms of quality and safety, these deficiencies, at least among China's major players, should be remedied in short order. The only thing they are lacking is foreign distribution.

The only acquisition by a major player that makes any sense to me would be one that opened up avenues for foreign distribution of, first, foreign-branded cars assembled in China, and eventually, Chinese-branded cars.

Wouldn't the $5-6 billion that a Chinese company could spend for Volvo go a lot further when poured into R&D at home?

Wednesday, March 25, 2009

FAW Projected Capacity Now 300,000 Fewer

According to, FAW Toyota will delay the opening of a new plant in Changchun which was to have had a capacity of 100,000 Corollas a year. Combined with its intention to sell an already constructed, but as yet unused, factory in Chengdu announced earlier this month, FAW's projected capacity is already 300,000 fewer vehicles. First Auto Works, the group holding company of FAW Toyota, is currently China's second largest automaker by number of units sold.

FAW and Toyota announced this planned factory only last October, and while FAW has obtained its share of the funding, Toyota has yet to contribute. This is thought to be part of Toyota's overall strategy for cutting global capacity during the current downturn.

According to Gasgoo,
FAW Toyota has a total capacity of 440,000 vehicles in China, but in 2008 the joint venture fell short of its sales target of 410,000 units and this year it aims to sell 380,000 units. The surplus capacity has rendered the facility expansion less urgent for the moment.
FAW's recent announcements seem to run counter to other announcements of capacity increases within the past year including new factories for FAW-Mazda, FAW-Haima, Brilliance and Dongfeng Honda, among others. And despite the fact that Chinese auto sales have surpassed those of the United States for the past two months in a row, overall Chinese sales growth is considerably weaker than in recent years -- this despite the government's recent successful attempt to goose sales by cutting sales taxes on small cars.

It's amazing how quickly conditions can change, and how quickly they can affect ambitious plans. If FAW is cutting back capacity expansion this quickly, can other automakers be far behind?

At this point, smart money in China should be going toward R&D to develop independent brands (自主品牌) and alternative energy vehicles (新能源汽车). In the coming capacity shakeout, those companies with a technological edge are more likely to survive. Those that offer little more than massive production capacity may find themselves carved up and sold off to the winners.

Tuesday, March 24, 2009

BYD's Edge in Battery Technology

WSJ's China auto reporter, Norihiko Shirouzu, recently visited BYD's factory to observe their key competitive advantage: battery technology.

As mentioned in previous posts (here, here and here), unlike every other car company in the world that is currently scrambling to offer alternative energy vehicles, BYD started, not as a car company, but as a battery company. Only in 2003 did BYD buy an auto company and begin to mesh the two technologies. In December, they stole a march on the rest of the world by releasing the world's first production plug-in hybrid, a year ahead of Toyota, and two years ahead of GM's Chevy Volt.

According to Shirouzu, BYD's advantage is its iron phosphate-based lithium ion battery.
Unlike conventional lithium-ion batteries, the type of battery BYD is now producing for its green cars is markedly safer. Conventional cobalt-based batteries, used primarily in cell phones and laptops, have shown a tendency to overheat, and have caught fire and even exploded in some rare cases. The phenomenon is known among scientists as “thermal runaway.”

By contrast, iron-phosphate batteries overheat only to the point where they might start smoking, but unlike cobalt-based batteries, even if an iron-phosphate battery overheats and reaches that smoking stage, it will not turn into thermal runaway because of its inherent chemical stability.
These iron phosphate based batteries also have greater tolerances for mistakes in the manufacturing process, an advantage for BYD which, like most Chinese manufacturers, is still very labor intensive:
There is a definite labor-intensive, low-tech feel to the way BYD, which China Journal recently visited, produces high-tech batteries and other key components for electric cars. Rows of workers in their late teens and early 20s, wearing blue company uniforms, assembled the batteries by hand. There were few robots, and little visible automation - very different from advanced battery plants you might see in the U.S., South Korea and Japan whose companies have been the world’s leaders in hybrid and electric-car batteries.
For all its recent talk about the need for a big push to develop alternative energy vehicles, China's government seems to be playing catch-up to privately-held, Hong Kong traded BYD. Yet while BYD is ostensibly private, it has also benefited from heavy support from the governments of Shenzhen and Guangdong Province.

Somewhere between the Western model of no government ownership (pre-crisis, of course), and the China model of state control (which describes 8 of China's top 10 automakers) there is a semi-public/private model wherein private firms receive heavy state support. Could this be a model for the future of innovation?

Friday, March 20, 2009

Human Flesh Search Engines in the World of Finance

Today I encountered a new term: "listed company human flesh search engine" (上市公司人肉搜索).

Those who follow China are familiar with the term "human flesh search engine" as a metaphor for a spontaneous online uprising of people whose main purpose is to exact revenge for a perceived wrong -- an online equivalent of the mob who showed up outside Dr. Frankenstein's house with torches and pitchforks.

This term has now been prefixed with "listed company" to describe people who obtain inside information on listed companies and spread that information online for the purposes of manipulating the share price.

The Shenzhen Stock Exchange announced today that it would be taking steps to counter this kind of behavior, first of all by simply warning investors of the risks of following the advice of such unauthorized communication. They even used a term that I have not often encountered in the Chinese press: 投资者关系 or investor relations -- a concept that has been slow to catch on in China so far since the only investor most listed companies have to worry about is the government.

Secondly, and most importantly, the Exchange vows to strengthen supervision over the manner in which listed companies release information to the public, ensuring that information is released in a more timely manner. In a lesson that many governments could stand to learn, the Exchange gets the fact that rumors can be countered with more timely release of official information.

An "industry insider" was quoted as saying that, from this point forward, people without credentials would have to "shut their mouths", and only those with approved credentials would be able to conduct equity analysis for public consumption. Organizations providing analysis will be supervised by both the authorities and the investing public. If someone has a problem with a particular analyst's work, they may file a complaint.

This is a good start, and many of the provisions make sense; however, as with all good starts, there are shortcomings. First, the internet is a big place, and while the authorities have developed the capability to filter out political content, it will be much harder to filter out information regarding companies. Any filter that blocks certain keywords could end up blocking legitimate information channels as well.

Second, while it is good that there are legitimate equity analysts with valid credentials in China, I have yet to find anyone in China who accords fundamental analysis any importance in their investment decisions.

It is early days yet, and Chinese shares still do not reflect the underlying value of the firms they represent. And even if they did, the state's controlling share in most of the listed companies makes inside information as to the state's intentions one of the most important pieces of information for determining the future direction of a stock price. Will credentialed analysts be privy to such information?

Thursday, March 19, 2009

Remind me again...What does "IPO" mean?

It has been so long since we've seen any IPO action that the average observer may be forgiven for not remembering what the term means.

Sohu, a Chinese portal site has filed with the SEC its intention to list the shares of its online game subsidiary on NASDAQ. Sohu, itself also listed on NASDAQ, controls 70.7 percent of the shares of Changyou, the subsidiary that it intends to list.

This latest IPO is all the more interesting because it is a Chinese company preparing to list shares in the United States. In the 1990s, Chinese IPOs in New York, particularly those of internet-related companies, were not uncommon. A number of large Chinese SOEs also listed their shares in the U.S. in order to take advantage of the vast sums of wealth available outside of China.

Over the past decade or so, there has been a noticeable decrease in overseas (not including HK) Chinese IPO activity for a couple of reasons. First, the Central Government has begun to speak out against overseas listings and encourage more domestic listings. Second, there's so much more money floating around China now, and domestic investors are always eager to snap up new offerings.

According to this story at Economic Observer Online, online games have been a bright spot in an otherwise dismal economy this year. Sohu's online game revenues are already 2.4 times the same period last year.

The market, however, is not impressed. Sohu was downgraded to "sell" this morning.

Wednesday, March 18, 2009

Suppliers and Transparency in China's Auto Industry

Note: This particular post is more theoretical in nature than usual. It is based on research and discussions with knowledgeable people, but I do not yet offer empirical evidence to support my claims. I welcome constructive criticism from anyone with the time and inclination to read this to the end.

Q: What factors influence a Chinese auto assembler's selection of suppliers?
  • low price?
  • dependable quality?
  • flexibility?
  • degree integration with supply chain?
  • all of the above?
A: All of the above should be important, and indeed many of these factors probably enter into many sourcing decisions; however, there is another important factor that, if not unique to China, is certainly important in the world's more controlled economies. That factor is transparency.

The transparency I refer to here is not transparency of a supplier's operations; it is transparency of an auto group's financial condition -- or more precisely, the lack thereof. Before I explain what this means, a little background is in order.

The typical Western model of assembler-supplier relationship has evolved over time from one of in-house suppliers to many outside suppliers. At some point, GM decided to focus on its core competency, assembling automobiles, and it spun off its Delphi parts maker. Ford did much the same with Visteon. Delphi and Visteon are now publicly traded companies that not only manufacture parts for their former owners, but are also free to do so for any other firm that wishes to engage their services.

The value for Ford and GM is that they now have more options for sourcing parts, and their suppliers now have to compete against each other for business.

What sort of assembler-supplier models do we see in China? So far I have identified two ideal types: the group parts supplier network and the external parts supplier network. In reality, these types are not mutually exclusive, and we see varying mixes of the two among China's domestic auto assemblers. However, by considering these two types we can gain an understanding of the motivations of Chinese auto assemblers.

The first type, the group supplier network, is one in which all or most suppliers, while not a part of the auto assembly enterprise, are part of the same group or "jituan" (集团) as the assembler. The second type is similar to the Western model in which all or most suppliers are external to, and not organizationally linked with, the assembly firm.

It is easy to assume that Chinese automakers, like their Western counterparts are moving toward the second model for the same reasons that GM and Ford did: increased competition among suppliers allows for lower prices. However, among China's major, listed automakers, the first model continues to dominate, and for reasons unrelated to efficiency. Furthermore, while the landscape continues to evolve, there are varying degrees of internal vs external suppliers for listed Chinese firms.

We might then assume that, ceteris paribus, those companies with the higher degree of internal supply have lower profitability since their suppliers endure less competition for business. In theory, however, we should expect to see exactly the opposite.

In China, most of the major automakers, despite being partially listed on the stock markets, are part of much larger group companies or "jituan". These jituan, while holding controlling ownership in the auto assembly firms, also own many other subsidiaries including hospitals, kindergartens, retail stores, real estate, and yes, auto supply firms. While the jituan's listed auto firm is required to publish audited annual financial statements, the jituan, and all of its non-listed subsidiaries, are not bound by such requirements.

This lack of transparency works in the jituan's favor. By requiring its internal parts suppliers to sell parts to the listed auto assembler at or below cost, the jituan is able to pump up the earnings of its listed subsidiary while hiding the losses of its non-listed subsidiaries. And, all things being equal, higher earnings by the listed subsidiary, lead to a higher stock price which increases the value of the jituan's controlling stake.

The auto firm with many external suppliers, on the other hand, buys a larger portion of its parts at a market-determined price, a price that will allow the parts supplier (itself also possibly a listed company) to earn a reasonable profit. Consequently, the assembler that benefits from competition among its suppliers is punished in the market for doing the right thing. Being unable to force its suppliers to absorb losses, the firm with external suppliers should, all things being equal, earn a comparatively lower profit than the firm with many internal suppliers.

This problem has not escaped the notice of China's State Council or its market regulators. In recent years, there has been increasing discussion of the concept of a "complete listing" (整体上市). The idea here is for a gradual move toward a listing of an entire jituan rather than selected subsidiaries.

As with many new concepts in China, rhetoric often outstrips implementation. For reasons that should be obvious, the jituan are in no hurry to increase transparency, and the government is in no hurry to witness the negative effects on China's stock market that would surely obtain if subsidiary losses are brought to light.

Sunday, March 15, 2009

The First Auto Merger of 2009? Hafei and Changhe

This one is kind of like kissing your sister, but it qualifies as a merger nonetheless.

Hafei Auto and Changhe Auto are both owned by AVIC (Aviation Industry Corp. of China), which is, in turn, owned by Central SASAC. AVIC, which also owns Harbin Dongan Auto Engine Company, has recently announced the creation of a new umbrella entity which will combine all three of these automobile-related companies. According to the 21st Century Business Herald, the new company, China Aviation Industry Automobile Corporation (中国航空工业汽车有限公司) officially began operation last Thursday (March 12) in Beijing.

I know I need to update this chart with 2008 numbers, and I will at some point, but even with 2007 numbers it still helps to illustrate the current market share landscape of China's auto industry.

Recall if you will that China's State Council designated a "Big 4" and "Small 4" among China's top auto producers. The Big 4, SAIC, FAW, Dongfeng and Changan will be allowed to pursue nationwide acquisitions. The Small 4, Beijing, Guangzhou, Chery and China HDT will be allowed to pursue regional acquisitions.

Among the remaining firms on this list are private automakers Geely, Great Wall and BYD, and state-owned automakers Brilliance, Hafei, Jianghuai and Changhe.

The private automakers will presumably be left to fend for themselves since, theoretically, the government has no say in their existence. That remains to be seen, of course, and is an interesting topic that I shall set aside for a future post.

Among the remaining state-owned firms, Jianghuai has already been mentioned as a possible partner for Chery since both reside in Anhui Province. (And since this previous post, I have also discovered that, though Jianghuai is owned by the provincial government and Chery is owned by a city government, both were started by Anhui's provincial government.)

This leaves only Brilliance without as yet any rumor of a potential suitor.

So what is AVIC hoping to accomplish by combining its auto entities into a single company?

AVIC is pushing these companies closer together to improve efficiency and profitability. The plans are to "coordinate on R&D, purchasing and sales platforms". They want to avoid competing in the same segments, and they also want to move toward using many of the same parts. There is also the requisite vow to "take the lead in development of low-emission and alternative energy vehicles" that no Chinese auto company can afford to leave out of any press release nowadays.

Given its priorities in aviation (such as building airliners to compete with those of Boeing and Airbus) does AVIC really want to remain in the automobile business? This is hard to answer, and at the moment AVIC has given no public indication that it wishes to exit the auto business. However, even if AVIC were keen on keeping its auto businesses, the point has recently been rendered moot by the government's "Big 4, Small 4" paradigm.

If I were to hazard a guess (and I do so haphazardly) it is that AVIC is grooming its auto businesses for a sale to one of the larger players. Perhaps AVIC believes that, by creating a much larger, and presumably more profitable, automobile company, it is less likely to come under pressure to sell its smaller Hafei or Changhe companies to smaller players for smaller money.

Thursday, March 12, 2009

Ready-Fire-Aim: China's "New Energy" Vehicle Policy

The current version of me is a scholar, and as a scholar, I endeavor to conduct dispassionate analysis "without fear or favor". If anything, I may lean harder on the American government because they take money from me, and I have opinions as to how it should be used.

As a China specialist, I also have plenty of criticism for China, but that criticism is often tempered by fascination -- fascination for how things work so differently in China, yet often manage to achieve success (to varying degrees). However, while the headline of this post may be interpreted as a criticism, it is anything but.

What fascinates me about China's policy for encouraging development of "new energy" vehicles (新能源汽车) is the manner in which it has been formulated. When it was first announced in January, some observers (myself included) were critical of the lack of details contained in the policy. The government announced a general commitment of 10 billion RMB to support the development of "new energy" vehicles, but no details of how this 10 billion RMB would be spent.

This is only one example, but it is not at all atypical of the legislative process in China. The State Council hammers out general rules, either leaving the details to be worked out by relevant ministries or local governments, or working out the details themselves over a longer period of time. The interesting thing here is that the Central Government frequently commits itself to big plans, often without knowing how they will be implemented -- apparently knowing that, in time, they will have to figure it out.

Deng Xiaoping's notion of "crossing the river while feeling the stones" continues to guide China's leaders.

Contrast this with the legislative process in Washington, D.C. in which laws must contain the basic details of their implementation. Because of the necessity of providing a detailed roadmap for implementation, legislation takes much longer to pass; it is these details over which much of the haggling takes place. And while Presidents and presidential candidates may often make promises regarding fiscal restraint or transparency, recent legislation, including the stimulus bill and yesterday's appropriations bill, demonstrate very clearly that the President has very little influence over legislation. (I recognize that, historically, some Presidents have exercised more legislative influence than others.)

My point here is not to claim that China's system is superior to America's -- both have their pluses and minuses -- but to point out that, sometimes, it may make sense to start firing your gun before you've had time to take aim. This is a way for a government to commit itself to big plans without having to work out all of the details in advance. It is also a way for factional governments to tie their hands so that those who may object to a policy will have a difficult time reneging on their (possibly grudging) support at a later date.

Today, an official of China's Ministry of Industry and Information Technology (MIIT), in an interview with Caijing, mentioned a few details that are being considered for support of "new energy" vehicle development. They are discussing what, by any standard, are rather generous subsidies of anywhere from 10,000 to 50,000 RMB per car, depending on how much energy a given car model is able to save.

If you do the math, the 10 billion RMB currently set aside would fund subsidies for anywhere from 200,000 to 1,000,000 clean energy vehicles. The midpoint would be about 600,000 cars.

If automakers are wondering whether there will be a market for the "new energy" cars they are being "encouraged" by the Central Government to make, numbers like this should offer some encouragement.

The MIIT official also pointed out that this is part of a "long-term incentive policy". China's government, it would seem, is determined that China become a major player in the global market for alternative fuel vehicles.

Are other governments willing to go this far? Are they able to go this far? Should they go this far?

Wednesday, March 11, 2009

Who Wants to Buy an Auto Factory in Chengdu?

First Auto Works has excess capacity. A factory in Chengdu that, according to, was to have been its third manufacturing base, is no longer needed. It makes sense that they would want to sell it to someone else who could make better use of it.

Who would be interested in a factory located far inland? Well, as it turns out, it doesn't really matter who is interested. While FAW wants to sell its factory, it has also placed strict conditions on who the purchaser can be. The purchaser must be a domestic auto firm with registered capital of at least seven billion RMB and annual revenue of 80 billion RMB. That limits the possibilities to only five: Changan of Chongqing, Bejing Auto, Dongfeng of Wuhan, Shanghai Auto or Guangzhou Auto.

However, if China's recent "big 4, small 4" designation is taken seriously, Beijing and Guangzhou would be dropped from the list as they will only be allowed to expand regionally, not nationally. So now we are down to only three possible purchasers: Changan, Shanghai and Dongfeng.

FAW, is one of only two centrally-owned automakers (three four if you count Hafei and Changhe which is are owned by AVIC, the aviation monopoly), so unlike locally-owned SOEs or private automakers, there is little chance that we will see FAW dragging its feet in implementing policy. The conditions on the sale of FAW's factory, we can be fairly certain, were placed, not by FAW, but by the Central Government. My money is on the NDRC (National Development and Reform Commission), which still thinks of itself as the state planner with the power to pull levers as if China were still a command economy -- but that is mere speculation on my part.

In a real market economy, FAW would decide it has too much capacity, put its factory up for sale, and accept the highest bid, regardless of who the bidder was. And such bidders might have included, not only Chinese auto firms, but also foreign auto firms or even a real estate firm.

The point here should not be surprising. It is that the Central Government intends to remain very much involved in the development of this industry. They understand very well that China's design capabilities are still in their infancy, and that foreign auto makers are viewing China as one of the few places in the world in which they can sell a significant number of cars.

Until recently, Chinese automakers have largely been content to learn manufacturing from their foreign JV partners, but the real key to growing an auto industry is not in manufacturing; it's in design. The Central Government is in the process of separating the sheep from the goats because they will want to see more concentrated efforts on R&D and less on just cranking out cars, half of the profits of which flow back out of the country.

FAW's factory will probably go to whichever among Changan, Shanghai or Guangzhou can demonstrate the ability to produce a high-quality, independently-designed sedan with national appeal, and quickly ramp up production.

Tuesday, March 10, 2009

Why a Chery-Jianghuai Merger would be a Tough Sale

There has been a lot of speculation in recent weeks of the possibility of a merger between Chery Auto and Jianghuai Auto, and I must admit that I have also taken part in the speculation. Still, this potential combination makes sense for a number of reasons.

  • Chery and Jianghuai are both headquartered in Anhui Province, so a merger would make sense from both a logistical and managerial standpoint.
  • They are both manufacturers of independent brands (自主品牌), so a combination would help to ease the R&D expense burden.
  • The Central Government really wants to see consolidation in this sector, and has increased recently increased the volume of its demands. A merger entered into by Chery and Jianghuai under their own terms would probably be preferable to one engineered from above.
  • Finally, Chery has been waiting for years to list itself on the stock market, and a merger with Shanghai-listed Jianghuai would give Chery instant access to equity markets.

However, despite all the good reasons for a merger to happen between these two, politics will likely intervene -- if not to stop a merger altogether, at least to ensure that it doesn't happen quickly or easily.

Chery, one of China's top-ten automakers, was recently designated by the Central Government as one among the "4 small" automakers that would be encouraged to expand regionally. Jianghuai, also among the top-ten, was overlooked in the listings, meaning that it will most likely be aquired by one of the others.

The difficulty with this possible arrangement is that Jianghuai's ultimate controlling shareholder is the Anhui Provincial Government while Chery's controlling shareholder is merely the City of Wuhu.

In an ideal world, this should not matter, if a combination makes business sense, then it should happen. But in reality -- and in China -- hierarchy is pretty important. There are a lot of egos at stake.

The Central Government, by designating Chery as one of the intended survivors of consolidation, may have unwittingly increased the difficulty of what should have been a naturally good fit.

Sunday, March 8, 2009

Geely's Li Shufu: Only Private Firms Can Compete

One of the biggest mysteries regarding China's auto industry is not only why private firms believe they can compete with the state-owned giants, but why some of them are actually quite successful. Three of China's top 15 auto firms are private: Geely, BYD and Great Wall.

State-owned enterprises are not only economic entities, but they are also political. The politicians who exert control over them tend to be more concerned with their own political futures than the economic viability of state-owned enterprises, and they find that SOEs are great vehicles for boosting employment and distributing favors to political allies. With the state purse at one's disposal, a politician can pay for this influence by subsidizing SOEs that are forced to operate in an economically imprudent manner.

Given the advantages held by SOEs, why do private firms bother?

Today's Economic Observer Online has an interview with the Chairman of Geely Auto, Li Shufu. While Li doesn't directly answer the question in this interview, he gives reasons as to why he believes that private firms will ultimately dominate China's auto industry.

Why does he bother competing with the SOEs? Because he believes he will win.

The interviewer asks Li what he thinks about the provision in the recent auto industry stimulus plan to promote consolidation in the industry. He responds (translated):
I firmly believe this is a competitive process: first, state-owned firms are defeated by foreign capital; then foreign capital (will be) defeated by private firms.

The auto industry has all along had a high degree of competition. At the same time, this industry is highly technology-, talent- and capital-intensive. It is not suitable to be developed by state-owned enterprises. From an economic perspective, the auto industry is a competitive mainstay (pillar) industry ... it is presently dominated by state-owned enterprises. But from a development perspective, the auto industry will experience a long, competitive process...

Right now, (the industry) is only at the beginning stages. Currently the domestic market is led by the foreign joint-venture brands. This situation is protected by current policy. As policy gradually becomes more open, the foreign enterprises will inevitably, gradually occupy the Chinese market...

Private enterprises have the innate advantage of localization. (Private enterprises) have accumulated many years of rich industry experience, upstream and downstream industry resources, distribution network systems, etc. The foreign enterprises cannot compete with these advantages.

I believe that the competitive process of the auto industry will continue for another 10 years. When the private Chinese enterprises ultimately win, I hope Geely will be among the best.

In summary, Li believes that,
as auto industry policy gradually becomes more open, SOEs will increasingly lack the ability to compete head-to-head with foreign firms. Of course, whether policy indeed becomes more open remains to be seen. Furthermore, what is to prevent SOEs, with their access to government funding, from also developing the advantages that Li ascribes to private firms?

It is, however, difficult not to admire Li's optimism. Until now, we in the West have been content to believe that private firms are driven by a hunger to survive, a hunger that cannot be found among state-owned enterprises. And it is this hunger that ultimately pushes private firms to be more efficient, productive and profitable than SOEs.

In the longer term, however, will that hunger be enough for China's private automakers?

Friday, March 6, 2009

Leaks on Beijing Auto Pursuit of Chrysler Assets

This was a big story about ten days ago, but the chatter has since died down. As with all of these types of stories, the participants deny them until they either happen, or something else takes place that precludes the possibility.

The Economic Observer Online is now reporting more specifics on the potential for a purchase of certain Chrysler assets by Beijing Auto, a local state-owned automaker that makes Hyundai, Mercedes and a few local brands.

News sources reveal ("消息人士透露") that the city government of Beijing will extend to Beijing Auto funding of up to 10 billion RMB (about $1.4 billion). Five billion will be used to buy Fujian Auto, a company that already makes some Chrysler models in China, including the Grand Voyager minivan. (Rumors of the Fujian purchase -- also subsequently denied -- surfaced several weeks ago.)

The remaining five billion RMB will be used to "buy seven Chrysler models, a research and development center, and an engine assembly line..."

The story also lists the names and positions of the individuals on Beijing Auto's merger and acquisition leadership committee.

Such details do not appear out of thin air. If these transactions do not ultimately happen, apparently it will not be for lack of trying.

Auto Industry Consolidation: Who Calls the Shots?

I am happy to see that my interest in consolidation in China's auto industry is shared by others. Part of the interest stems from my overall research agenda which is to understand the nature of business-government relations in general.

The auto industry presents a great opportunity to observe in detail how these relationships affect outcomes. It also gives us an interesting case to compare to the U.S. experience of about 80 to 90 years ago when, like China today, there were over 100 auto assemblers in the U.S.

My assumption today is that the U.S. government remained largely aloof from the consolidation process, but frankly, that's only an assumption. Perhaps the U.S. government had a bigger role than we realize. (That's not the topic of this particular post, but I'm just throwing that out there.)

A couple of interesting posts on other China-focused blogs have recently covered the issue of consolidation in China's auto industry to varying degrees.

First is an interview with Bill Russo, former Chrysler guy in China (still in China, but no longer with Chrysler) on Aimee Barnes' blog. (h/t ChinaLawBlog). I'm specifically drawn to the following passage in part 2 of the interview:
In China, there are over 100 licensed automotive OEMs. That can’t continue- this is a market that just isn’t big enough to sustain that many licensed manufacturers. So, what will happen is the weaker OEMs will merge with the stronger OEMs. The government will also act a lot faster to correct the supply and demand imbalance - this is a top down system. The government will act in a way that constrains the capital inflow and guides consolidation towards a particular and preferred outcome.
The other is a post specifically about China auto reform by David Wolf on his Silicon Hutong blog. Wolf offers several reasons why consolidation, while definitely in the cards, will not happen anytime soon:
  1. Geographical concerns. Forcing one auto maker to be acquired by another would require the Central Government to make hard political choices favoring one region over another. Wolf also notes that, while local governments have the power to derail possible mergers (an argument I have made before as well), the Central Government ultimately has the power to overcome local resistance.
  2. Hastily closing down excess capacity in China could hand market share over to the foreign joint ventures. Slowing the process would allow makers of independent Chinese brands to gradually gain a stronger local market position.
  3. It is too early to tell which Chinese automakers will come out on top, so the government is wise not to pick the winners too early.
Wolf concludes:
The nation's auto industry will be reformed in stages rather than with the single stroke of a pen, and the speed of those reforms will depend not only on market growth and global finance, but on the demonstrated ability of China's automakers to withstand the successive waves of change they will face in the coming years.
Based on my reading of the above, Russo appears to believe that the Central Government will act to bring about consolidation when it wants; whereas Wolf sees the process as more of a negotiated outcome that will take place over a longer period of time. I will throw out a few additional points that I think have an effect on consolidation and close with a series of questions.
  1. While the Central Government has been harping (justifiably, I believe) on the need to reduce overcapacity in the auto sector, now is not the time (from the perspective of China's leaders) to risk the additional unemployment that could result from forced acquisitions. Unemployment ≠ Harmonious Society.
  2. Despite its continual calls for consolidation, the Central Government appears to be more interested in the development of independent Chinese brands, and is willing to continue tolerating inefficiency in order for that to happen. For example, rather than allowing the Export-Import Bank to give Chery a 10 billion RMB loan for expansion, the Central Government could have made funding contingent on a merger with another automaker. Why didn't the Central Government take this opportunity? My guess is that Chery's position as maker of the best-selling independent Chinese brand had something to do with the decision. (This argument is related to Wolf's point 2 above.)
  3. Granted, the Central Government has the ultimate power to force consolidation. However, I am going to assume that the leaders in Beijing are intelligent enough to know that the cost of getting their way may not be worth the benefit.
In all fairness, because Russo's point was taken from a much larger interview whose focus was not consolidation, perhaps I have read too much into his belief in the Central Government's power to force consolidation. If that is the case, then I shall stand corrected. Nevertheless, I think the juxtaposition of these two points-of-view -- regardless of who holds them -- raises very interesting questions about business-government relations in China:

  • Which level government will have the greatest influence on the ultimate outcome?
  • Can the Central Government design its preferred outcome and gradually exert influence to ensure that it happens?
  • Or do the local governments have enough power to affect the ultimate outcome -- one that could be different from the Central Government's preference?
  • If local governments do have power to affect the outcome, do some local governments have more power than others? For example, could the richer or more well-connected provinces have a bigger say in the outcome?
  • Finally, does the market have any role at all in what will happen to this industry?
I realize these aren't open-ended questions, so please feel free to elaborate.

Thanks for reading!
UPDATE: As a former business person, I'm a bit embarrassed to admit that I left out one very important constituency in this process: the auto firms. Here are some more questions:
  • How do the automakers fit into this equation? How much influence do they have in the process?
  • What factors affect the influence of auto firms: size, market share, ownership (SOE vs private, Central SOE vs Local SOE, listed vs unlisted, etc.), company leadership, brands (local vs foreign)...
  • Okay, that's enough. Feel free to talk amongst yourselves...

Wednesday, March 4, 2009

The Boss' Dream: Bigger Empire, Fewer Direct Reports

An anonymous SASAC official has revealed to the 21st Century Business Herald that SASAC is preparing to establish a new state assets investment company along the same lines as their existing Zhongguo Chengtong Investment Group.

Early indications are that this new, as yet unnamed, investment company would buy and manage a handful of the current 141 state-owned enterprises under central SASAC. A SASAC official has indicated that this new company would most likely take over some of the smaller central SOEs, thereby decreasing the number of SOEs that are directly owned by SASAC.

The new investment company would be funded by more than 30 billion RMB that is expected to come partially from the capital budget, and partially from among the assets of the SOEs that it buys.

Based on this revelation, we can only assume that the small SOEs that would be bought by this new company must be sitting on valuable assets that are not essential to their operations. That being the case, this new company would be pulling a "Carl Icahn" (and doing the Chinese people a favor) by squeezing inefficiently allocated capital out of these SOEs -- presumably to be redeployed toward more efficient purposes (although that assumption may be a bit of a stretch).

What else might this accomplish for SASAC?

They would essentially be doing what any good manager would want to do: reduce the number of direct reports. When SASAC was established in 2003, it directly owned 196 SOEs (along with their thousands of subsidiaries). That number has now dwindled to 141 (along with their thousands of subsidiaries), but that doesn't necessarily mean that the overall size of SASAC's empire has decreased. Indeed it is now bigger than ever in terms of both assets and revenues.

The goal really isn't to have less revenue, or even less cost. (This is evident in the way that aggregate financial results of SOEs are reported. Notice that after every month-, quarter- and year-end, figures are compared to the same period in the previous year without any adjustment for changes in the number of organizations reporting to Central SASAC.) This is because very few of those organizations actually go away; they are merely subordinated to other organizations under SASAC.

This move to consolidate some of the smaller SOEs under a new investment company will not actually reduce the size of the organization; it will just make the boss' life easier. And if the new company's management are competent, it may increase SASAC's returns as well.

Sunday, March 1, 2009

Leadership Thinking in the Airline Industry

Today's SCMP has an interview with Liu Shaoyong, Chairman of China Eastern Airlines, the weakest among the "Big 3" central state-owned airlines. The 51-year old Liu is a former pilot and former head of China Southern Airlines, another of the "Big 3".

Some readers may remember that, five years ago, China Southern was loaded with debt and in desperate straits. Liu is credited with taking the helm then, and turning things around in two years' time. A similar feat is now expected of him at China Eastern.

Unfortunately for Liu, the bull market that drove demand for air travel as he worked his magic on China Southern has long since ended. He's performing without a net this time.

If I have any regular readers, I'm sure you have recognized by now my particular obsession with business consolidations in China. The China Eastern story presents an interesting case as highlighted in SCMP's interview with Liu Shaoyong:
Q: You have said that a merger between Shanghai Air and China Eastern would be a good thing. Is it on your agenda as one of your aims?

A: It is more complicated than it seems. China Eastern is owned by the central government, while Shanghai Airlines is owned by the Shanghai municipal government. There are no talks between the two companies. However, I do not know whether government officials have entered talks. I am not at liberty to discuss things that involve the government level.
One of the issues with which I have been fascinated is how and why mergers take place in China. Who initiates discussions? Who carries out the negotiations? Who has more influence, firms or governments?

In this instance, assuming that Liu is speaking truthfully, it would appear that Liu expects discussions to be initiated by the relevant levels of government, and that he may or may not be involved once discussions are initiated.

Presumably the companies themselves would eventually become involved so that a proper valuation of the acquiree can be reached, but that may be assuming too much. The story on last summer's consolidation in the telecom industry was that the details were arranged in high level government/Party discussions, and the companies were only notified after the decision had been made.

It is also quite likely that who the respective owners of these airlines are would determine how discussions begin. If both airlines were centrally-owned, then Li Rongrong, chief of Central SASAC, could probably wave his hand and make a merger happen. Since one of the owners is the Shanghai Government (represented by the local SASAC which reports, not to Beijing, but to the local govt), a lengthy negotiation is likely to take place.

Despite its authoritarian reputation, the government in Bejing does not always get its way. And while it may be able to force, say, the government of Sichuan Province to sell its provincial airline to Air China (as it did a few years back), Shanghai's government tends to carry more negotiating heft.

Despite Liu's denial, the SCMP interviewer presses him on the rationale for a potential merger anyway:
Q: State-owned enterprises cannot implement layoffs, but the benefits of mergers and acquisitions are mainly derived from reducing staff. So what would be the real benefit of a consolidation between Shanghai Air and China Eastern, if any?

A: This is "socialism with Chinese characteristics". Chinese enterprises are operating in a tougher environment than other companies in the world. Companies in other parts of the world can either sack people or resort to bankruptcy protection when they are not doing well. Airlines can cancel or delay aircraft where necessary. But this is not applicable in China. We solve problems by growing bigger and lowering unit costs. We aim at making profit by increasing revenue.

Q: Analysts suggest that merging two loss-making companies may not work? Do you agree?

A: Generally speaking, when a company reaches an optimal scale, all the benefits from economies of scale will come along, such as cost-effectiveness.
While profit is a good thing, and keeping people employed is even better, ultimately, the leaders of SOEs gain promotion by expanding their empires. While I have yet to see any empirical evidence that this is true across the board, everyone with whom I have discussed this issue -- and this includes many knowledgeable people both inside and outside of China -- seems certain that organizational size is among the most important factors for a leader's career.

Liu will probably not be successful in turning around China Eastern in the near term. The economic downturn will give him a perfect excuse for not succeeding, and anyway, the government has no problem pumping more money into big SOEs in order to keep them afloat. Hard budget constraints rule in the new China...until they don't.