China's merger mania revives state reforms

By Bill Savadove

BEIJING (Reuters): China has put reforms to its overwhelmingly dominant state sector back on track with two high-profile mergers in the power and aviation industries, but analysts said on Tuesday it still has a long way to go.

China's looming entry to the World Trade Organization (WTO) has fueled urgency to reform state-owned enterprises, which virtually ground to a halt during the Asian economic crisis.

A desire to lure foreign investors to China's overseas listed companies also drove the latest merger mania, officials said.

"WTO has always been thought of as the sledgehammer for pushing through SOE reform," said Ken Ho, head of China research for Jardine Fleming Securities in Hong Kong.

"Now WTO is close to being concluded. There will be quite a lot more mergers and acquisitions."

China hopes to join the WTO this year.

In a long-awaited move, China's aviation regulator said on Friday it would merge 10 carriers to create three airline groups, with assets of US$6 billion each.

The announcement followed news that China's largest independent power producer, Huaneng Power International, would take over Shandong Huaneng Power Development Co to create a group with $2.9 billion in assets.

The job of creating bigger, stronger and more profitable companies from the ruins of the state sector is huge.

China set a policy in 1997 of using mergers, acquisitions and even bankruptcies to reform the state sector, but the number of declared insolvencies has been small.

Chinese leaders say maintaining social stability is a fundamental prerequisite for promoting reform and the government fears closures will bring protests from laid-off workers.

Beijing lacks the will to bankrupt weak firms for fear the laid-off workers could spark social unrest, analysts say.

Despite strong economic growth of 8.2 percent in the first six months of this year, nearly half of the large state firms are still losing money.

"We must strengthen state enterprise reform and strategic adjustment," Ye Zhen, spokesman for the State Statistical Bureau, said last week in announcing the figures.

Analysts said the power industry was a good place to start. Besides airlines, other sectors ripe for more consolidation included the automotive and petrochemical industries, they said.

The merger between Huaneng Power and Shandong Huaneng would be made easier by strong central government backing and a common parent, state-owned Huaneng Group, they said.

It will create a regional power giant and give the new Huaneng Power access to the booming coastal province of Shandong, company officials said.

The more than 70 percent premium Huaneng Power will pay for Shandong Huaneng's shares will also appease investors -- the stock has languished since listing in New York in 1994.

"This delivers a message of further industry consolidation," said Ingrid Wei, analyst at ING Barings in Shanghai. "We think that mergers and acquisitions will be an inevitable trend for the industry, but it will take time."

Faced with government policies which limit both expansion in their service area and new power projects, producers will have to make acquisitions to expand and remain competitive, she said.

The airline merger too aims to take a fragmented industry of 34 carriers -- many small and losing money -- and create three competitive groups with regional ambitions, analysts said.

The new groups will be based on flagship carrier Air China, overseas listed China Eastern Airlines and China Southern Airlines.

"The fact that they are consolidating in the Chinese market is not new. They've been trying to do that for a while but progress has been very slow," said Tiffany Co, an analyst at Salomon Smith Barney in Hong Kong.

"In other regions in the world, the U.S. and Europe, this trend has been prominent. Now it's getting into Asia."

Analysts said they were heartened the government appeared willing to take a more hands-off approach to the latest mergers.

Officials from the Civil Aviation Administration said the seven smaller airlines would be free to select which group they would join, with guidance from the government.

China has pushed mergers as a tool of state enterprise reform before, arranging shotgun marriages to make strong companies absorb weaker ones.

Its biggest steel maker, Shanghai Baosteel, absorbed two ailing metal companies in a government-brokered merger in 1998, but it has dragged on the firm.

"The caveat is you have to screen for the good deal," said one foreign analyst. "If China is perceived to be the one who drives through those bad deals, then the whole thing will collapse."