The Next Hot Spot For M&A: Shanghai

As China's top officials prepare for the National People's Congress on Mar. 5, all factions agree that the 110,000 state enterprises are bleeding the country dry. Nearly half of them are in the red, consuming nearly 60% of the state budget. It's largely because of the subsidies to the enterprises that urban inflation is roaring at about a 24% annual rate. And even though banks are already overburdened with bad loans to these enterprises, they have to keep the companies afloat because they employ 100 million workers.

A solution may be found in an experiment due to be launched soon in Shanghai. City officials tell BUSINESS WEEK that they will create a mergers-and-acquisitions market where assets from Shanghai-based state enterprises would be sold to the highest bidder. Having won approval from Beijing, Shanghai officials are working out the details of this new M&A exchange. If Shanghai does the job well, "this will accelerate the corporatization and privatization process," says Jonathan R. Woetzel, senior manager of McKinsey & Co. in Hong Kong.

The goal of the exchange is to dismantle money-losing enterprises with the least amount of pain. Shanghai intends to begin the pilot program with small enterprises first. Evaluators will appraise company assets, including product lines and manufacturing facilities. They will then be listed separately on a local "property exchange."

The authorities have yet to determine exactly how the workforce will be dealt with as part of the new program. But it's likely that contracts would preclude buyers from shuttering factories and laying off workers. At first, the exchange will not be open to foreigners, but there are plans to include them in the future.

Officials at Shanghai's State-Owned Management Assets Office, established early last year, plan to announce by June how state assets will be evaluated. Shanghai may be well suited for such an experiment because it has made the most progress in social service reforms. For instance, the city is working on alternatives that would ease the burden on state enterprises, which traditionally have been the exclusive providers of health care and education for their workers.

China now has nothing that can be called an M&A market. "We don't have situations where the big fish comes, eats the little fish, and then spits out the bad parts," says Li Shuguang, deputy director of a private consulting firm on mergers and bankruptcies in Beijing. To date, most mergers have been forced by the government, which urges a strong company to take over a faltering one. Small property exchanges do exist in rural areas. But they only involve township, collective, and private enterprises.

BLOATED. Aside from the Shanghai M&A exchange, a host of other experiments is in the offing. The central government has drawn up a list of 100 enterprises targeted for modernization. The plan is to help these companies improve management systems, streamline bloated workforces, and keep the government out of day-to-day business. There are other smaller experiments taking place in large cities across the country.

While Shanghai business leaders hope their experiment will work, others are not convinced. Poorly run businesses may use the exchange as a way to unload liabilities, says Bob Ching, Shanghai-based director of Boston Consulting Group, which advises companies on doing business in China.

Eventually, mergers and acquisitions are "inevitable if China wants to improve its industrial management," says a Hong Kong securities analyst. Since Beijing's jittery leadership is afraid to shutter enterprises for fear of massive unemployment and reluctant to privatize others for fear of losing assets to outsiders, the Shanghai experiment is about as bold a move as anyone can expect in China these days.

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