China's Takeover Troubles Putting Xi's 'Zombie' Reforms to Test

  • Cement maker's control of rival stymied as NPC mulls changes
  • Missing company stamps, factory standoff mar consolidation

Talk about a hostile takeover.

What seemed like a straightforward consolidation of two Chinese cement makers has morphed into a test of President Xi Jinping’s push to streamline bloated industries and rebalance a lagging economy. Missing company chops, seized corporate offices, $700 million in bond defaults and suspended shares are major plot points in the story of Tianrui Group Co.’s effort to absorb China Shanshui Cement Group Ltd.

“It is very risky to do a hostile takeover in China,” said Christopher Lee, managing director of corporate ratings for Greater China at Standard & Poor’s in Hong Kong. “There is the risk of the existing management sabotaging and resisting changes.”

This takeover is getting more hostile as China’s leaders meet to adopt economic stimulus measures, including reforming the “zombie enterprises” once at the core of skyrocketing prosperity. Facing the slowest growth rate in a quarter century, the National People’s Congress is drafting rules to cut “outdated” capacity in the cement, shipbuilding, aluminum and glass industries.

“We will address the issue of ‘zombie enterprises’ proactively yet prudently by using measures such as mergers, reorganizations, debt restructurings and bankruptcy liquidations,” Premier Li Keqiang said in a work report delivered to NPC delegates in Beijing.

China produced about 57 percent of the world’s cement last year, according to U.S. Geological Survey estimates. That’s after a 4 trillion-yuan ($585 billion at the time) stimulus package unveiled in November 2008 catalyzed construction of airports, highways, railways and public housing.

Yet by October last year, about 38 percent of those makers were losing money because of competition and a slowing property market, according to data compiled by Bloomberg.

“Cement capacities ramped up crazily after the stimulus package,” said Michelle Leung, an analyst with Bloomberg Intelligence. “This created a competitive landscape where factories were scattered all around the country.”

China Shanshui employed almost 24,000 people in 2014, and its materials helped build the high-speed railway between Beijing and Shanghai. Yet the company’s operating profit and net income fell for three straight years, and its market value plummeted about 25 percent from a 2011 peak to the current $2.74 billion.

In April, a Tianrui Group unit that competed with China Shanshui increased its stake in Shansui to about 28 percent from about 11 percent. It all sounded like what Xi was after: consolidation in rust-belt industries that built too many factories in the boom years and now needed to slim down in a weakening economy.

Bond Defaults

Instead, China Shanshui became the poster child for market dysfunction. Soon after the announcement, the Hong Kong exchange suspended the stock because its public float fell below 25 percent of the issued capital.

More obstacles came via a slew of legal proceedings involving employees, directors and other shareholders. Some financial institutions limited the company’s borrowings, and some suppliers and contractors demanded prompt payments.

China Shanshui Cement has defaulted on 4.6 billion yuan of debt since November. A month later, Tianrui won a shareholder vote to dismiss China Shanshui executives, including founder Zhang Caikui and his son, Chairman Zhang Bin, and vowed to help pay off the obligations.

Managers of China Shanshui’s main operating unit -- Shandong Shanshui Cement Group Ltd. -- called the executive dismissals illegal and refused to recognize them, and the government in its home city of Jinan sent staff members to help maintain production and make business decisions. The parent company didn’t gain access to the headquarters for more than a month.

Missing Chops

“Existing business owners in China tend to react in a defensive way instead of looking out for the best interest of shareholders,” said Ben Sy, the head of fixed income, currencies and commodities at the private banking arm of JPMorgan Chase & Co. in Hong Kong. “This could sometimes turn a win-win situation into a lose-lose one.”

China Shanshui also said it can’t find all the company chops used to stamp legal documents, including those instituting the management changes, so they can be registered with the government. The seals were held by the ousted directors, who allegedly brought in gangsters to help them, the parent company said in a Dec. 31 filing.

As the NPC prepared to meet, the Tianrui-backed management sued Jinan’s mayor and deputy mayor to force them to help retrieve company books and records. The lawsuit also seeks to stop the Jinan government from recognizing the former leadership. Yet as of Tuesday, Zhang Bin was registered as the legal representative for Shandong Shanshui.

On Wednesday, the Jinan government said it had no right to interfere in China Shanshui’s internal dispute and would take legal action if China Shanshui disseminates “false information.”

‘Lack Respect’

Liu Yiu Keung, executive director at China Shanshui, didn’t answer two calls to his mobile phone or respond to an e-mail seeking comment. Two calls to Shandong Shanshui’s general line went unanswered.

“Chinese companies still lack respect for law and contracts,” said Ji Weijie, a credit analyst at China Securities Co. in Beijing. “Chinese businessmen usually have deep emotions toward the companies they founded and don’t want to be taken over.”

The stalemate augurs poorly for China going forward, especially as the pace of deals quickens. Last year, the value of domestic mergers and acquisitions in the nation was $360.5 billion, more than double the previous year, according to data compiled by Bloomberg.

“China needs to have a top-down framework on disputes and lawsuits on hostile M&As,” said Xia Le, chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. “That would help reconcile those transactions and make the capital market -- and China’s economy -- more efficient.”

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