BEIJING - Foreign investors will realize the largest returns in the next five years from Chinese companies that are privately owned, according to a new report.
The report, by CMG Mahon (China) Investment Management Ltd., a private equity investment firm based in Beijing, says that while the Chinese government focused its support on companies in industrialized cities between 1949 and 1992, enterprises in the then predominantly agricultural provinces, on the coast and in the "hinterland," had to make their own way.
"Their struggle has made them the strongest companies in China," according to the report.
The prime source of foreign direct investment in 2001, which CMG expects to total about $35 billion, will be from expansion of privately held industrial companies.
Although it is difficult to say how much private equity money will be invested in China in 2001, according to CMG, such financial companies as J.P. Morgan Fleming Asset Management and United Overseas Bank Ltd. are working to put mutual funds together in order to qualify for licenses to operate such companies, which will then invest money in Chinese companies.
Selling assets
David Mahon, managing director of CMG, said, the firm focused on selling investment assets that it took over from China North Industries Investment Management Ltd., most of which are joint ventures with Chinese companies associated with the People's Liberation Army that manufacture consumer goods and construction machinery.
CMG also has a $6 million portfolio from the China Investment Co., a private equity investment firm.
"We are seeking more funds under management in 2001 as we are nearly fully invested," he said.
Official Chinese government statistics poorly describe the balance between state-owned and non-state-owned companies, according to the report. The Chinese economy's largest and healthiest companies with the best growth potential are the non-state-owned enterprises, which comprise 60% of the value of industrial output and dominate China's fast growing tertiary sector, according to the report.
Wrong direction
Both the Chinese government and many foreign investors have made the wrong choices in the last 15 years, during which $250 billion in direct foreign investment has flowed into the Chinese market, according to the report, which says that both groups have been "mesmerized" by the apparent scale of the economy and its fast rate of growth.
"It is only independent companies that will bring value to the Chinese economy," the report maintains.
The report names two private independent companies that have become market leaders over the last 10 years. Hope Group in Sichuan, a family-owned firm that is involved in a variety of businesses, including animal feed, real estate and construction, produces 62.7 million renminbi (US$7.5 million) in profits out of annual revenue of more than RMB525.8 million.
Gas cylinder maker Liangqi, in Guangdong, has thrived despite state-owned competition. Liangqi produces low-cost cylinders for household and vehicle use that meet international safety standards, which many of the state-owned competitors don't.
Through this company, its founder and namesake, Zhang Liangqi, controls 30% of China's gas cylinder market. "He has maintained his advantage through developing his own technology, thereby avoiding the high cost of imported production lines, and by focusing upon safety and service," according to the report.
Instead of concentrating on state-owned companies, foreign investors and economists should establish new models with which to assess the Chinese economy, which take into account the strongest forces of the economy, the report says.
While there are private companies in which to make investments, the report says, investors are often better off establishing "new, fully foreign-owned vehicles. They can then employ the people who will bring networks and relationships to the new business."
"Avoiding the fire sales that the Chinese government will resort to in coming years in a last gasp to get some value from their beleaguered assets, foreign investors may also take over entire companies," the report says.
"If they change the old leadership of these with strong local managers and skilled expatriates, they may yet prove to be good vehicles within which to navigate China's complex marketplace."
Question turnaround
The report says that the Chinese government was "juggling" the numbers when it said that the state-owned companies had turned around.
"There are many in China who being so dependent on preserving the Party, will mislead foreign economists, journalists and investors as to the true state of the economy," according to the CMG report. "There are, however, just as many that do sincerely believe in the state-owned sector and will argue that it is the future of the Chinese economy."
Without the continuation of state-owned enterprises millions of people would lose their jobs and China would lose the services that the state-owned companies provide, the report acknowledges.
However, the report points out, as the private sector grows within China, it will be able to absorb workers from the state-owned companies, and the problems of the state-owned companies will be less damaging.
Non-state-owned enterprises make up 62% of the value of Chinese gross domestic product and constitute more than 70% of the service and commercial sectors of the Chinese economy, according to the report. "Accustomed to coping without the support of banks, without direct access to sources of raw materials or the state distribution system, they are often tough and adaptable in a way that their state-owned competitors will never be."
"The Chinese government will one day take the credit for the growth of the non-state sector as a product of its own foresight and the fine balance of its reform strategies," according to the report. "Yet it is ironic that by neglecting the township and private sectors, the present leadership has inadvertently assisted in their development."
