The Right Way to Reform a State Enterprise

For 30 years, Southwest Aluminum Industry not only produced aluminum for everything from airplanes to Pepsi cans but also supplied housing, schools, and health care for thousands of workers. The Chongqing company's role was to create jobs. Earnings were an afterthought. So the firm racked up $620 million in bank debt. By early 2000, it was threatened with closure by China's newly profit-minded leaders.

Instead, last spring Southwest became a model for Beijing's state-enterprise reform by embarking on an extensive restructuring. Advising on the reorganization are officials from state-backed Huarong Asset Management Co. and Cinda Asset Management Co., which had assumed control of $345 million in Southwest debt from its two lenders, Industrial & Commercial Bank of China and China Construction Bank. Huarong and Cinda then helped convert Southwest into a joint-stock company and traded the debt for 52% and 38% equity stakes, respectively. Chongqing municipality took the rest. Now Huarong and Cinda managers sit on Southwest's board and direct its transformation into a real business.

DOWNSIZING. One of the first reforms was to wind down Southwest's role as a social agency. The company is shifting support for schools serving more than 3,000 students to the city, and its hospital is now a service company. "The relationship between them and Southwest is like that between a customer and supplier," says Xiao Changhua, general manager of Huarong's Chongqing office.

At the plant itself, radical change is under way. Management plans to trim its workforce of 10,000 by 40%, with pay based in part on performance. Technology is being upgraded, and new products and markets developed. With its annual interest payments chopped down by some $25 million, the company was able to manage $3 million in net earnings last year, on $307 million in revenue--its first profit in eight years. "Our employees are too many, and our labor efficiency is still low," says Liao Zanshun, director of the board and party secretary at Southwest. "Our biggest challenge will be competing in the market after China enters the World Trade Organization."

RAILROADED. As foreign competition looms, Southwest plans to spend several million dollars a year to upgrade its factory, using its own revenues, loans, and investment from domestic and foreign sources, including French aluminum giant Pechiney. It has already installed an 8,000-ton hydraulic aluminum press, making Southwest the first Chinese company that can cut plates large enough for train cars. A new investment strategy department is developing such products as lithographic prints, duct materials, and high-pressure electronic foils for TVs and computers.

Southwest's 11-person board includes 7 members from the asset-management companies. A supervisory committee from Huarong must approve all major decisions. "Huarong is helping Southwest improve its management," says Xiao.

The final step in the restructuring will be for the asset managers to sell their stakes and cut Southwest loose. That won't necessarily be easy. Another heavy industrial company in Huarang's portfolio, Xinjiang Shiyue Tractor Manufacturing in remote Urumiqi, had a hard time closing a deal. Yet Southwest might do better, especially if it can merge with other Chinese producers and spin off its best parts. Pechiney is even exploring a joint venture. And it all started with a debt swap.

By Dexter Roberts in Chongqing

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