Local SOEs seem to be edging toward reform

'Mixed ownership' of State firms could be role investors hoped for

The buildup of China's local government debt is a constant source of worry for China watchers, but it can also be an opportunity for private investors.

Many local governments are considering spinoffs of some State-owned assets to alleviate their mounting debt repayment pressure, according to the Economic Information Daily, a newspaper under the Xinhua News Agency.

Local governments are unlikely to admit that these moves are being driven by debt pressures. More likely, they would describe them as efforts to restructure the lethargic State-owned sector in line with the central government's call for a move to a "mixed-ownership" model.

For realists, what actually drives such restructuring moves has little relevance. The real point is that finally, local governments have incentives to do something.

China's SOE reform has gone a long way in the past three decades. Especially in the past 10 years or so, the landscape has been dramatically transformed. Once feeble, bureaucratic and struggling to survive, China's SOEs now are muscular, expanding and ambitious.

But for those who had hoped China's market-oriented reforms would lead to a situation where "the State retreats and the private sector advances", the past decade was a disappointment.

Private-sector companies did flourish, but they were overshadowed by the aggressive SOEs. SOEs not only consolidated their grip on sectors such as petroleum and the power grid but also expanded their presence in competitive sectors such as retail, property and manufacturing.

Local governments, naturally, played a crucial role in fostering local SOEs. Jurisdictions at virtually every level of local government own several SOEs.

Each major SOE spawns a number of subsidiaries, which together make up a web of State firms that penetrates every aspect of the economy. Local governments have favored them in financing, land allocation and public procurement, and officials have shown little interest in diversifying the shareholding of well-run SOEs.

But now the tide is shifting. As of mid-August, 18 provincial governments, including Beijing, Shanghai and Guangdong, have announced their own versions of mixed-ownership reform. In the southwestern municipality of Chongqing, authorities have vowed to make two-thirds of the local SOEs "mixed-owned".

Chongqing is also among the nation's most indebted cities, with a total debt equivalent to 92.75 percent of fiscal revenue as of mid-2013, second only to Beijing.

"For some local SOEs that run lackluster businesses, it can be a great opportunity to invigorate State assets by introducing private capital. Efficiency could be lifted, while State assets could be cashed out," Zhao Quanhou, an expert with the Fiscal Science Research Center, was quoted by Economic Information Daily as saying.

This is good news for private investors that have long sought a role in SOE-dominated sectors but could not find any way in. Some such investors may still be hesitant as few available targets offer a controlling stake. But for most private equity firms, which mainly pursue financial returns, a minority stake is no problem.

On the other hand, many local SOEs perform poorly, and that is not just because they are in declining industries. They also lack accountability, functioning boards and incentives for staff and managers. PE firms are good at introducing such market-oriented discipline.

Anyone who doubts whether management can make a difference should look at Hony Capital, a leading PE firm under Legend Holdings Corp. The firm is particularly interested in buying SOEs.

Hony has invested 14 billion yuan ($2.25 billion) over the past decade for stakes in 31 SOEs. The total value of those companies has more than doubled on average. The latest example is its move to take a 10 percent stake in Shanghai Chengtou Holding Co, a city-backed real-estate and waste-management company.

There are lingering concerns over such deals. A top worry is that local governments may be so desperate to sell their assets that they sell them cheap.

But much of the worry is overblown, although in the past 20 years such fears have often been exploited to thwart meaningful reform. Where there were cheap sales of State assets, they took place because of overly rigorous audit and accounting systems and public oversight.

These flaws just provide more reason to conduct reform; they are not an excuse for the status quo. In any case, assets only generate value through active management.

The real problem is that so far, local governments' emphasis has been on diversifying SOEs' shareholding structure without also reducing their presence in competitive sectors.

Without such a clear commitment, mixed ownership reform may actually give SOEs increased dominance across the board.