China to use mergers and acquisitions to bolster state sector next year

PUBLISHED : Monday, 14 December, 2015, 11:08am
UPDATED : Monday, 14 December, 2015, 11:10am

To revitalise its failing state sector, the Chinese government is exploring mergers and acquisitions as a key method of combatting sluggish demand and overcapacity in state owned enterprises next year, analysts say.

China’s state owned enterprises or SOEs have seen great losses in recent years, with profits from the coal mining and ferrous metal industries producing only 10 and 20 per cent of the profits gained in 2011 respectively, according to a report by Standard Chartered. Experts say the government will focus on mergers and acquisitions moving forward to cut the risks to the country’s financial sector.

The sector has seen several M&As lately, with one of the most recent the buy out of equipment-maker China Metallurgical Group by China Minmetals Corporation - the country’s biggest metals trader - last week.

“A combination of sluggish demand and large oversupply - caused by overcapacity in China’s traditional sectors - is the main drag on its economy,” said Standard Chartered analysts. “We expect rapid progress in M&A in China’s oversupplied sectors, such as steel, non-ferrous metals, petrochemicals and electricity generation, in the year ahead.”

Overcapacity in traditional sectors has caused price and profits of key industrial products to plunge in recent years. The producer price index, measuring the average change in selling prices of goods and services, dropped continuously since March 2012.

Steel and coal products fell 40 per cent in the past four years, with steel becoming one of the largest sources of deflation in China, the report said.

One way the government can restructure the sector include allowing firms that are failing to gain profits to close down and leave the industry, redistributing their resources to newer and more productive companies. Yet analysts say that the process must be closely monitored, since many of the state’s traditional sectors remain major contributors to the nation’s GDP and support the labour market.

As of October, the chemical, ferrous metal and coal and mining industries employed 4.7 million, 3.6 million and 4.4 million workers respectively, CEIC data showed.

“An abrupt shutdown of these industries could potentially lead to a sharp rise in unemployment and defaults in the financial market,” Standard Chartered analysts warned.

At a meeting last week, the State Council called for several upgrades to restructure the sector, pushing SOEs in industries like nuclear power, smart grids and high-speed railways to innovate and enter the international market, according to a report from Bank of China International.

SOE’s were also required to close factories that have been unprofitable for the past three years, as well as those that do not meet proper environmental, quality and safety standards.

Other reforms include asking firms to restrict investment expansion in industries that are oversupplied, sell non-core businesses, and reduce public service functions, the report said. Commercial banks were required to expedite write-offs of non-performing loans in sectors with overcapacity.

“I think China is getting smarter - you have to be profitable to survive,” said Louis Tse Ming-kwong, director of VC Brokerage. “(There’s) a lot of competition outside. That is the key reason (for reforms).”