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Shirley Yam

We believe China Cosco Holdings, which operates the largest bulk fleet in the world, deserves a premium to its peers.

Cazenove research report, September 5, 2007

Yes, but only if the four competing bulk-shipping arms  genuinely work as one. I am not talking about classical challenges that made most mergers and acquisitions worldwide go bust for shareholders, but those with Chinese characteristics.

Let's start with the very strange phenomenon that was witnessed in the shipping industry last year.

It was a  bulk freighter boom and rates were going up. Any bulker long on ships would have relet them for a good profit, but this was not the case with the bulker arms of China Ocean Shipping Group (Cosco Group), parent of the listed China Cosco.

Its Hong Kong arm (also know as Cosco Hong Kong), with excessive capacity, held on to the spare ships instead of chartering them out. Yet at the same time, three ships were chartered by its Tianjin arm (also known as Cosbulk) from outsiders at expensive  rates to satisfy earlier shipping commitments.

Anyone would see that a more sensible way was for the headquarters to get Cosco Hong Kong to sub-lease ships to its Tianjin 'brother company'. Controlling a third of dry bulk ships in the region, the Cosco group could have gained handsomely from the boom.

Yet it did not.

The reason was political. With the parent company talking of a merger of its major bulker operations, no one wanted to let out ships for fear of losing  bargaining power, which such a move would incur.

For people in the industry, the bickering among the group's main bulker arms - based in Hong Kong, Tianjin, Qingdao and Shenzhen and which will all be injected into the listed vehicle - is no news.

Though they all carry the Cosco flag, these subsidiaries have always worked as lone wolves. An illuminating fact is the big difference in their percentages of chartered vessels - an indicator of the management's market outlook - which can range from 7 to 38 per cent.

One will say that's exactly why a merger has to be done and where the fat is. In fact, the synergy of bringing 'solo' subsidiaries together  was  the promise made  at China Cosco's press conference on Wednesday.

Its financial controller, He Jiale, said: 'After the merger, there will be a single operating system and strategy ... There will be  tight supervision.'

But before we jump to that, there are two questions to ask. Why has  competition  been allowed to  develop in the first place?  Will the cause be eliminated by putting the subsidiaries under the listed vehicle?

To answer that, we have to know their history. Instead of being branches set up by the holding companies, many of Cosco group's subsidiaries are companies backed by provincial authorities to get a share of the huge pie. Joining the group used to be the only way to get into the business due to government restrictions.

The loyalty of these units is more to the provincial authorities than to the headquarters in Beijing. The provincial officials in turn are more concerned with local economic interests and employment than the group's profit.

It's therefore not difficult to understand why  Wei Jiafu, the group's president and chief executive, has been working on the merger for almost a decade without much success.

The impetus  for change did not arrive until last year. In a bid to make centrally owned enterprises big and competitive enough for the global market, Beijing has begun to push for large-scale restructuring, in particular the injection of all the assets into a single listed company.

The State-owned  Assets Supervision and Administration Commission even threatened to cut the number of centrally owned enterprises from 155 to 80 by 2010. Its chairman, Li Rongrong, recently added that companies that did not make it to the top three of the industry would be ordered to merge.

The question is how well this fear of losing one's turf will work in bringing together competing arms and in generating synergies instead of  creating merely a one-off addition in numbers. In a country where a clear and fair reward system has yet to be established, this challenge can only be underestimated.

A more important challenge is perhaps in getting the provincial authorities to support any streamlining and staff cuts that might follow a merger. Both China Eastern Airlines and Tsingtao Brewery have bled badly from their earlier acquisitions made amid the hostility   of local officials.

I emailed the management these questions on Wednesday. There has been no answer so far.

Perhaps, I should send the questions to every mainland enterprise that has been carrying out major asset injections and witnessing rocketing share prices. After all, the challenges they face are different from China Cosco only in scale, not in complexity and nature.



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