CHINA/SOE REFORM: THE LOCAL VIEW, AS SEEN FROM QINGDAO

UNCLAS SECTION 01 OF 03 BEIJING 005639 SIPDIS SIPDIS SENSITIVE STATE FOR EAP/CM PSECOR, JYAMAMOTO TREASURY FOR OASIA RDOHNER, BCUSHMAN USDOC FOR 4420/ITA/MAC/CEA/MCQUEEN USTR FOR BHATIA/STRATFORD/WINTER/ALTBACH/MCCARTIN E.O. 12958: N/A TAGS: ECON ENRG EINV EPET EFIN CH SUBJECT: CHINA/SOE REFORM: THE LOCAL VIEW, AS SEEN FROM QINGDAO -------------- INTRODUCTION/SUMMARY -------------- ¶1. (SBU) Coverage of state-owned enterprise (SOE) reform in China tends to focus on the 155 large national firms managed from Beijing by the central State Assets Supervisory and Administration Commission (SASAC). Easily overlooked, however, are the tens of thousands of companies run by the 32 provincial-level and 448 prefecture-level SASAC entities. Recent meetings held by Econ M/C and Econoff in Qingdao illuminate the degree of autonomy experienced by these "local" SASACs as well as the unique challenges faced in executing enterprise reform at the local level. ¶2. (SBU) Our meetings with Qingdao's SASAC and local SOEs focused on the challenges of diversifying ownership and implementing new policies and regulations, such as a dividend payment plan. With local SOEs accounting for 40 percent of Qingdao's GDP, the city's SASAC has a geographically-based stake in enterprise reform that is quite different from the broader perspective enjoyed by the central SASAC. Meanwhile, the local SOEs themselves are struggling to court outside investment, and some have or are looking to list on stock exchanges and/or expand to include operations overseas. Two well-known companies, Tsingtao and Haier, provided very different perspectives on doing business in the United States. End Introduction and Summary. -------------- QINGDAO DIVERSIFYING OWNERSHIP OF LARGE SOES -------------- ¶3. (SBU) Qingdao City SASAC Vice Director Gao Sizhang told us that the commission's number one reform priority is diversifying ownership of the city's 32 large SOEs. Qingdao SASAC is accomplishing this through three methods: inviting strategic investors to acquire a stake in a SOE; using mergers and acquisitions between SOEs; and finally, publicly listing SOEs both in China and abroad. Gao stated that the SOEs will become more competitive as a result of ownership diversification. Qingdao SASAC has come to recognize that wholly state-owned SOEs cannot survive in an open-market, said Gao. ¶4. (SBU) Vice Director Gao noted that Qingdao SASAC is carefully monitoring the impact of enterprise diversification upon the local economy. The commission must be prudent when diversifying since SOEs account for 40 percent of Qingdao's gross domestic product (GDP). There are four basic categories of SOEs in Qingdao: manufacturing; services and investment; public infrastructure and utilities; and finally, trading. Each enterprise category has rules regulating the percentage of the enterprise that the city must retain, according to Gao. ¶5. (SBU) Gao stated that the most restrictive enterprise direct investment category belongs to the Qingdao's public sector, including the city's public transportation and utilities resources. Qingdao must maintain a 60 percent minimum stake in this area. Other enterprise categories have less restrictive investment rules and are being handled on a case-by-case basis. A British company acquired a 40 percent stake in Qingdao's port authority. The company has brought much needed capital, managerial talent, and technology to the port as it goes through an expansion. Meanwhile, the city retains only a 30.56 percent ownership stake in the famed Tsingtao Brewery. The United States brewer Anheuser-Busch (AB) SIPDIS acquired a 27 percent stake with Tsingtao Brewery holding on to the rest. -------------- QINGDAO SOES SLOWLY GOING PUBLIC -------------- ¶6. (SBU) In a separate meeting, Qingdao SASAC Vice Director Changjun Yang told us that so far only six of Qingdao's large SOEs are publicly listed. Qingdao SASAC maintains a 20 to 30 percent ownership stake in those publicly listed enterprises. SASAC will soon host a seminar intended to better prepare other Qingdao enterprises for public listing. SASAC has invited several large Chinese and international banks as well as rating companies to speak at the conference, an event intended to help local enterprises improve their corporate governance and learn more about obtaining financing for future IPOs, said Yang. -------------- LESS ATTRACTIVE OPTIONS FOR SMALLER SOES -------------- BEIJING 00005639 002 OF 003 ¶7. (SBU) Vice Director Gao said that Qingdao SASAC is also reforming the several hundred small-to-medium (SMEs) sized enterprises it supervises, but noted that the commission spends far less time managing this issue. The most important SME reform is adoption of a policy to allow the enterprises to go bankrupt if they run into financial difficulties. This has become more common as the SMEs' access to cheap capital has eroded. Bank loans to Qingdao SMEs are increasingly tied to the enterprises' performance, a departure from past practices which had led to local banks holding large sums of bad debt. Gao said that there are two other options for SMEs encountering financial difficulties: apply to convert the enterprise to a wholly-privately owned company, or seek joint ventures with foreign-owned companies. Managers of faltering SMEs are required to work with Qingdao SASAC to choose the most appropriate option, according to Gao. -------------- SOE'S GINGERLY TESTING THE OVERSEAS MARKET -------------- ¶8. (SBU) Vice Director Yang stated that Qingdao SOEs are slowly beginning to expand to the overseas market. Qingdao SASAC plays a limited, supporting role in this regard. It is up to the individual enterprises' leadership to determine if their companies are ready to expand overseas. The vast majority of the city's SOEs are too small and their business too locally focused to expand overseas. We met separately with two of the city's largest SOEs, Haier and Tsingtao Brewery, to discuss this issue and received very different views on expansion into the United States market. So far, Haier considers its aggressive move into the United States to be a disappointment. In contrast, Tsingtao is pleased with its partnership with a larger United States brewer (AB) and is content with its niche share of the United States market. -------------- --- HAIER COMPLAINS ABOUT ITS FORAY INTO U.S. MARKET -------------- --- ¶9. (SBU) Yang Mianmian, Executive Vice-President of Haier, China's top white goods manufacturer, stated that the company's operations in the United States have been unprofitable and a disappointment. Haier understands that the company will not receive preferential treatment in the United States but believes that U.S. companies have an upper hand in their home market. Yang cited three examples: The company lost a bidding war for another company's brand (Maytag) to a competitor; U.S. regulators temporarily pulled a freezer model from the shelves in a standards dispute; and a competitor copied a Haier freezer model. Yang also noted that Haier was unprepared for the legal environment in the United States and has struggled in dealing with several lawsuits that have been filed against the company there. -------------- -------------- TSINGTAO OPENS AMERICAN TAP, BUT KEEPS LOCAL GAZE SIPDIS -------------- -------------- ¶10. (SBU) Chu Liangjing, Vice General Manager of Tsingtao Brewery told us that his company has been pleased with its experiences in the United States. Its partnership with AB has brought much needed management expertise and technology. Tsingtao has also used the partnership to better access the United States market. The company has worked very hard to promote its brand in the United States, but recognizes that its target demographic is a small sliver of the overall market. Chu stated that given Tsingtao's place in the United States market, the real payoff for the company's ties to AB comes from being able to grow more competitive in a Chinese market that is increasingly crowded with domestic and international competitors. -------------- -------------- QINGDAO FOLLOWS BEIJING'S SOE LEAD, NOT LED BY IT -------------- -------------- ¶11. (SBU) In response to a question from Econoff, Vice Director Gao provided insight into the relationship between local SASAC offices and the Central Government SASAC. He noted that although the Central Government SASAC provides policy guidance to local SASAC offices, these offices do not directly report to Beijing. Instead, local offices profit from Beijing's experiences rather than following a set of rules issued by the capital. Gao noted there are several policy issues, including dividend payments, establishment of boards of directors, and diversification out of non-core business interests, that the central and local government SASACs are working BEIJING 00005639 003 OF 003 on simultaneously. -------------- QINGDAO WRESTLING WITH DIVIDEND POLICY -------------- ¶12. (SBU) Vice Director Gao stated that similar to the Central Government, Qingdao SASAC is exploring implementation of a policy requiring its SOEs to pay dividends to the city government. Qingdao SASAC and the city's finance office are working on this together. Gao said that the Central Government so far has not issued guidelines, such as suggestions on what percentage of the profits to tax or how to use the money, which could assist localities. Instead, Beijing is encouraging localities to create their own dividend plans. Gao noted that Qingdao is looking to other cities, such as Shanghai, to learn how those city governments are structuring their programs. -------------- SOE MANAGEMENT REFORM ON-TRACK -------------- ¶13. (SBU) Vice Director Gao noted that Qingdao SASAC is also undertaking enterprise management reform similar to that ongoing at the national level. As part of this reform, many large Qingdao SOEs, including Haier, Hisense, and Tsingtao Brewery, have established boards of directors (and some have even listed on the Shanghai and Hong Kong exchanges). Since most of Qingdao's large enterprises are not monopolies, they have had to undertake such reform in order to remain competitive in the open market. Qingdao SASAC also has recently established a pay-for-performance plan for its SOE managers. The commission sets performance standards in several different categories for each enterprise based upon the SOEs individual circumstances. Managers at enterprises that excel beyond those standards receive bonuses. Qingdao SASAC is still refining this program; some of program's evaluation and auditing process needs work, commented Gao. -------------- PARING NON-CORE INTERESTS, SOCIAL SERVICES -------------- ¶14. (SBU) Vice Director Gao stated that the city's enterprises must be concentrated in their core business areas. On average, the large Qingdao SOEs are spread across six to eight sectors unlike the Central Government enterprises that frequently have hundreds of subsidiaries doing business across a host of sectors. As an example of the non-core business activities Qingdao SOEs pursue, Gao noted that Hisense, an electronics manufacturer, is a very successful property developer in Qingdao. Gao also told us that almost all social service responsibilities have been separated from Qingdao's SOEs. During the separation period, the SOEs transferred ownership of schools, buildings and other social service related infrastructure to the local government. The enterprises bore the human resource costs of the transfer for about a year, but otherwise, the Qingdao government has covered most of the costs, according to Gao. RANDT