Foreign investors should perform their due diligence with great care, says Mr. Tse. Prior to striking a deal, foreign investors tend to spend time at the acquiring company’s main office, where capabilities may be high, leading investors to assume similar skill levels across the entire company. “The competitiveness of some SOEs is quite high, particularly at the headquarters,” says Mr. Tse. “But these competencies can drop when you go to the regional or local offices.” Such problems are particularly pronounced in Chinese SOEs, says Mr. Tse, where many managers and staff at the local and regional offices lack the right skills and training.
Mr. Meyer cautions against jumping into China for fear of missing an opportunity. China’s banking system, as noted above, is particularly perilous, leading many to question why firms like Citigroup — which offered twice the book value for Guangdong Development Bank in a recently quashed consortium deal — are clamoring to get in. Investment in China’s national banks, according to Mr. Meyer, opens the entire Chinese market to foreign banks who would otherwise have to be licensed one city at a time. However, the Chinese banks have not completely solved the problem of nonperforming loans (NPLs) and anticipate an increase in NPLs this year. (Although Beijing has given billions in handouts to the banks to cover past NPLs, new high-risk loans are being made at an alarming rate, notes Professor Meyer.)
As with any mergers and acquisitions activity, the number crunching will most likely be the easy part. Once the “hardware” of these deals has been completed, it’s the “software” that will pose the biggest challenge, says Mr. Tse. “The best companies in the world have a clear vision and well-defined values that transcend locations and national borders,” he says. “How will you get two companies together to agree on a common set of values when values reflect the deepest layers of history?” For example, there are substantial differences in the way Easterners and Westerners approach work. The Western capitalist notions of meritocracy and careers that define the individual will run headlong into the dramatically different views that prevail in China. “For most people working in a SOE,” notes Mr. Tse, “it’s just a job.”
Although Mr. Tse is confident that the government is serious about SOE reform, some observers are reserving judgment until privatization and Western-style governance take a stronger — and more visible — hold. That’s still a way off: Beijing’s stated goal is to go from about 135,000 wholly state-owned enterprises to a “core” of 1,000. (A lack of transparency on ownership makes those numbers difficult to verify. The vast majority of listings on the Chinese stock exchange are actually for minority shares in subsidiaries of wholly government-controlled companies.)
Not Just for Foreigners
Local investors have also started eyeing SOEs. In early March, a delegation of about 50 firms from Wenzhou, in Zhejiang province on the east coast of China, visited the capital as guests of the Beijing Assets and Equity Exchange Center (BAEEC), which oversees the reform of SOEs, to discuss investment opportunities. The discussions revolved around the possibility of the Wenzhou companies, known for their entrepreneurial skills, either taking over or investing in about 180 SOEs in Beijing. BAEEC president Xiong Yan told the local media that the discussions were intended to send a signal “to the private capital of China that Beijing needs your investment.”
In another bold step, the Chinese government is experimenting with inviting outside directors — from within and without the country — to sit on the boards of some of its SOEs. At Baosteel, the number of outside directors on the board exceeds that of internal ones. Booz Allen’s Mr. Tse describes the government’s experiment as “another way of creating better corporate governance.” In traditional state-owned enterprises, he explains, there was no requirement for — and, in fact, no definition of — a board of directors. Concludes Mr. Tse: “The government is now realizing that to truly change an enterprise, you need to go inside of it and fundamentally change its heart and soul.”