Cablegate: China/Soe Reform: The Local View, As Seen From Qingdao

VZCZCXRO1807
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #5639/01 2400831
ZNR UUUUU ZZH
P 280831Z AUG 07
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 1277
INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RHEHNSC/NSC WASHDC PRIORITY

UNCLAS SECTION 01 OF 03 BEIJING 005639

SIPDIS

SIPDIS
SENSITIVE

STATE FOR EAP/CM PSECOR, JYAMAMOTO
TREASURY FOR OASIA RDOHNER, BCUSHMAN
USDOC FOR 4420/ITA/MAC/CEA/MCQUEEN
USTR FOR BHATIA/STRATFORD/WINTER/ALTBACH/MCCARTIN

E.O. 12958: N/A
TAGS: ECON ENRG EINV EPET EFIN CH
SUBJECT: CHINA/SOE REFORM: THE LOCAL VIEW, AS SEEN FROM QINGDAO

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INTRODUCTION/SUMMARY
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1. (SBU) Coverage of state-owned enterprise (SOE) reform in China
tends to focus on the 155 large national firms managed from Beijing
by the central State Assets Supervisory and Administration
Commission (SASAC). Easily overlooked, however, are the tens of
thousands of companies run by the 32 provincial-level and 448
prefecture-level SASAC entities. Recent meetings held by Econ M/C
and Econoff in Qingdao illuminate the degree of autonomy experienced
by these "local" SASACs as well as the unique challenges faced in
executing enterprise reform at the local level.

2. (SBU) Our meetings with Qingdao's SASAC and local SOEs focused on
the challenges of diversifying ownership and implementing new
policies and regulations, such as a dividend payment plan. With
local SOEs accounting for 40 percent of Qingdao's GDP, the city's
SASAC has a geographically-based stake in enterprise reform that is
quite different from the broader perspective enjoyed by the central
SASAC. Meanwhile, the local SOEs themselves are struggling to court
outside investment, and some have or are looking to list on stock
exchanges and/or expand to include operations overseas. Two
well-known companies, Tsingtao and Haier, provided very different
perspectives on doing business in the United States. End
Introduction and Summary.

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QINGDAO DIVERSIFYING OWNERSHIP OF LARGE SOES
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3. (SBU) Qingdao City SASAC Vice Director Gao Sizhang told us that
the commission's number one reform priority is diversifying
ownership of the city's 32 large SOEs. Qingdao SASAC is
accomplishing this through three methods: inviting strategic
investors to acquire a stake in a SOE; using mergers and
acquisitions between SOEs; and finally, publicly listing SOEs both
in China and abroad. Gao stated that the SOEs will become more
competitive as a result of ownership diversification. Qingdao SASAC
has come to recognize that wholly state-owned SOEs cannot survive in
an open-market, said Gao.

4. (SBU) Vice Director Gao noted that Qingdao SASAC is carefully
monitoring the impact of enterprise diversification upon the local
economy. The commission must be prudent when diversifying since
SOEs account for 40 percent of Qingdao's gross domestic product
(GDP). There are four basic categories of SOEs in Qingdao:
manufacturing; services and investment; public infrastructure and
utilities; and finally, trading. Each enterprise category has rules
regulating the percentage of the enterprise that the city must
retain, according to Gao.

5. (SBU) Gao stated that the most restrictive enterprise direct
investment category belongs to the Qingdao's public sector,
including the city's public transportation and utilities resources.
Qingdao must maintain a 60 percent minimum stake in this area.
Other enterprise categories have less restrictive investment rules
and are being handled on a case-by-case basis. A British company
acquired a 40 percent stake in Qingdao's port authority. The
company has brought much needed capital, managerial talent, and
technology to the port as it goes through an expansion. Meanwhile,
the city retains only a 30.56 percent ownership stake in the famed
Tsingtao Brewery. The United States brewer Anheuser-Busch (AB)

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acquired a 27 percent stake with Tsingtao Brewery holding on to the
rest.

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QINGDAO SOES SLOWLY GOING PUBLIC
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6. (SBU) In a separate meeting, Qingdao SASAC Vice Director Changjun
Yang told us that so far only six of Qingdao's large SOEs are
publicly listed. Qingdao SASAC maintains a 20 to 30 percent
ownership stake in those publicly listed enterprises. SASAC will
soon host a seminar intended to better prepare other Qingdao
enterprises for public listing. SASAC has invited several large
Chinese and international banks as well as rating companies to speak
at the conference, an event intended to help local enterprises
improve their corporate governance and learn more about obtaining
financing for future IPOs, said Yang.

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LESS ATTRACTIVE OPTIONS FOR SMALLER SOES
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7. (SBU) Vice Director Gao said that Qingdao SASAC is also reforming
the several hundred small-to-medium (SMEs) sized enterprises it
supervises, but noted that the commission spends far less time
managing this issue. The most important SME reform is adoption of a
policy to allow the enterprises to go bankrupt if they run into
financial difficulties. This has become more common as the SMEs'
access to cheap capital has eroded. Bank loans to Qingdao SMEs are
increasingly tied to the enterprises' performance, a departure from
past practices which had led to local banks holding large sums of
bad debt. Gao said that there are two other options for SMEs
encountering financial difficulties: apply to convert the enterprise
to a wholly-privately owned company, or seek joint ventures with
foreign-owned companies. Managers of faltering SMEs are required to
work with Qingdao SASAC to choose the most appropriate option,
according to Gao.

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SOE'S GINGERLY TESTING THE OVERSEAS MARKET
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8. (SBU) Vice Director Yang stated that Qingdao SOEs are slowly
beginning to expand to the overseas market. Qingdao SASAC plays a
limited, supporting role in this regard. It is up to the individual
enterprises' leadership to determine if their companies are ready to
expand overseas. The vast majority of the city's SOEs are too small
and their business too locally focused to expand overseas. We met
separately with two of the city's largest SOEs, Haier and Tsingtao
Brewery, to discuss this issue and received very different views on
expansion into the United States market. So far, Haier considers
its aggressive move into the United States to be a disappointment.
In contrast, Tsingtao is pleased with its partnership with a larger
United States brewer (AB) and is content with its niche share of the
United States market.

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HAIER COMPLAINS ABOUT ITS FORAY INTO U.S. MARKET
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9. (SBU) Yang Mianmian, Executive Vice-President of Haier, China's
top white goods manufacturer, stated that the company's operations
in the United States have been unprofitable and a disappointment.
Haier understands that the company will not receive preferential
treatment in the United States but believes that U.S. companies have
an upper hand in their home market. Yang cited three examples: The
company lost a bidding war for another company's brand (Maytag) to a
competitor; U.S. regulators temporarily pulled a freezer model from
the shelves in a standards dispute; and a competitor copied a Haier
freezer model. Yang also noted that Haier was unprepared for the
legal environment in the United States and has struggled in dealing
with several lawsuits that have been filed against the company
there.

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TSINGTAO OPENS AMERICAN TAP, BUT KEEPS LOCAL GAZE

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10. (SBU) Chu Liangjing, Vice General Manager of Tsingtao Brewery
told us that his company has been pleased with its experiences in
the United States. Its partnership with AB has brought much needed
management expertise and technology. Tsingtao has also used the
partnership to better access the United States market. The company
has worked very hard to promote its brand in the United States, but
recognizes that its target demographic is a small sliver of the
overall market. Chu stated that given Tsingtao's place in the
United States market, the real payoff for the company's ties to AB
comes from being able to grow more competitive in a Chinese market
that is increasingly crowded with domestic and international
competitors.

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QINGDAO FOLLOWS BEIJING'S SOE LEAD, NOT LED BY IT
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11. (SBU) In response to a question from Econoff, Vice Director Gao
provided insight into the relationship between local SASAC offices
and the Central Government SASAC. He noted that although the
Central Government SASAC provides policy guidance to local SASAC
offices, these offices do not directly report to Beijing. Instead,
local offices profit from Beijing's experiences rather than
following a set of rules issued by the capital. Gao noted there are
several policy issues, including dividend payments, establishment of
boards of directors, and diversification out of non-core business
interests, that the central and local government SASACs are working

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on simultaneously.

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QINGDAO WRESTLING WITH DIVIDEND POLICY
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12. (SBU) Vice Director Gao stated that similar to the Central
Government, Qingdao SASAC is exploring implementation of a policy
requiring its SOEs to pay dividends to the city government. Qingdao
SASAC and the city's finance office are working on this together.
Gao said that the Central Government so far has not issued
guidelines, such as suggestions on what percentage of the profits to
tax or how to use the money, which could assist localities.
Instead, Beijing is encouraging localities to create their own
dividend plans. Gao noted that Qingdao is looking to other cities,
such as Shanghai, to learn how those city governments are
structuring their programs.

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SOE MANAGEMENT REFORM ON-TRACK
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13. (SBU) Vice Director Gao noted that Qingdao SASAC is also
undertaking enterprise management reform similar to that ongoing at
the national level. As part of this reform, many large Qingdao
SOEs, including Haier, Hisense, and Tsingtao Brewery, have
established boards of directors (and some have even listed on the
Shanghai and Hong Kong exchanges). Since most of Qingdao's large
enterprises are not monopolies, they have had to undertake such
reform in order to remain competitive in the open market. Qingdao
SASAC also has recently established a pay-for-performance plan for
its SOE managers. The commission sets performance standards in
several different categories for each enterprise based upon the SOEs
individual circumstances. Managers at enterprises that excel beyond
those standards receive bonuses. Qingdao SASAC is still refining
this program; some of program's evaluation and auditing process
needs work, commented Gao.

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PARING NON-CORE INTERESTS, SOCIAL SERVICES
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14. (SBU) Vice Director Gao stated that the city's enterprises must
be concentrated in their core business areas. On average, the large
Qingdao SOEs are spread across six to eight sectors unlike the
Central Government enterprises that frequently have hundreds of
subsidiaries doing business across a host of sectors. As an example
of the non-core business activities Qingdao SOEs pursue, Gao noted
that Hisense, an electronics manufacturer, is a very successful
property developer in Qingdao. Gao also told us that almost all
social service responsibilities have been separated from Qingdao's
SOEs. During the separation period, the SOEs transferred ownership
of schools, buildings and other social service related
infrastructure to the local government. The enterprises bore the
human resource costs of the transfer for about a year, but
otherwise, the Qingdao government has covered most of the costs,
according to Gao.

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