Can China's Revamped Oil Giant Fly On Wall Street?

Petrochina hopes to raise $5 billion

In the annals of Chinese corporate restructuring, it was a job almost on the scale of building the Forbidden City. Last summer, all 23 stories of Beijing's Taoran Hotel were taken over by an army of advisers that included 700 PricewaterhouseCoopers auditors, 50 McKinsey & Co. consultants, and lawyers from seven law firms. Investment bankers from Goldman, Sachs & Co. trekked to the remote reaches of China for field work; industry moguls like BP Amoco PLC Chairman John P. Browne dropped by to lend advice.

Their task: Transform the best parts of China National Petroleum Corp. (CNPC), an unwieldy relic of socialist central planning with 1.5 million employees and everything from gas stations in Tibet to refineries in Central Asia, into a world-class, modern corporation. In February, the team will get to see how their creation--now named PetroChina Co.--flies on Wall Street. In what should be the biggest initial offering by a Chinese company to date, PetroChina hopes to raise at least $5 billion by floating a 15% stake on the New York Stock Exchange, as well as in Hong Kong, an IPO underwritten by Goldman and Beijing's China International Capital Corp., a venture that includes Morgan Stanley Dean Witter.

Even after a radical downsizing, PetroChina is a giant. It controls more than two-thirds of China's oil and gas production and ranks among the world's top five oil companies. Its payroll of 480,000 is still quadruple that of Exxon Mobil Corp. The company also owns pipelines that move 84% of China's natural gas, a market growing 15% annually. It also owns 3,400 gas stations--1,000 of them bought in the past 10 months--in a sector that's consolidating fast.

Now PetroChina must convince Wall Street that big Chinese corporations are good investments. In the early 1990s, China began floating stakes in poorly performing companies such as beer breweries and car distributors. Eager to boost sagging foreign investment and the revamping of state enterprises, Beijing now is offering some of its best assets. In the process, leaders hope giants like PetroChina, China Telecom, and China Petrochemical will attain the stature of leading multinationals. China's expected entry into the World Trade Organization is another stimulus. To survive competition against multinationals, says Chinese Academy of Social Sciences professor Zhong Jiyin, "these companies must improve management and introduce new marketing and corporate strategies."

Some 2,000 outside advisers were involved in whipping PetroChina into shape. The Taoran Hotel, owned by CNPC, converted its bottom two floors into offices used for the restructuring efforts; advisers slept in rooms upstairs. Weekly steering committee meetings started at 9 a.m. on Saturdays and often lasted until dawn on Sunday.

Management merged 13 CNPC divisions into four and shifted their control from once powerful provincial fiefdoms to headquarters in Beijing. Core businesses, such as the Daqing oil fields and gas pipelines, were transferred into PetroChina. Other assets, from overseas ventures and low-grade domestic refineries to schools and medical clinics, remain in CNPC. So do 1 million workers, many of whom will receive payments or be retrained using more than $1 billion of the IPO proceeds.

PetroChina's advisers also aim to boost financial performance. In 1998, CNPC earned just $1.1 billion on $17.7 billion in revenue. That improved last year, thanks largely to higher oil prices. But return on capital is only around 5%, one-third of what major oil companies like Exxon Mobil make. Management wants to trim $1 billion in costs over three years without firing workers.

BRIDGING THE GAP. To do so, PetroChina will pare capital spending and everything from entertainment expenses to its fleet of company cars. But the big savings should come from more efficient production. It costs the company $5 to get a barrel of oil to market, compared with about $3.50 for foreign oil giants. PetroChina hopes to reduce that to $4 within a year through more efficient energy use and staffing, and by improving technology needed to tap China's 20.3 billion tons of oil reserves and 2.2 trillion cubic meters of gas reserves. Outmoded equipment "puts them behind the world's leading companies," says oil expert Hu Jianyi of Beijing's Research Institute for Petroleum Exploration and Development. Bridging that gap would help PetroChina reach its goal of at least 10% return on capital within three years.

The 300-odd top managers who survived the cut will have a strong interest in profitability. In China's most far-reaching management-incentive program, up to 75% of their compensation will be tied to cost-cutting and profits. To list on the NYSE, PetroChina has adopted U.S. accounting standards. And it will bring non-mainland Chinese onto its board.

Still, because control of PetroChina will remain firmly in the hands of the government, it can only go so far in achieving global performance standards. With 480,000 persons, its workforce still will be hugely overstaffed. But "the reality is that CNPC cannot just throw surplus workers upon society--that would cause instability," says a PetroChina official. "It's really a problem." The use of IPO proceeds to help laid-off workers is a novel way to get foreign investors to bear some of the social burden of restructuring.

China's overseas business dealings also raise political risks for the IPO. CNPC's 40% interest in Sudan's Greater Nile Oil Project, which includes a 1,500-kilometer pipeline and an oil field, is a stumbling block. The U.S. has imposed economic sanctions on Sudan for allegedly aiding terrorism and suppressing dissent. U.S. critics of China have urged the NYSE to reconsider the listing.

To assuage the concerns, PetroChina says it will have nothing to do with Sudan, leaving that country to parent CNPC. PetroChina says outside lawyers and accountants will make sure its money is not used in Sudan. "It's not an issue because of the extraordinary steps the company is taking to ensure IPO proceeds are only used domestically," says Goldman Sachs International Vice-Chairman Robert D. Hormats.

Bigger challenges loom at home. China's gas station market, for example, is scheduled to open to foreign competition in 2003. Two years later, Beijing will allow foreign players into wholesale distribution of petroleum products. The stiffest competition is likely to come from neighboring South Korea, which is awash in excess petrochemical capacity, and from Singapore, where multinationals are expanding production. Once China enters the WTO, says the PetroChina official, "everyone knows the pressure will be very cruel." And to keep tapping Wall Street, PetroChina will need better profits.

If management can turn around this behemoth and handle excess workers in the process, however, it will provide an important blueprint for overhauling state enterprises. And it could mark the emergence of China's new corporate giants on the world scene.

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