Do China’s Stock Markets Matter?

Carl Walter

Berkeley Center for Law, Business and the EconomyUniversity of California, Berkeley

November 1, 2011

Overview

What role do China’s stock markets play in the overall political economy?

How can an economy with no private property develop equity capital markets?

How were state-owned enterprises transformed into corporations and listed?

- slicing and dicing corporates

- creating the National Team

- some consequences of this original restructuring approach

- restructuring the banks

- some consequences of this restructuring approach

Final comments

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China’s equity capital markets are not important financiallyCorporate capital raised in Chinese markets

Equity = 5.7% Bank Loans = 85.4% Corporate Bonds = 8.9%

Aggregate number of domestic Chinese IPOs

Plus 800 Chinese companies listedon international markets

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The State

The State provides supplies and the State distributes the output

State-ownedEnterprise

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SOEs—an indivisible part of the StateBe

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1992: China embarks on Corporatization for its SOEs

ShenzhenRiots

ShenzhenRiots

Southern Tour

Southern Tour

The Contract System is Replaced by Corporatization

January May June August October October

The “Standard Opinion” gave legal basis to corporatization and legally defined share classes• Created non-tradable shares

Cooperation with Stock Exchange of Hong Kong provided access to a large and mature market • Put domestic market development in a subordinate position

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1993 – 1997: SOE Reform via public listings

The Company Law affirmed corporatization as the basis of SOE reform

Securities Law affirmed CSRC as sole regulator

Oct. 92—1st overseas listing

July 93—1st HK listing

Aug. 94—1st NYSE listing

Oct. 97—China Telecom IPO

July 93— Exchange Regulations

July 93— Accounting standards

July 94— Company Law

July 99— Securities Law

Two track listings Creating legal basis

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Oversight

NewCo becomes a fully incorporated company wholly-owned by its Ministry in the form of State Shares

Standard Opinion—corporatization method 1

SOE

Govt Ministry

NewCo

SOE

Selected net assets State shares

100% ownership

Gov’t Ministry

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What if Multiple SOEs under the same Ministry are involved?

SOE#1 and #2 end up receiving State Legal Person shares in return for their net asset contributions. Public investors get A shares in return for cash.

Standard opinion—fund raising method 2

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Non-State Investors

DomesticLP shares

LP shares or A/B/H shares

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The type of share depends on who invested

Shanghai and Shenzhen Exchanges market structure

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SOEs—big and complete, small and complete

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How do you take THAT and create a modern corporation?

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Slicing and dicing: a thorough restructuring

Out

???In

Factory #1 Factory #2 Factory #3

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Cash

Receivables

Fixed Assets

LT Receivables

LT Investments

Intangibles

ST Debt

Payables

LT Debt

Verify with bank statements

Verify payment schedule

Identify ownership, conduct asset appraisal

What are these? Who owes them?

What are these?

What are these?

Whose debt, can it be gotten rid off?

Whose payables, ditto

Whose debt, ditto

A thorough restructuring 2

Comparative Companies plus draft audits are the critical report card

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Does the proto-NewCo have a positive net worth? Is it too much?Berk

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The goal of restructuring: Valuation, one fundamental problem

– Profitability both in absolute and in marginal terms– Sustainable growth prospects: what are the industry’s prospects– Strong balance sheet – Competitive products– Sound management– Management oversight through a Board of Directors

The NewCo is designed to resemble as much as possible an existing listed company in the same industry

The problem is: even if all the above goals are achieved, the NewCo remainsan untested company with no operating track record. It is fundamentallynot comparable with existing listed companies operating in market economies

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Non-productiveassets

Retirees

Productive assetsand workers

The cash generated by the productive assets and labor supports everything and everyone else in the SOE

A single unrestructured Chinese enterprise: another problem

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In China the SOE is the country’s social security program

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The cash generated by the productive assets and labor can no longer flow directly to the rest of the SOE, except a trickle as dividends.

How can the Parent now support itself and its staff?

The post-IPO cashflow crunch

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Listed Co.

Parent Co. (SOE)

ADRS

H shares

A shares

Post-offering overall Group corporate structure

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Individual enterprises

Ministry

Unrestructured industry: a third problem

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The creation of National Champions

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Parent SOE companies

New company

Ministry

Holding Co. Ltd.

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100%

100%

75%

Guangdong MobileZhejiang MobileJiangsu MobileFujian MobileHenan MobileHainan Mobile

100%US$4.5 bn= cash contributed for shares

100%

100%

US$6.6 bn = appraised Net Asset Value contributed

25%Guangdong BVI

Zhejiang BVIJiangsu BVIFujian BVIHenan BVIHainan BVI

Ministry of Posts and Telecommunications

China Mobile BVI

China Mobile Hong Kong Group

China Mobile Communications

Corporation

China Mobile (HK) Co. Ltd.

NYSE/HKSEListed SharesNYSE/HKSE

Listed Shares

The China Telecom IPO, 1997US$4.5 billion dual listing

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1998: government streamlining eliminates industrial ministries

1950-1998 1998-2003

State Asset Management

Bureau

Ministry of Finance

Ministry X

ListCo

SOE Y

Ministry X

ListCo

State Asset Management

Bureau

Ministry of Finance

Group Company

Who “owns” the group company?

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2003: SASAC is established: yet another problem

State Administration of State Assets Commission

(SASAC)

SOE Group

ListCo 4ListCo 3ListCo 2ListCo 1

50%+50%+ 50%+50%+

Board of Directors

Supervisory relationship

Equity ownership

SOE Group

SOE Group

SOE Group

Board of Directors Board of Directors Board of Directors

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Who is the beneficiary of SOE profits?Be

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What to do with the money?Be

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Invest in brother and sister SOE listings

* denotes overseas returnee issuer

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Who profits? Your brother and sister SOEsBe

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An alternative to SASAC: Central SAFE Investments

MOF

AgriculturalBank of China

China Construction

Bank

Bank of ChinaIndustrial andCommercial

Bank of China

China Development

Bank

Huijin

Original Huijin investments pre-2005

Post-2005 Huijin investments

100%85%50%48.7% 50%

Board of DirectorsBoard of Directors Board of Directors Board of Directors Board of Directors

PBOC

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The Big 4 banks: from 2004-2010 paid US$84 billion in cash dividends

Source: bank H-share annual reports for the Big 4 banks

The four banks raised US$106 billion in IPO proceeds =ABC 2010 IPO of US$22 billion + US$84 billion in cash dividendsBe

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Final comments

The adoption of shares and stock markets led to the creation of a national capital market, China first

The corporatization of SOEs turned them into property which could be “owned”

- the process enhanced the independence and power of SOE management

Experience with markets and corporatization led to a more sophisticatedrestructuring approach for the banks

- but this approach put banks into play

Overall, corporatization and shares created property that the State could monetize if desired

- could be used to fund a social security program- could be used to pay down state obligations

Created the infrastructure for true privatization

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