Beating the slowdown by banking on S.O.E. reform

Beijing's plan to restructure state-owned enterprises (SOEs) has created opportunities for investment bankers struggling for business in traditional segments amid a market downturn.

While many investment banks have suffered lately as issuers have delayed their initial public offering (IPO) plans, Reorient Group, a new financial firm managed by veteran Hong Kong and Western investment bankers, sees SOE restructuring as one of its focus areas.

'Yes, the initial public offering market has performed very badly recently, but conducting IPOs is not the only business for investment banks,' Reorient executive managing director Angelina Kwan said.

The euro-zone crisis triggered a 12 per cent drop in the Hang Seng Index last month and many firms, including jeweller Graff Diamonds, have put their listing plans on hold to wait for stronger market sentiment.

'The current market situation may not bode well for mega IPOs but could provide the right climate for mergers and acquisitions. The two markets are not linked,' Kwan said.

'We are here to help SOEs restructure, dispose of assets, or find potential merger and acquisition opportunities as well as assist Western and Asian companies seeking SOE assets.

'When the market is slow, it could be a good time for both buyers and sellers to negotiate a deal.'

Louis Tse Ming-kwong, director of VC Brokerage, echoed the view.

'It is true that Beijing has been encouraging SOEs to restructure and improve their efficiency. Some state-owned oil and natural resources companies are just too small to have a good economy of scale. A fragmented market has led to a lack of efficiency,' Tse said.

'Hong Kong brokerage and investment banks can help overseas investors to inject capital and provide management teams to help restructure the SOEs.'

Tse said that apart from bringing in offshore investors to buy into mainland SOEs, there were also more Chinese firms looking overseas.

'There are a lot of US and European firms trying to sell assets to tide them over the euro-zone crisis. This provides good buying opportunities for mainland companies and Hong Kong bankers can play a role in it,' he said. 'Recently, we have seen an increasing number of mainland clients wanting to buy vineyards in France. This is a prime example of mainland companies trying to branch out internationally, and this will be a long-term trend.'

In the past two years, Beijing has issued several policy initiatives designed to improve the efficiency and profitability of SOEs. According to the State-owned Assets Supervision and Administration Commission (Sasac), which is authorised by the State Council to guide SOE reform and restructuring, one of the aims is to cut the number of SOEs Sasac supervises from the roughly 120 now to 80 to 100 in the next few years.

This includes plans to restructure up to 40 SOEs through IPOs, mergers and acquisitions as well as disposals of non-core and non-profitable operations.

SOEs play a critical and central role in the economy. The Second National Economic Census conducted in 2008 found that SOEs controlled some 30 per cent of the industrial and service sectors on the mainland and together were valued at 63 trillion yuan (HK$77.19 trillion).

Kwan admitted there were challenges in handling SOE restructuring, especially when it came to transforming social-enterprise units from loss-makers to profitable entities. Various not-for-profit SOEs have traditionally provided supermarkets, hospitals, schools, and nursing homes for their staff, and it is hard for bankers to repackage them as profit-making entities attractive to buyers.

Other challenges included due diligence such as checking if the financial particulars of a company's assets properly reflected its operations as well as finding the best capital-raising structure for these companies, she said.

Steve Vickers, chief executive of consultancy Steve Vickers and Associates, said due diligence was an absolute must for investment banks and potential buyers before they sealed any merger and acquisition deals.

'Before any mergers or acquisitions, the buyers should know if the management behind the companies have any criminal links, and should also check if the operations of the target companies are in line with their financial statements. All these need people with investigative skills,' he said.

Vickers said that earlier, when overseas investors had limited knowledge of the mainland, they would often jump into merger and acquisitions deals without carefully checking the targets. But now, he said, there was an increasing demand for pre-acquisitions due diligence.

30%

The share of the mainland's industrial and service sectors controlled by state-owned enterprises