Are going-out companies paying too much?

In the late 1980s, Japan had over-inflated stock and property markets. Its companies, fleeing the lack of opportunities in Japan itself, vastly overpaid for all manner of U.S. assets. I often dreamed that some Japanese investor would overpay for the house I owned at the time.

The rate of Chinese companies making overseas investments has more than doubled since last year. They often have a business model designed to bring technology and foreign business practices to the huge domestic Chinese market?a much better-defined plan than the Japanese, who were mostly purely financial investors, ever did. But, still I worry that they are paying too much.

Let’s take a look at a recent deal. Beijing-based LeEco Global Ltd announced last Tuesday that it agreed to pay $2 billion cash for Vizio Inc, a California-based manufacturer of inexpensive television sets and sound bars. This at a time when the dollar is high relative to the yuan. LeEco argued that Vizio will enable it to gain market share in the coming internet-of-things technology that links all kinds of smart products together. And, it certainly may turn out in that LeEco made a smart move in the long run. But, I still wonder about the pricing.

Vizio filed initial public offering papers with the U.S. Securities and Exchange Commission in July of 2015, but never actually carried out the IPO. According to accounting data in the SEC filing, Vizio’s profits were $44.96 million in 2014 and $31.35 million in the first half of 2015.

Since Vizio is privately held and decided not to go through with the IPO, subsequent data are not available. But these numbers imply a profit of roughly $56 million in 2015, assuming that Vizio makes slightly more than half of its profits in the first half, as it did in 2014. Vizio has not been a growth company?its sales and profits in 2014 were about the same as in 2010 and were lower in the years in between.

Vizio’s business in the U.S. is in brutally competitive markets. Most consumers in the U.S. consider television sets to be almost undifferentiated commodities?they buy the cheapest one. Vizio has become the biggest-selling brand of TVs in the U.S. by following a low-price strategy. But, this strategy leads to very low margins?profits have averaged less than 3 percent of sales.

Vizio’s TVs are connected to the internet, so the company receives potentially valuable data on what shows its customers are watching. But, the company so far has not been able to reap profits from this information. In any case, William Wang, the current CEO and majority owner of Vizio, will retain 51 percent ownership of the Insight division, which will own this data.

The bottom line is that LeEco has agreed to pay about 35 times earnings for a producer of near-commodity products in a highly competitive business. This compares with Apple Inc, which currently trades for 11 times earnings, Google Inc at 30, and Samsung Electronics Co at 3.3.

If Vizio had completed its IPO and received 10 times earnings, which seems about right for a low-margin company, it would have had a market value of $600 million. Even at the current historically high average Dow Industrials price-to-earnings ratio of about 20, which is too high for a company in such a competitive market, Vizio would be worth $1.2 billion.

China Daily reported that Jia Yueting, founder and CEO of LeEco, said that the purchase of Vizio is part of a “big bang plan” to enter the U.S. market.

It may get access to Vizio’s distribution channels to sell its phones and other products?but, Vizio sells its TVs through big box stores, such as Best Buy Co Inc, which insist on paying low-margin prices to their suppliers.

It may be able to use its LeEco system to add value to the TVs, but Vizio made its name through low prices?proving that customers are reluctant to pay more for sophisticated TVs. Just about every merger or acquisition is justified on the basis of “synergies”, but few actually pay off.

Companies spending their own money have more incentive to get it right than does an outside analyst like myself. But, I do hope the current wave of Chinese companies going-out are not paying too much.

(By David Blair)

Uber China team to get 6 months base salary and equity vesting as bonus

After China’s ride-hailing market leader Didi Chuxing confirmed Monday that it will acquire Uber’s business in China, Uber China held a staff meeting in the evening, announcing that the company will pay a cash Close Bonus in recognition of Uber China team’s contribution, according to a report by technology media site tech.sina.com.cn,

The bonus will be valued at 6 months base salary and 6 months equity vesting that includes new hire grants, performance bonus and referral bonus.

The company said half of the bonus will be paid in cash within one week after the merger closes and the remaining half will be paid to employees one month after the closes.

Only employees who have worked with Didi or Uber for at least 30 days after the signing of the deal are qualified to receive the remaining half of the bonus.

Didi’s acquisition of Uber China’s business will give Uber a 5.89 percent stake in Didi, and Didi will also gain a stake valued at $68 billion in Uber’s global business.

Apart from Uber’s chief executive officer Travis Kalanick’s blog post, Uber China officials have not commented on the acquisition yet.

Low private investment, high debt weigh down growth

Beginning with the second quarter of the year, China will be in the do-or-die battle of its economic transition, according to Hong Kong-based researchers.

The country’s transition will undergo its most difficult stage, although it will probably maintain around 6 percent growth in GDP in the second half of the year, according to economists and financial analysts recently surveyed by China Daily.

According to the National Bureau of Statistics, the economy saw year-on-year growth of 6.7 percent in the second quarter, slightly above market expectations. The second quarter’s growth rate was the same as in the previous quarter.

The growth was powered by retail sales, industrial output and new loans directed to fixed-asset investment.

But several things are at the center of concern, said Sun Mingchun, senior partner and chief economist of China Broad Capital Co Ltd, including an excess of industrial capacity, a large total social financing and a high leverage ratio, meaning a high level of debt.

Private investment was 15.9 trillion yuan ($2.39 trillion) in the first half of 2016. Its annualized growth rate fell from 3.9 percent in the first five months to 2.8 percent in the first half of the year, which means there was quite a dip in June alone.

Private companies are not seeing encouraging returns from their investments in most industries. And they probably still will not see a good profit in the next two to three years, Sun said.

By contrast, the State sector investment rose an impressive 23.5 percent in the first half of the year, concentrating mostly on infrastructure development in the less-developed areas.

But so much investment is still not as powerful a driver of growth as consumer spending, especially that on services, said Fielding Chen, Asia economist for Bloomberg Intelligence. If investment sees a further decline in the second half of the year, which he expects, the economy’s growth engine will remain weak.

According to Cui Li, managing director and director of macroeconomic research at CCB International, the economy will be in its difficult period because it is facing an “unprecedented balancing risk”, including “weaker-than-ever global demand, need for a sharper-than-expected capacity cut for the industry, and a round of bond defaults that weigh on investor sentiment.”

Ding Shuang, head of China research at Standard Chartered Plc, said that although the hard landing scenario is less likely to happen, the mainland economic situation will remain complex, with questions about how to deal with its mounting debt and avoid the threat of capital outflow.

Ding expects that in the coming months of the year, China’s fiscal policy will keep expanding while its monetary policy will be neutral. Cutting the reserve requirement ratio for banks may be the best way to enlarge the credit supply. But before the RRR is cut, the government may use reverse repos and lower interest rates on the medium-term lending facility.

Debt is a particularly ugly spot, the researchers said. As measured by Fitch Ratings Inc’s Adjusted Measure of Total Social Financing, credit to companies, local governments and households rose as much as 15 percent in 2015 in the Chinese mainland, more than double its GDP growth.

Insurers, banks post sharp drops

Shanghai stocks ended nearly flat yesterday, with falls seen in financial and insurance firms.

The Shanghai Composite Index edged up 0.1 percent to close at 2,994.32 points.

Banks were vulnerable following investor concerns that curbs on their investment in wealth-management products might restrict capital flow.

China Everbright Bank lost 1.55 percent to 3.82 yuan (57 US cents), and China Merchants Bank shed 1.32 percent to 17.14 yuan.

China Life Insurance Co fell 1.35 percent and Ping An Insurance Group lost 1.04 percent after the China Insurance Regulatory Commission said local insurers’ combined profits plunged more than 54 percent in the first half due to lower investment return despite growing premium income.

Airlines gained as oil prices declined, with China Eastern Airlines adding 1.29 percent to 7.01 yuan and China Southern Airlines jumping 1.85 percent to close at 8.54 yuan.

Yuan to join world’s top three currencies for payments

Key challenges persist in internationalization process, experts warn

The yuan is expected to become the third-largest payment currency after the U.S. dollar and the euro by 2018, an expert said during the 2016 International Monetary Forum in Beijing on Sunday, while noting that the currency’s internationalization still faces key challenges.

“The yuan is expected to surpass the Japanese yen and the British pound to become the third-largest payment currency,” said Xiang Songzuo, a vice director of the International Monetary Institute (IMI) under Renmin University of China.

The yuan’s internationalization has progressed steadily in recent years, according to the 2016 Renminbi Internationalization Report, which was released by the institute during the forum.

As of the end of 2015, the Renminbi Internationalization Index (RII) stood at 3.6, a year-on-year increase of 42.9 percent and an increase of more than 10-fold over the previous five years, said the report.

The RII is used by the institute to measure the internationalization of the yuan. It takes into account the currency’s status in international trade and finance and in official foreign reserves.

A currency’s internationalization can range from zero to 100.

The yuan ranked sixth in terms of payments as of June 2015, Chen Yulu, a vice president of the People’s Bank of China (PBC), the country’s central bank, told the forum on Sunday.

Chen noted that 36 countries and regions had signed currency swap agreements with China as of June this year, with a total volume of 3.3 trillion yuan ($494.3 billion).

The factors driving the yuan’s internationalization are the steady performance of China’s economy, its orderly pursuit of financial reform and its enhanced financial infrastructure and support mechanisms that are in line with international standards, the report said.

China’s GDP grew by 6.7 percent in the first half of 2016, after expanding 6.9 percent in 2015, according to data released by the National Bureau of Statistics on July 16.

The yuan’s internationalization has moved forward in steps. For example, in October 2015, China launched the first phase of the yuan’s Cross-border Interbank Payment System, which provides clearing and settlement service to domestic and foreign financial institutions for cross-border and offshore yuan businesses, according to a statement on the PBC’s website at the time.

Then in November 2015, the IMF announced it would include the yuan in the basket of currencies for its Special Drawing Rights reserve unit.

That move is scheduled to take effect in October 2016.

However, the yuan’s internationalization still faces big challenges amid a complex, volatile and cloudy international monetary environment, Xiang warned.

One challenge is investors’ confidence in the country’s economy, Tu Yonghong, a professor who specializes in international currencies at Renmin University of China, told the Global Times on the sidelines of the forum.

Since the global financial crisis in 2008, many structural obstacles have emerged in China’s economy.

These include weak innovation abilities, an unbalanced economic structure, difficulties in channeling finance to small and medium-sized companies, said the report.

Xia Le, chief economist for the Asia research department of Banco Bibao Vizcaya Argentaria, told the Global Times in an interview during the Beijing event that China may have to further liberalize the yuan’s exchange rate.

But he said this process should be slow, as it may lead to capital outflows if the yuan sharply depreciates.

The core task of China’s monetary authorities when it comes to macro financial management is to establish comprehensive, targeted strategies to achieve financial stability, concluded the report.

China should also communicate with private companies in Western countries including the US, the UK and Europe to understand how their policies are formulated, rather than communicating only on a government-to-government level, Alistair M. Michie, secretary-general of the British East Asia Council, told the Global Times in an interview on the sidelines of the financial forum.

“With the rapid pace of China’s economic upgrading and reform, the yuan’s inclusion in the SDR basket and the country’s ‘Belt and Road’ initiative, the yuan will be needed more by the market,” Chen said.

110 of nation’s firms on Fortune Global 500 list

A record 110 Chinese companies have squeezed onto the latest Fortune Global 500 list, 13 of which made their debut, including manufacturing powerhouse China Railway Rolling Stock Corp, e-commerce juggernaut JD.com, home appliance maker Midea and property developer Wanda.

Experts said that it is not surprising for more Chinese companies to be listed, because of the country’s relentless efforts to upgrade manufacturing, boost innovation and drive consumption.

“We will see the continued rise of Chinese companies to capture that tremendous growth of the local economy,” said Adam Xu, partner of Strategy&, which is PricewaterhouseCoopers’ strategy consulting business.

As more technology and commerce companies leverage and benefit from China’s tremendous market potential in e-commerce, entertainment and real estate segments, they will make the Fortune Global 500 list, Xu added.

Three of the top five companies on the list are from China. State Grid rose to second place from seventh last year, surpassing the State-owned energy giants China National Petroleum Corp and Sinopec Group.

State Grid, generating $329.6 billion in sales last year, attributed its performance to successful investment strategies and research and development input.

Among the 13 debut Fortune Global 500 companies from China, JD.com ranks at 366, with revenue reaching $28.85 billion last year.

“It is not a surprise, given how quickly China e-commerce has been growing and how advanced China is for digital and mobile commerce,” Xu said.

JD.com positions itself as a self-managing e-commerce giant. Alibaba acts more like a service provider to numerous online shops, which is why Alibaba’s revenue is not as huge as JD.com’s.

China Railway Rolling Stock Corp, which ranks 266, has grown into a leading global supplier of bullet trains and subway cars.

It is widely expected that China will become the largest e-commerce and consumption market and will nurture a new consumer-centric ecosystem, Xu said.

State-owned companies topped the Chinese companies on the list, because the ranking is based on the companies’ revenue instead of their profitability, said Han Xiaoping, an independent energy analyst.

“All State-owned energy enterprises are large enough to compete from a global perspective. But they are facing huge pressure when it comes to financial performance amid falling oil prices,” he said.

China Vanke debuted on the list at 356, with annual revenue of $29.33 billion, followed by real estate giants Dalian Wanda Group at 385 and Evergrande Real Estate Group at 496.

Wanda, headed by China’s richest man, Wang Jianlin, said after the list was released that this was the first time the conglomerate had registered for the Fortune Global 500, even though it could have secured a place before.

Factbox

Thirteen Chinese companies have appeared on the Fortune Global 500 list for the first time

102 China South Industries Group

266 CRRC

349 China State Shipbuilding

356 China Vanke

366 JD.com

381 China Aerospace Science and Industry

385 Dalian Wanda Group

408 China Electronics Technology Group

427 New China Life Insurance

473 CK Hutchison Holdings 481 Midea Group

495 WH Group

496 Evergrande Real Estate Group

Chinese brands lead smartphone sales

Chinese smartphone brands, including Huawei, Oppo and Vivo, posted double-digit growth in the second quarter, compared with a 3.2 percent year-on-year rise in sales globally, a report said yesterday.

The combined sales of Chinese brands hit 139 million units, up 13.8 percent year on year. The high growth rate of Chinese brands is set to remain in the third quarter, according to market watchers.

Comparatively, sales of overseas brands grew slowly and even fell.

Huawei’s sales grew 7.4 percent to 29 million units, cementing its No. 3 ranking globally. Sales of Oppo and Vivo jumped about 15 percent in the second quarter.

The global smartphone sales hit 320 million units in the second quarter, led by the top-five market leaders Samsung with a 24.5 percent share, Apple with 15.1 percent, Huawei with 9.2 percent, Oppo with 5.6 percent and LG with 5.4 percent, according to TrendForce, a Taiwan-based research company.

Sales of iPhones in May shed 1.2 percent year on year in China’s mainland after they fell 26 percent in the first quarter from a year earlier, said Hong Kong-based market researcher Counterpoint Research.

COFCO cuts operations after merger with Chinatex

After taking control of competitor Chinatex Corp, the giant grain and oil processor and trader China National Cereals, Oils and Foodstuffs Corp (COFCO) announced on Monday it will close six departments at its headquarters and establish professional operating platforms to manage some of its businesses.

The State-owned Assets Supervision and Administration Commission (SASAC) approved the merger of the two State-owned enterprises (SOEs) on Friday.

COFCO said the combination will help increase its market share in the edible oil processing sector to 18 percent, which will make it No.1 nationwide, according to an e-mail COFCO sent to the Global Times on Monday.

The company’s cotton business will further develop and eventually hold 10 percent of the global market for the crop, COFCO noted in the e-mail.

Chinatex will become a subsidiary of COFCO, according to an announcement posted on the website of the SASAC on Friday.

Combining two former competitors is in line with China’s SOE reform -guidelines, which encourage the creation of giant, highly competitive entities in various industries, Feng Liguo, an expert at the Beijing-based China Enterprise Confederation, told the Global Times on Monday.

“However, COFCO has little experience in operating the textile and cotton-spinning businesses of Chinatex, which is likely to be challenging after the merger,” Feng said.

The companies have similarities, however, in grain and edible oil processing, as well as trade and logistics, and the tie-up will improve Chinatex’s competitiveness as well as its probability, COFCO Chairman Zhao Boya told a meeting held Monday morning.

Further streamlining operations and transforming the company into a “pilot investment firm” are the next steps that COFCO will take in restructuring, the company noted in the e-mail.

The number of staff at its headquarters will be downsized from 610 to less than 240, according to the e-mail. However, COFCO did not specify whether those employees will be transferred to other positions or be laid off.

COFCO had planned to reduce losses by more than 50 percent in the next three years and had identified 65 subsidiaries for improvement and 91 subsidiaries for intensive management, according to a statement posted on the website of the SASAC on June 13. Also, the company would restructure 102 subsidiaries through mergers and acquisitions (M&As), the post showed.

M&As are not enough, though and companies shouldn’t see them as crucial to SOE reforms. Building a modern corporate structure including an effective board of directors and an appropriate staff recruitment system has to be further emphasized, noted Liang Jun, a research fellow with the Guangdong Academy of Social Sciences.

“We are paying too much attention to downsizing the State sector now,” Liang said, noting that some media reports said the motivation behind the merger is that SASAC intends to reduce the number of SOEs to less than 100.

The shrinkage of the sector has been wrongly seen as part of the SOE reforms.

COFCO noted in the e-mail that the company will assign responsibility for asset allocation, production, research and development, employee evaluations, payroll and recruitment to 18 professional operating platforms.

By 2020, the company will develop two or three platforms that generate 100 billion yuan ($14.91 billion) in annual revenue and four or five that generate 50 billion yuan, the e-mail said.

COFCO will hire more professional managers and establish an incentive-based compensation system, it said.

However, the company didn’t give details about how those platforms will operate or what the hiring process will be, Liang noted.

“It’s still vague in terms of how COFCO will be transformed into an investment firm or a modern company,” he said.

As the next step in SOE reforms, COFCO should also separate its two major sectors. One is for edible oil and grain products traded in the market, the other is foodstuffs production and management for State reserves, Feng said.

Apprentice program to foster high job skills

Following a series of pilot projects, China is expected to promote a new model of apprenticeship to foster high-end skilled workers.

“Apprenticeship is an essential means to promote skill development and realize successful transitions from school to work,” said Yin Weimin, minister of Human Resources and Social Security.

“The initiative is for building high-quality apprenticeships and developing a workforce that possesses strong capabilities in both theory and practice and meets the needs of the labor market,” Yin said after the G20 Labor and Employment Ministerial Meeting on Wednesday.

Yin said skill development has always been a key topic of the G20 Labor and Employment Ministerial Meeting.

In August, the Ministry of Human Resources and Social Security promoted a new model of apprenticeship that combines company training with vocational schools. Every one of the total 13 provinces or municipalities chose three to five enterprises involving about 7,000 people. Everyone under the pilot project was a worker as well as a student.

Yu Zhiwei, vice-president of LinkedIn China, said the mismatch of the labor market has two aspects.

“On one hand, we have an excessively large group of medium- and low-skilled workers who cannot find proper jobs; on the other hand, we have an acute shortage of professionals, innovative talent and high-end talent.”

According to The Human Capital Report 2016 released by the World Economic Forum, approximately 25,000 new workers will enter the labor market in developing countries every day until 2020, while more than 200 million people globally continue to be out of a job. Yet, simultaneously, there is expected to be a shortage of some 50 million high-skilled job applicants over the coming decade.

Li Shanxiang, deputy head of human resources at Linyi Mining Group in Shandong province, said the company has signed a contract with Shandong Coal Technician College, aiming to leverage the skill level of 100 medium-skilled workers in two years.

“We are very keen to cultivate our workers into high-skilled ones. The new apprenticeship model provides one teacher for three to five apprentices and provides special training for them.”

Baosteel prepares to slash capacity through 2018 in supply-side reform

Baosteel Group, China’s second-biggest steelmaker, plans to cut its production capacity over the next two years as it pursues supply-side reform, it said on its website on Tuesday.

Baosteel’s announcement comes as the Chinese government works to reduce capacity gluts in the steel and coal sector.

The government has earmarked 27.6 billion yuan ($4.12 billion) to pay for closures in the sectors as the country has pledged to cut up to 150 million tons of steel capacity and 500 million tons of coal output in the next three to five years.

Overcapacity in China’s steel sector has also created trade tensions as India, Australia and the U.S. have imposed duties on Chinese steel exports amid allegations of dumping.

Baosteel pledged to cut 9.2 million tons of crude steel capacity between 2016 and 2018, the company said, equivalent to about one-quarter of its 2015 production.

The capacity shutdowns will include facilities in its flagship plant in Shanghai and branches outside of the city. The company will not resume production after the closures, it noted.

Baosteel’s cutbacks follow a statement by the State-owned Assets Supervision and Administration Commission on Friday that China’s government-run steel and coal companies will cut capacity by about 10 percent in the next two years and by 15 percent as of 2020.

The listed units of Baosteel and Wuhan Steel Group, the country’s sixth-largest mill, separately said in June they would restructure, without specifying details.

Baosteel Chairman Xu Lejiang told a government meeting on July 8 that large State-owned steel companies should use mergers and acquisitions to improve the concentration level of the industry and urged the government to step up efforts to close inefficient capacity, the company said on its website on Monday.

In April, a Chinese government official said the country has 1.13 billion tons of crude steel production capacity.