Foreign companies in China
The deal is being hailed as another step forward in the mainland's march towards western capitalism. Some observers scent a change in official policy. In recent days China's Railway Ministry has said that it is ready to let foreigners take full ownership of its local railways. Last month UBS, a Swiss bank, gained a 20% holding and management control of Beijing Securities, the first time a foreign investor has been granted a direct stake in a licensed domestic broker. Late last year, Goldman Sachs was allowed to set up a domestic investment bank, over which it claims future control rights. Meanwhile there are rumours that foreign beer firms including Anheuser-Busch and Heineken are discussing taking a controlling stake in China's eighth biggest beermaker, Fujian Sedrin Brewery.
All this looks like evidence that Beijing is willing to relinquish control over state companies. Fang Fang, a managing director at J.P. Morgan, the bank that advised on the Xugong sale, calls the deal: “a change in thinking. It signals that the regulatory and legal and capital markets frameworks in China have come of age.”
If true, this would be good news. Government ownership is bad for companies everywhere and especially in China. Despite years of restructuring, China's state-owned firms remain poorly profitable and under-capitalised. Even in private firms, meddling by local and provincial governments have ruined many a well-run company. Kelon, a once high-flying maker of fridges, is now close to collapse after excessive state interference. Having a government owner can also kill the overseas expansion plans of even the most modern Chinese company. Fu Chengyu, head of CNOOC, an oil company, recently said he would consider asking the government to cut its 70% stake in his firm. This summer, Mr Fu was forced to withdraw an $18.5 billion bid for Unocal, an American rival, following furious resistance by American politicians who objected to a Chinese state-owned firm owning strategic American assets.
Yet the Xugong deal is not quite the change of heart by China's leadership that observers think. Construction machinery is not regarded as a sensitive sector, which eased Xugong's sale. Critical industries from energy to defence and especially China's banks, which desperately need foreign owners, will probably remain under state control. The banking regulator this week confirmed reports that the investment arm of China's central bank, Central Huijin Investment, which is the biggest shareholder in Bank of China, has voted to block a long-mooted plan by Singapore's Temasek to take a 10% stake in the lender. Moreover, the Xugong deal was not hatched in Beijing; rather it was the initiative of the Xuzhou city government in liberal Jiangsu province, where the company is based. Even so, getting Beijing onside took two years.
Gaining control also comes at a price for foreigners. Carlyle had to pay almost twice book value compared with the 30% premium of previous Chinese private-equity deals. It also had to agree to take on Xugong's 43% share of a listed roadbuilding subsidiary that has just posted big losses. Moreover, because the city government still owns 15%, Carlyle cannot gear up Xugong with debt as in a conventional leveraged buyout, potentially reducing its returns. Such complications could reduce the pool of potential foreign buyers.
Critically, China is not giving foreigners a free hand to manage their investments. With half the mainland market for mobile cranes and booming construction demand, Xugong already makes decent profits. Its chairman Wang Min insists the management team will stay in place, as will the name—a condition to which Carlyle had to agree. The real reason the Americans have been invited aboard is to build Xugong into an “international brand” and give it access to new technology.
Carlyle clearly think it can achieve this goal and make money. But the Chinese government's obsession with creating hi-tech national champions risks undermining the very thing that has given Chinese companies an edge—low costs and prices. Kelon was ruined after its state managers forced costly technology on it when its real advantage had been stylish, but simple and cheap fridges. Xugong faces similar risks. Its success so far has come through selling decent machines at one-third of the price of foreign rivals. Yet Carlyle has been told to introduce Xugong to technology firms to help it compete with foreign rivals like Caterpillar overseas.
Rather than being free to clean up Xugong and sell on a focused and efficient machinery-maker, Carlyle is being pushed by the government into the latest quest to create a global champion. China may really reap the benefits of foreign ownership only when the government drops the belief that it knows best and stops imposing conditions on foreign buyers.