Title: The Challenges of China’s Attempt to Value State-Owned Enterprises Based on Socialist Credentials
Introduction:
China’s attempt to convince investors to evaluate its state-owned enterprises (SOEs) based on their socialist credentials rather than Western capitalist measures has faced significant challenges. Despite an initial rally in share prices after the government’s call for a “rating system with Chinese characteristics,” several indices characterizing SOEs have declined. This article delves into the reasons behind the failed attempt, explores the performance of SOEs compared to their private counterparts, and discusses the implications of this valuation system. Additionally, it provides insights into the difficulties faced by state-owned banks in convincing investors of their financial reliability.
I. Government’s Efforts to Promote Socialist Valuation System
A. Creation of “rating system with Chinese characteristics”
B. Establishment of government-backed mutual funds to invest in state-owned listed companies
II. Declining Indices and Market Performance of SOEs
A. Wind Banking Industry Index: down 8% since one-year high
B. Bank of China’s decline: 13% drop after all-time high
C. Shanghai Stock Exchange Chief Executive’s emphasis on increasing bank share prices
III. Skepticism among Investors and Fund Managers
A. Fund manager James Wu’s doubts about the rally’s sustainability
B. Lower return on equity and return on invested capital for SOEs compared to private companies
C. Difficulty in convincing investors about the reliability of financial data
IV. Comparison of SOEs and Private Companies
A. Underperformance of SOEs compared to their Western peers
B. Falling price-to-book ratios for listed state-owned banks
C. Challenges faced by SOEs in attracting international investors
V. Beijing’s Valuation System and Historical Context
A. Link to Deng Xiaoping’s “socialism with Chinese characteristics”
B. Initiatives to sustain the market and economy amidst pandemic controls
VI. Challenges and Prospects for the Valuation System
A. State-owned banks’ efforts to address investors’ concerns and biases
B. Long-term asset managers adopting a dividend-oriented stock-picking approach
C. The need for further measures to drive up bank share prices
Additional Piece: Understanding China’s Complex Corporate Landscape
China’s corporate landscape, particularly its state-owned enterprises, presents a unique set of challenges and opportunities for investors. The country’s attempt to value SOEs based on socialist credentials adds another layer of complexity to an already intricate market. To truly understand and navigate this landscape, it is crucial to grasp the following key insights:
1. Dual Role of SOEs: State-owned enterprises in China often serve as both economic entities and instruments of government policy. This duality influences their performance, decision-making processes, and market dynamics.
2. Performance Comparisons: Comparing the performance of SOEs solely based on profit margins or other financial metrics may not provide a complete picture. SOEs are often tasked with fulfilling social obligations and job creation, which can impact their financial performance.
3. Governance Challenges: The governance structure of SOEs, with government-appointed executives and Communist Party influence, introduces unique challenges. Balancing party objectives with commercial success can be a delicate task.
4. Market Reforms: China has been gradually reforming its state-owned sector, aiming for improved efficiency, competition, and market-oriented operations. As these reforms progress, the valuation and performance of SOEs are likely to evolve.
5. Investment Strategies: Investors seeking opportunities in China’s corporate landscape should carefully consider their risk appetite, investment objectives, and understanding of the local market dynamics. A diversified approach, combining both private and state-owned companies, could offer the best risk-adjusted returns.
Summary:
China’s attempt to establish a valuation system based on socialist credentials for its state-owned enterprises has faced significant challenges. Despite an initial rally, several indices characterizing SOEs have declined, raising skepticism among investors and fund managers. SOEs often underperform their private counterparts, making it difficult to attract international investors. However, the valuation system is rooted in historical context and aims to sustain the market and economy. State-owned banks have been particularly struggling to convince investors of their financial reliability. Understanding the complexities of China’s corporate landscape is crucial for investors seeking opportunities in this market. Ultimately, a diverse and informed investment strategy will be key to navigating this unique environment.
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Beijing’s attempt to persuade investors to value its giant state-owned enterprises according to their socialist credentials, rather than according to the conventional measures of Western capitalism, has failed after their shares’ rally failed this month.
Shares soared after officials in November called for the creation of a “rating system with Chinese characteristics” that departed from traditional market-based methods by recognizing the merits of “the Communist Party’s corporate governance.”
To bolster the move, government-backed asset managers set up 16 mutual funds, nine of which are index-linked, with a mandate to invest in state-owned listed companies.
However, despite the initial gains, a number of indices characterizing SOEs have since declined. The Wind Banking Industry Index, which tracks listed lenders in Shanghai and Shenzhen, is down 8% since hitting a one-year high on May 8, with the Bank of China shedding 13% after hitting an all-time high.
James Wu, a Shanghai-based fund manager, said he sold bank shares this month as he doubted the rally would continue.
“I’m not going to keep an investment just because the government says it’s worth buying,” Wu said. “There are better investment opportunities than state-owned banks with no growth potential and independent management.”
China’s 1,432 listed state-owned enterprises have long been seen as a tool of government policy and often underperform their peers in the West. The listed banks, all state-owned, have seen their price-to-book ratios fall below 0.6 from 1.2 over the past five years, compared to PB ratios of more than one for US banks over that period.
Elsewhere, Wind State’s Key Enterprises Concept Index, which tracks 55 major SOEs, has lost 9.2% since peaking early last month. The Hang Seng China Central SOEs index of Hong Kong-listed state-owned companies has lost 9% since hitting a 15-month high in May. The indices remain up on the year to date.
“Some short-term traders will decide they can ride a fast wave and then look to exit before the tide changes,” said Andrew Collier, managing director of Oriental Capital Research in Hong Kong.
“But international investors won’t be convinced because data for SOEs show that they generally have a lower return on equity and return on invested capital than private companies.”
At a conference hosted by the Shanghai Stock Exchange last month, its chief executive Cai Jianchun said the capital of China’s 42 listed banks meant they could only increase credit supply by less than 9%, below the target double-digit set by the government. “Lenders need to replenish capital from the capital market,” Cai said, adding that it was a “major task” for the stock exchange to drive up bank share prices.
He listed measures including hosting more earnings calls and events targeting international investors, and developing more SOE-focused funds.
But representatives of the state-owned banks said they were having difficulty convincing investors that their financial data was reliable. An official at the Industrial and Commercial Bank of China, the world’s largest bank by assets, said investors have “concerns and biases”. Cai responded that long-term asset managers should adopt a more dividend-oriented stock-picking approach as this would favor state-owned banks.
Beijing’s new “valuation system with Chinese characteristics” harks back to when the late leader Deng Xiaoping coined the phrase “socialism with Chinese characteristics” in 1982, when he called for an economy that blends Western market concepts with state planning .
The initiative had come with the government looking for ways to sustain a market and an economy still struggling to recover from three years of strict pandemic controls.
Additional reporting by Joe Leahy in Beijing
https://www.ft.com/content/8e585e43-5451-49c8-ba06-d9177d2971e5
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