Whenever China encounters difficulties or problems, its state-owned media and foreign ministry are often quick to blame "hostile foreign forces" which include foreign (i.e. non-Chinese) media organizations. These accusations are often preposterous, but unfortunately, they are sometimes based in fact.
An article posted today on Business Insider serves as an unfortunate illustration. The article, "These Fake Chinese Microchips Were Made To Disarm U.S. Missiles," by Robert Johnson levels some startling charges:
Last year, the U.S. Navy bought 59,000 microchips for use in everything from missiles to transponders that turned out to be counterfeits from China.
Wired reports the chips weren't only low-quality fakes, they had been made with a "back-door" and could have been remotely shut down at any time.
What??!! This is a major international incident! Why is it not all over the news?
Following the link to the Wired report, we find out why: it simply isn't true.
The chips turned out to be counterfeits from China, but it could have been even worse. Instead of crappy Chinese fakes being put into Navy weapons systems, the chips could have been hacked, able to shut off a missile in the event of war...
...but they weren't, and a further link in the Wired report to a Washington Post story fills us in on the actual facts as reported by an actual journalist (not that all actual journalists are above fabrication).
My point is that we need to be better than this. If a Chinese company somehow conspired to get fake chips with backdoors into US hardware, then, by all means, let's nail them to the wall. But Business Insider's Robert Johnson has either read the Wired article so quickly that he failed to fully understand it, or he has maliciously fabricated a false story -- and neither reflects very well on Business Insider.
And it just adds to the pile of evidence that the "hostile foreign forces" really do exist.
China's corrupt, opaque system will continue to produce enough negative stories on its own. It isn't necessary to make up stuff like this.
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EDIT: Note that since I posted the above, Business Insider has since changed its headline slightly, which prompted me to write this subsequent post.
Saab-Hawtai
Interesting things happening with the failed purchase of Saab by Hawtai. I wish I had more time to comment on this, but I am in the homestretch to finish my dissertation and get it filed -- possibly as early as next week. I will say, however, that I find it interesting that the two sides are starting to change their stories.
My guess, based on what little reading I've had time for, is that Beijing wants Saab to go to one of the larger Chinese automakers. The last thing it wants to do is strengthen a tiny, private automaker like Hawtai which only produced about 80,000 vehicles last year. And the reason China's other automakers haven't stepped up to bail out Saab yet is that they are counting on Saab's assets being cheaper after Saab has declared bankruptcy. Smart move.
The Chinese media are all suddenly beginning to say (almost as if directed by someone) that Chinese automakers no longer need foreign help. Which, I'm sorry, is total BS. If Chinese automakers had the necessary engineering skills to build great cars, they would be flooding the American market with them as we speak.
Last October I wrote about a situation in which BYD, the private automaker from Shenzhen, was punished for attempting to build a factory on farmland near Xi'an.
In short, BYD was fined about $435K and had seven buildings, on which it had already begun construction, confiscated and ordered destroyed. In addition 14 local officials in Shaanxi province were also punished for violating rules forbidding the use of arable land for non-farming purposes. Ouch. And this came in a tough year for BYD whose sales only grew 16 percent in 2010 (compared to China's auto industry as a whole which enjoyed 32 percent growth).
The story surfaced a few days ago that BYD was preparing to restart construction in Xi'an. According to an earlier story in the Economic Observer, the land has been "legalized" (合法化) and rezoned as industrial land. BYD was allowed to bid for the land in a public auction, and -- surprise! -- BYD won the auction. (There was no word on whether anyone else bid for the land.)
Even though BYD didn't get all of the land it had secured before, it still got most of the land, and, most conveniently, it got the part of the land on which its unfinished construction already stood. Back in October, the announcement from the Ministry of Land and Resources said BYD's buildings would have to be destroyed, but, fortunately for BYD, no one had got around to destroying them yet.
This strikes me as quite a miraculous turnabout for BYD. The problem that led to BYD's punishment was (and is) that China, despite being a huge country, has precious little of the arable land it needs to feed 1.3 billion people. The central government has recently become quite serious about preserving arable land.
But not that serious apparently.
In the months following BYD's punishment last October, Local officials in Xi'an had begun to complain that they had been deprived of a major source of local income -- sales of land use rights. The Economic Observer quoted a local official as saying that Shaanxi's annual demand for industrial land is running at about 400,000 mu (67,000 acres) per year, but they are only able to supply about 150,000 mu.
I was initially happy to see the central government finally taking a stand last fall by supporting their own laws forbidding illegal use of arable land. For once, it wasn't just about the money. At the time, I took this as a positive sign that rule-of-law was actually starting to mean something in China.
It's amazing to me how a scarce resource such as arable land could have been so quickly and easily "rezoned" as industrial. Apparently it really was about the money.
Last December I wrote about a trend among Chinese-foreign automotive joint ventures in which the foreign partner gives technology to the JV to sell under a Chinese brand. Some of the English language China auto blogs refer to these as "sub-brands."
For example, Honda contributed the design of an outdated City vehicle it no longer makes to its JV with Guangzhou Auto. The JV now sells it under the Chinese brand Linian.
At the time I noticed this trend among several automakers (Guangzhou Honda, Dongfeng Nissan, Shanghai-GM), my assumption was that this was an attempt on the part of the Chinese automakers to wean Chinese consumers away from foreign brands. Chinese consumers still overwhelmingly prefer foreign brands (if they can afford them), because they perceive them to have higher quality.
Now several other foreign automakers including Volkswagen and PSA Peugeot-Citroen are discussing similar arrangements with their Chinese partners. PSA Peugeot-Citroen's CEO told the Financial Times that helping their partner to develop a local brand is now "part of the deal".
Last December I speculated that this may have been under central government coordination, but I had no evidence of that. Today, evidence seems to have surfaced in this report from the Financial Times.
The story quotes Mike Dunne, formerly of JD Power in China, who now has his own consulting company:
Nothing is written down, but when automakers go to apply for capacity expansion, in their application it’s clear that they should have a plan for an indigenous brand with jointly owned product rights and some provision for new energy vehicles. Foreigners want more capacity; China is saying: ‘We want more own brands’.
Back in 2001, when China joined the WTO, they gave up the right to demand technology transfer as a condition for approval of foreign investment. Of course, this new rule did nothing to change China's appetite for foreign technology.
The new demand, rather than for "technology transfer", appears to be: if you want to expand capacity, then X% needs to be devoted to Chinese-branded cars.
The foreign automakers now have a choice. They can pour precious R&D money into joint development of cars that compete directly with their own, or they can just hand over technology they already have.
The technology the foreigners are now handing over may be slightly outdated, so the foreigners aren't being forced to hand over their latest and greatest innovations. But again, it seems to me that these foreign-designed, Chinese-branded cars that the central government is now forcing the JVs to sell will fill the perceived quality gap between Chinese- and foreign-branded cars.
China's central government fully intends that its largest state-owned automakers will be global contenders, and they are patiently finding ways to make that happen. The WTO will not stand in the way. Wherever there's a rule, there's a way around it.
For anyone wondering where I've been for the past several months, I've been right here at my desk. But instead of posting to this blog, I've been in a push to complete a full first draft of my dissertation by the end of March -- which is beginning to look like a real possibility.
For now, here's a quick post of some numbers I've been looking at for the past few days on market shares in China's auto industry.
Probably the most consistent component of China's auto policy since the mid-80s has been the insistence of the central government on consolidation in the industry. Just looking at the raw numbers, I think most people would agree that this demand has been completely justified.
In 1978, the year that Deng Xiaoping launched the first experimental market reforms in China, there were 55 auto assemblers. The number peaked at 124 in the mid-90s, and by 2008 (the latest numbers available) there were still 117 -- clearly, way too many.
But just how fragmented is China's auto industry? Here is a quick comparison with the US.
This chart compares cumulative 2010 market shares for the top five auto companies in the US and China.
If China were to take the US as its example, then it would seem to have already achieved a fair amount of consolidation. China’s largest auto group has a slightly larger share of its market than does the largest automaker in the U.S., and the top five in both markets are practically even.
Of course, we already know that the US market is somewhat less concentrated than it used to be. In 1980, for example, the Detroit Three held 76 percent of the US market. But I think few people would argue that less concentration in the US market has not been good for consumers.
So while it would appear that China is starting to see some solid growth out of the players at the top of its auto industry, the problem lies with all of those tiny companies at the bottom that, for some reason, refuse to go away.
Who are these small players? Quite a few are small, locally-owned automakers that lack any kind of scale to be profitable. In any given year, they probably break even on a cash flow basis, which means that the local government is absorbing their cost of capital. If exposed to true market competition, these small firms would quickly disappear.
So why haven't they? Local governments don't want them to. They employ anywhere from a few dozen to maybe even a few hundred local people, and local governments are not inclined to create any more of an unemployment problem than they have to.
Of course, the central government, through the NDRC or MIIT, could force these local enterprises to close, but why would they? The central government is no more interested in putting people out of work than are the local governments.
So if we simply accept that some of these small players are part of a welfare system that keeps people gainfully employed, then China's leaders should at least be satisfied that, at the top of its auto industry, it appears to have the makings of an increasingly strong and competitive industry. Right?
I don't think so, and this next chart reveals why.
Here we have the top five companies in both the US and China along with their respective market shares.
What I notice about this chart is that each of the companies on the US side also corresponds with a brand, but each of the companies on the Chinese side is just a big old state-owned enterprise that assembles cars for foreign companies.
SAIC makes most of its money selling VW and GM cars. Dongfeng sells Nissan and Citroen. FAW sells Toyota and VW. Chang'an sells Ford, Mazda and Suzuki. BAIC sells Hyundai and Mercedes.
Yes, each of these companies also sells some cars under its own brand, but the numbers are comparatively small. Overall, only 30.9 percent of sedans sold in China in 2010 were of local brands -- up only slightly from 30 percent in 2009.
And therein lies the problem. China's central government wants its biggest SOEs to get bigger so that they can compete with the foreign multinationals. For now, they would just like to dominate in their own market, but eventually, they want to compete in overseas markets as well.
The problem is that, while these SOEs are indeed developing their own brands, it's just so easy to sit back and rake in profits while the foreigners contribute all of the intellectual property.
Designing your own stuff is hard.
More arcane corporate governance stuff...
In my previous post, I noted that Geely's 2008 and 2009 annual reports mentioned an unnamed "associate" of Li Shufu as co-owners of the entity that has ultimate control over the sprawling Geely empire.
In the interest of ensuring my readers (all three of you) have the most up-to-date information that I have, and in the interest of the pursuit of truth and transparency, I think a new post is in order.
Fortunately for the English speaking world, Geely is listed in Hong Kong, which means that, not only is the company required to report significant events to its shareholders, but it is also required to do so in English. (Call me lazy, but plowing through a 150-page annual report in Chinese is not my idea of fun--not to mention the fact that mainland reporting standards still don't measure up to those in HK.)
Here is what I have learned today. I can now say for certain that Li Shufu has complete (legal) control over the Geely listed company. This document (pdf) that I found on the HKSE website just happens to mention that Li Shufu owns 90 percent of Zhejiang Geely Holding Group, Ltd. (ZGHGL), which means the "associate" (in the yellow box) can own no more than 10 percent. (See abbreviated corporate structure below.)
What the document also spells out is exactly which entity now owns Volvo. As you can see in the structure below, I have added a couple of boxes at the bottom left side. The green box is "controlled" by ZGHGL (which we now know is 90% owned by Li Shufu). The orange box is Volvo, which is clearly owned and controlled, not by the listed Geely Auto Holdings (the purple box), but by Li Shufu's unlisted ZGHGL.
That explains why Li Shufu has been quoted as saying, "Volvo is Volvo, and Geely is Geely", meaning that these two companies are entirely separate entities. The only thing they have in common is control by Li Shufu.
This means a couple of things.
First, Li Shufu almost certainly had to rely on bank loans in order to pull off the Volvo purchase. Since the cash on the HK-listed Geely Auto Holdings' balance sheet belongs, not only to Li Shufu, but also to the company's public shareholders, Li Shufu could not have used Geely's cash to fund even part the Volvo purchase. Whatever cash was put into the deal would have had to come from any of the entities on the Li Shufu side of the chart. (Yes, it's possible Li could have borrowed money from Geely for the Volvo purchase.)
And while it's possible those entities have other business operations of which we aren't aware, the likelihood that these apparent shell companies were sitting on the necessary cash to fund the deal is pretty slim. Of $1.3billion in cash given to Ford in the Volvo purchase (Ford also got a note for $200 million), about $588 million came from Daqing and Jiading local governments, the remaining $712 million would have had to come from Li Shufu-related entities. At least part of that must have come from loans. (Early indications were that several major state-owned banks were lining up to help with the Volvo purchase, but this has not been verified since the purchase took place last August.)
Second, because Volvo is now 100 percent owned by an unlisted entity, we will no longer have full transparency into the company's operations.
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