July 2006
Dear Friends,
We are pleased to send along this month's DDA China Snapshot .
We hope you will find it enjoyable and informative. As usual, we have focused on a number of recent developments that provide a lesson or two for those who want to do business or invest here, or already do; open a window on how a particular sector is evolving; reflect a new trend; or otherwise get our attention. We have also tried to include things that may not have been in the news where you are.
China Energy Updates
Speaking of subjects in the world's headlines, nothing beats the confluence of China and Energy. So we also wanted to tell you about the new China Energy Updates that we are producing in association with our partners at SinoFile and Audax Communications. These daily on-line reports provide the most comprehensive, up-to-date information presently available on China 's energy sector, much of it not available outside China from any other source. If you would like a free trial subscription, please contact Jacques Boppe at jacques.boppe@dieboldassoc.cn
New Staff Members
We are also delighted to announce the recent appointment of Christophe King and Jacques Boppe as our newest Associates. Christophe is based in our Beijing office while Jacques joined us in Shanghai .
Christophe has a Bachelor of Mechanical Engineering Degree from Columbia University , where he was Vice President of the Asian American Society of Engineers, and is an MBA candidate at the Schulich School of Business at York University in Toronto , Canada . He is also a graduate of Beijing Language and Culture University here in Beijing . Christophe has worked as a Project Manager at Axcelis Technologies in Rockville , Maryland and as a Mechanical Engineer in the Photo-resist Asher and Etcher Group of Matrix Integrated Systems Inc. in Richmond , California .
Jacques graduated from the Lyc¨|e Francais in Hong Kong where he spent his early years, and also has a Master of Science in Engineering and Automation Degree from the Swiss Federal Institute of Technology and a Master of Philosophy in Management Studies Degree from the University of Cambridge . His Master's thesis at the Judge Institute of Management Studies was on Foreign Investments in China 's Electricity Generating Sector. Jacques has previously worked at the European Headquarters of Proctor & Gamble, and at OC&C Strategy Consultants in London .
New Advisory Board Member
We are also pleased to announce that Lin Yong Qing, Co-founder and CEO of ChinaValue.net, China 's first and largest business blog, has become the newest member of our International Advisory Board.
Recognized as one of China 's leading entrepreneurs, Alex also worked for many years with Intel, and was associated with Tsinghua TongFang Computer Ltd. He has an MBA from Xiamen University and has studied at the London School of Economics, New York University's Stern School of Business, and in the joint program of Tsinghua University and Harvard Business School .
Alex brings a wealth of experience in China 's dynamic IT, internet and new media sectors.
And, Now, Our Monthly Highlights:
Government/Macroeconomic Policy
Keeping the Exuberance Rational Recent moves by the People's Bank of China, China's central bank, to tighten credit, and by the State Council, to cool and rebalance China's property market show that the government will not hesitate to take action when it is needed, if the economy gets going too fast or starts heading off in the wrong direction. That China would make these moves when the central banks in the US , Europe and Japan have also been tightening rates tells another story as well, about China 's continuing integration into the global financial system.
While we believe the government will not hesitate to take additional measures to cool the economy if these do not do the job, we would still not expect them to go too far or too fast, for fear of endangering either China 's high rate of growth or the inward flow of foreign investment that supports it. As they say when the lights go off at Washington 's annual Gridiron Club dinner, for the traditional Speech in the Dark: "to singe but not to burn".
The new rules for China 's property market were also notable for requiring a much larger proportion of development land to be set aside for more affordable housing.
Finance/Banking/Insurance
The BOC Floats in Hong Kong with Shanghai Next Bank of China (BoC) successfully launched its Hong Kong IPO on May 24th raising US$ 9.7 billion, the world's largest IPO since AT&T floated its wireless unit in 2000. The shares offered to individual investors were reported to have been oversubscribed by 80 times.
Shortly after the government's recent lifting of a moratorium on IPO's on China 's domestic exchanges, BoC also announced plans for a further RMB denominated offering in Shanghai as early as July. The plan to raise a further US$ 2.5 billion in A-shares has been well received with 20% already placed with domestic investors. China 's insurance companies have reportedly taken the lion's share, adding to their already large equity holdings from the Hong Kong listing.
China 's Accountants and Lawyers Are Cashing in Too The bankers are not the only ones cashing in on these record-breaking bank IPO's. The international auditing standards and sophisticated legal engineering required have been good news for China 's accountants and lawyers too.
On the accounting side, both PriceWaterhouseCoopers (PwC) and KPMG have won huge auditing contracts for China 's biggest bank listings. Ernst & Young is set to do even better if, as expected, the Industrial and Commercial Bank of China (ICBC) goes forward with its US$10-15 billion offering later in the year.
In fact, the surge in activity has placed huge strains on accounting firms' capacity, both big and small. KPMG recently announced plans to double its staff in greater China to 9000 in the next four years. PwC has located its office in Guangzhou next to the eastern rail station so that accountants from its Hong Kong office can commute to cover the shortfall. Smaller firms in Hong Kong complain that staff costs have gone through the roof.
With new accounting rules going into effect in the mainland, and the gearing up of domestic M&A activity around the corner, accounting qualifications have never been so valuable in China . We also see the recent cooling of other, non-bank IPO activity in Hong Kong as temporary, and not affecting this longer term trend.
The story is the same on the legal side. Mainland China 's biggest law firm, King & Wood, recently announced plans to hire 100 more lawyers. Just as more mainland firms are setting up offices and alliances in Hong Kong and beyond, more U.S. , British and Hong Kong firms are moving into the mainland. US and British firms have opened 25 new offices in China in the last two years alone. According to a recent Bloomberg report adapted by the International Herald Tribune, China has about 120,000 lawyers for its 1.3 billion population. That compares to 1.1 million in the United States , with 280 million people. In 1993, just 13 years ago, there were 60 private law firms in China ; today, 30,000. It reminds me of that old story, a town that will not support one lawyer, will always support two.
But on a more serious note, these growing opportunities for lawyers and accountants also reflect some fundamental changes going on, in the ways that China operates.
Non Performing Loans On the surface, China 's banking system is looking significantly more robust. By the end of last year, 75% of commercial banks were reported to have achieved the statutorily required 8% capital ratio, up from just 0.6% in 2003. While many analysts still question the reported figures and others express new concern over the huge new lending spree in the first quarter of 2006, particularly in sectors at risk from overheating, this has not dampened investor support for the massive bank IPOs in Hong Kong over the last year. At the end of the day, few doubt the Chinese government will or could step back from whatever support of its major banks is still necessary.
Today's single digit rates have only been achieved after massive injections of public funds to buy Non Performing Loans (NPLs) at book value from the country's top lenders. A large share of these are still on the books of the four state-owned asset management companies (AMCs) that were set up to hold and dispose of them - for example 38% of these distressed assets bought by the government in 1999 are still lying unresolved.
Recent government pressure to clear the AMCs' portfolios by the end of this year should bring new opportunities for those smart enough to identify the right packages to invest in, and know how to best optimize the bottom line return. Not an investment for amateurs but for those who get it right, the profits can still be huge.
Entertainment
Football Mania Grips China With tens of millions of Chinese fans tuning in to watch the World Cup games on TV, and millions more crowding into bars, internet cafes and other public places across the country to see it, football mania grips China .
These are serious fans. They don't just buy the jerseys; they can debate the teams, the players and the plays, and all the other statistics and nuances with the best of them, and they seem to do it all day every day and night. If you can't keep up, you risk being labeled "wei qui mi" - pseudo football fan. There is hardly a corner of any major city that doesn't have a football hanging from somewhere, or a poster of some player or another slogging something. China Mobile paid US$ 13 million for 2 exclusive contracts for TV specials and is offering World Cup highlights over its mobile phones via text and picture messaging. Brewer Tsingtao was reported to have paid US$ 5 million to sponsor CCTV's World Cup features. Chinese football fans traveling to Germany have pumped an estimated US $75 million into the Chinese and German travel industries.
China's TV set manufacturers have seized the opportunity as well and no upwardly mobile Chinese yuppie would dare be caught watching the games on anything other than the latest and biggest flat-screen high-resolution TV he or she could buy. Hong Kong listed Skyworth, one of China's major TV-set makers based in Shenzhen, estimates that it will sell a staggering US$ 250 million worth of TV sets just on the back of the tournament. And all of this together would be only a fraction of the illegal betting going on.
The lessons: China 's younger generation really does reach out and embrace the world. They have more money to spend, and they are spending it. People here have always loved a big show. And it makes us think, this is only a small preview of the national mood when Beijing hosts the Olympics in 2008. Get ready.
Logistics
Building the Future The world's logistics giants continue their aggressive expansion here. DHL has spent a cumulative US$ 900 million in the greater China region, while UPS now runs more flights into China than any other US airline, passenger or freight.
ProLogis, another of the world's largest logistics providers, recently announced plans to nearly double its distribution capacity in China . They will spend US$ 90 million on 3 million sq. ft. of new properties along China 's booming eastern seaboard. The company already has 4.1 million sq. ft. of operational facilities with a further 2.5 million under construction.
Meanwhile the Ministry of Communications announced that it will develop two new port "clusters" to supplement existing shipping capacity around Shanghai , Tianjin and Shenzhen. The two new development regions will be centered around Xiamen , anticipating increased trade with Taiwan , and western Guangdong province. Planners expect the developments to match the importance of the three existing trade hubs, and will have crude oil as well as container facilities.
The scale of the infrastructure that is being built and planned here every day of the week remains so impressive.
High Tech/Telecommunications
Making it Work in China We have highlighted in earlier Snapshots the importance to any company doing business in China , of being flexible enough to adapt its strategy and the way it does business in other places, however successfully, to the unique characteristics of the Chinese market. We have cited IKEA and Samsung as two examples of those who have succeeded here by operating as if they were Chinese companies. Well, here are two more recent examples, both also in the same high-tech space as Samsung:
General Electric, the world's second largest company, recently predicted that GE sales in China could reach US$ 6 billion this year, a 20% year-on-year increase and 5 times its revenue in 2001. When you look at how they are doing it, one thing jumped out - a recent agreement between GE and China's powerful National Development and Reform Commission (NDRC) under which GE and the NDRC will work together in areas such as wind energy, the development of jet engines that have lower emissions and use less fuel, power-efficient railway locomotives, water desalination and the conversion of coal to gas. GE will also be investing up to $50 million in ecology-related research and development at its Shanghai Technology Center, and provide management and leadership training to 2500 Chinese managers and officials. Given new Chinese government policies to improve the environment and curb pollution, they will be doing their share.
During his visit to Asia last month, Microsoft chief executive Steve Ballmer said that China was "big enough, different enough that we'll take our global strategies and change them quite a bit to make it work in China ". Mirroring GE, Microsoft recently signed a new agreement with China 's Ministry of Information Industry (MII) to support innovation in China 's IT and software companies and help close the divide between China 's developed and rural areas. Over the next few years, MII and Microsoft will establish and run a series of joint laboratories. The two parties also plan to train 1000 instructors, 20,000 software engineers and another 50,000 IT workers. Microsoft will also be providing training and consultancy to three jointly designated software companies in China to enhance those companies' overall competitiveness in the global market.
Autos and Auto Parts
The State of Play China continues to be the world's only automotive market where raw statistics sound exciting. For the first five months of the year, production of passenger cars totaled 3 million units, up a monumental 46% on the same period last year. Encouragingly, sales rose by a comparable 44% representing over 97% of all cars produced. Meanwhile the government has announced new legislation requiring vehicle companies to achieve sales equal to 80% of their production capacity before building new factories. All new vehicle companies will also now be required to produce Chinese branded vehicles.
Luxury Cars and the Chinese MG The top five selling cars in China cost an average of US$11,000, and this surely will remain the common denominator in China 's domestic market for years to come, as well as in the coming export wave of Chinese branded cars. But anyone passing the many Rolls Royce, Bentley and Ferrari dealers in China's major cities, or seeing a Maybach rolling along the highway, will know there is also a healthy demand for luxury cars as well.
The Toyota-FAW joint venture in Sichuan province has begun manufacturing its Prado Land Cruiser, which will sell in China for US$ 70,000. Meanwhile Porsche is expanding its sales network to 13 outlets, with a target of 1,350 luxury sales this year.
Nanjing Automobile Corporation, currently reassembling the production lines it shipped from MG Rover in the UK, plans to have the first Chinese made MG sports car in production by March next year. In the meantime, it has already started producing aftermarket MG parts for overseas customers.
SAIC Hires its First Senior Foreign Executive Philip Murtaugh's recent appointment as Executive Vice-President for International Operations at Shanghai Automotive (SAIC), China 's second largest vehicle producer, is notable for any number of reasons. First, Murtaugh is the first foreign executive of a major Chinese auto manufacturer. Although the international management experience of foreign executives can add value to about any Chinese company, their presence at the top of any major Chinese company is still rare. Second, Martaugh used to be Chairman of GM China, SAIC's joint venture partner in the production of GM cars in China , until he quit that post last year citing policy differences with GM's management in Detroit . That provides an interesting dynamic just by itself.
Given his reputation as a well experienced, straight-talking executive, his appointment says as much about SAIC as it does about him. His new responsibilities are reported to involve SAIC's foreign procurement and business development. He is also expected to have a key role in sorting out SAIC's foreign acquisitions including the integration of Korea 's Sangyong Motor.
Executives like Philip Martaugh who can operate with experience on both the Chinese and Western sides will be one of the keys to success in the next phase of China 's development. We wish him good luck.
Hong Kong
Despite recent pressures on the Hang Seng and other emerging markets as the world's central banks including China 's moved in unison to increase rates and soak up excess liquidity, and Beijing 's efforts to cool down and rebalance the mainland's property market, the essentials remain sound.
We certainly do not view either the recent postponement of several scheduled non-bank IPOs in Hong Kong including Shui On Land's or the success of recent IPOs in Shanghai after an earlier ban there was recently lifted, as foreshadowing any fundamental adjustment in Hong Kong 's role.
Hong Kong will remain China 's window into the international financial markets for many years to come. Looking at it from the trade side alone, last year's trade between Hong Kong and the mainland increased 21.3% over the previous year. Hong Kong remains the mainland's fourth largest trading partner.
Vice Minister of Commerce Liao Xiaoqi's recent comments about the enduring strength and value to China of Hong Kong's services sector, and the mainland's commitment to the further development of the Closer Economic Partnership Arrangement (CEPA), provided a timely restatement of the mainland's continuing commitment to Hong Kong.
Special Note on Chengdu
Chengdu has become another hot-spot for investment. In the last 5 years, it has achieved economic growth rates averaging over 12%. The city was an early beneficiary of the central government's "Go West" policy, a major initiative to encourage the development of second and third tier cities in the less developed inland provinces.
It has much to offer: abundant energy, modern infrastructure, a large internal market, and manufacturing wages averaging $126 a month, about half those in Guangzhou or Shanghai .
Chengdu has a highly skilled pool of labor with 24 universities and 17 colleges in the area offering relatively inexpensive education. A Motorola R&D center was lured to the city in 2001 by low costs and access to well qualified engineers. According to Chengdu 's Trade Bureau, 100 of the world's top 500 companies have so far established operations in the city.
It has already become the logistics hub of western China , and its glittering new airport is the country's fifth busiest. All glass, it looks just like the striking modern airport in Munich . High levels of investment have also attracted real estate developers eager to capitalize not only on a growing expatriate population, but also on the local Chinese, who have seen income levels steadily rising over the last several years.
Despite rapid growth, Chengdu has also avoided the speculative price hikes seen in cities along the east coast. Many, as a result, view Chengdu 's real estate market as much more stable than others the government is trying to cool down.
Speaking Engagements
David Diebold gave the keynote speech at the opening session of the Autologistica Asia conference in Shanghai on 15th May; spoke in two sessions of the US government's China: Risk, Reward and How to Win conference in Washington, D.C. on 18th May, alongside Zhou Wenzhong, China's Ambassador to the United States; and again on 24th May at the Annual Meeting of the Automotive Distribution Federation in the United Kingdom. If you would like a copy of his remarks at any of these conferences, feel free to let him know at dd@dieboldassoc.com .
DDA - Your Business Compass in China
David Diebold & Associates specializes in delivering professional services to companies and investors entering or established in China , in 3 main areas:
We Help Companies Enter the China Market We Help Investors Find Good Investments in China We Help Companies in China Solve Their Problems
For a more detailed description of our services, please visit our website at www.dieboldassoc.com . If you would like to talk with us about a specific matter or need, please contact us at +86 10 6597 0886 or by email at info@dieboldassoc.com .
David Diebold & Associates (H.K.) Limited Beijing Representative Office Suite 2902 , 29-30th Floors, Tower 4 Central Park No. 6 Chaowai Avenue Beijing 100020, P.R. China Tel: +86 10 6597 0886 Fax: +86 10 6597 0622
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