Rare questions are being asked about the power of China’s state-owned corporations as details emerge about the purchase of three mines in Shanxi Province

August 7, 2013

Silence Underground


ZHONGSHE, China — A moribund coal mine here descends deeply, more than 3,800 feet underground. But the deal in which a Chinese state-owned conglomerate bought it may be even darker and more labyrinthine. The Zhongshe mine and two others, in Shanxi Province in northern China, are at the center of unusually public accusations of mismanagement and corruption afflicting one of the nation’s flagship state conglomerates, China Resources. Critics say that the $1.6 billion purchase was vastly overpriced and illegal and that large sums may have been squandered or, as some are claiming, improperly diverted.Leaked documents about the deal, and a court case in Hong Kong, have shed an unusually harsh light on the usually secretive workings of a major state-owned company. The disputed deal raises a stark question: Are China’s economy and resources held hostage by privileged state corporations and their executives, who can use influence and gain access to easy credit in ways that undermine long-term growth?

The dispute has become a chief exhibit in a debate in China about the wisdom of investing so much of the nation’s money in state-owned companies, especially when China’s economy has slowed. For the Communist Party leadership, the case distills concerns about the grip that state-owned conglomerates exert.

The problems for China Resources began in 2010, when its affiliates as well as a partner state company agreed to pay 9.9 billion renminbi ($1.6 billion) for the three coal mines and related assets, according to documents submitted to a Hong Kong court. The seller was a businessman, Zhang Xinming, a man with a reputation as a swashbuckling gambler, who also gained a 20 percent stake in the new joint venture.

The deal appeared to give China Resources a foothold in the coal industry here in Shanxi, the hub of China’s coal industry for more than a century and close to the energy-hungry cities and factories on the coast. But the company’s monthly business operations statements show that since the mines changed hands in 2010, the mines have not produced any coal.

“Legally speaking, this was a totally abnormal transaction,” said Chen Ruojian, a lawyer with the Duan & Duan law firm in Beijing. Mr. Chen is helping to represent the minority shareholders in Hong Kong, where the subsidiary behind the deal, China Resources Power Holdings, is listed on the stock exchange.

“It’s impossible to understand why they’d do this — pay so much for mines with expired exploration licenses,” he said. “State-owned companies have all sorts of problems, but we think it’s rare to have something as stark as China Resources.”

Political unease over the case grew after two Chinese journalists made accusations of corruption about the deal, and one singled out Song Lin, the chairman of the parent conglomerate, China Resources.

The Web site of People’s Daily, the Communist Party’s newspaper, has reported that the party’s discipline unit has received an accusation of corruption against Mr. Song and other senior executives at China Resources and is processing the complaint. Mr. Song has not been detained or charged with any wrongdoing, judging from the reports on the company’s Web site of his various public appearances. China Resources has denied wrongdoing and has hinted it might take legal action against Chinese journalists who have raised corruption accusations.

China Resources “is a major global player,” said David Zweig, a specialist in Chinese natural resource companies at the Hong Kong University of Science and Technology. If the claims about the coal mines are proved true, he added, “it would show that these companies can be ripped off or tricked. It doesn’t bode well for the globalization or professionalization of these companies.”

China Resources traces its roots to the days of Mao Zedong’s revolution, when it was established in 1938 in Hong Kong to raise money and buy military supplies to support Communist forces.

By 2012 it was China’s 18th-largest state-owned industrial company by sales, with revenue of $52 billion. Its wide-ranging products include medicine and beer, coal and real estate. Its chairman, Mr. Song, holds the same government rank as a vice minister.

The controversy over the coal deal has made China Resources a lightning rod for criticism of all state-owned enterprises, which produce about two-fifths of the nation’s economic output.

“Chinese shareholders have been treated like little lambs being slaughtered,” said Li Jianjun, a Chinese journalist who has taken up the accusations against Chinese Resources. “Companies like this need to be taught a lesson.”

“Marx forgot the problem that whoever manages a company tries to become its owner,” he added.

“State-owned enterprises try to spend as much as they can, so they have an excuse to demand more support and take more kickbacks.”

In the late 1990s, Zhu Rongji, then the prime minister, pushed hundreds of thousands of state-owned enterprises into the private sector, but the 120 or so largest of these businesses had the political muscle to resist privatization.

Instead they won official backing as pillars supporting the state’s role in the economy. They gained wealth and influence over the last decade, partly from their almost unlimited access to low-interest loans from state-owned banks.

But since taking office in March, Prime Minister Li Keqiang has dropped hints that he wants to rein in the privileges of state-owned enterprises, so that private companies win a bigger share of bank loans, investment projects and market opportunities.

“State-owned enterprises and private business should be regarded equally,” Mr. Li said at a meeting with economists and executives in April.

Party insiders and economists have said, however, that the issue of state-owned enterprises is so contentious that a party leadership meeting in the fall is likely to put off any big decisions.

The biggest state-owned enterprises possess enormous political sway, employ hundreds of thousands of people and extend a global reach. Many, like the State Grid, the monopoly electricity transmission company in most of China, or China Telecom, the giant mobile phone carrier, are widely criticized within China both for their inefficiency and for the fat profits they earn from charging high prices. Those profits allow them to hire and promote the offspring of senior government officials, who in turn ensure their longevity.

Chinese journalists have made many accusations. Wang Wenzhi of Economic Information Daily published a long report in mid-July on his blog stating that China Resources had paid almost twice what the mines were appraised for just three months earlier by another state-owned coal company, Datong Coal Mine Group, that had sought to buy them.

Mr. Wang had few specifics regarding Mr. Song, but the Chinese media and Internet discussion groups have been full of speculation over where the sums paid for the mines ended up.

Another journalist, Li Jianjun, used the Internet to distribute excerpts from what he said was a government auditor’s report last year that said the deal appeared plagued by missteps, overpayment, uncertainties and risks. “It remains unclear whether individual economic problems are involved,” the report said.

Others in the industry still see value in the mines. Shi Chunping, an independent coal trader specializing in coal from Shanxi Province, said in an interview that at least two of the three mines had valuable reserves.

He said that he had been down into the Zhongshe mine to inspect the coal, and that the reserves there were plentiful and of high quality.

The problem is that the reserves are quite deep. “The main issue is that the investment needed to develop the mine is huge,” he said. He declined to comment on the price paid by China Resources because he said he did not know the details of the transaction.

The economics of the deal have not been helped by a steep decline in coal prices since China Resources bought the mines three years ago. The output of strip mines in Inner Mongolia now exceeds Shanxi’s mine, while demand has grown more slowly than expected. As a result, coal prices have tumbled to 400 renminbi a ton (about $68) from 750 renminbi in 2010.

The region is economically troubled and residents in Zhongshe are eager for China Resources to start the mine here after years of inaction.

“It’s pitiful — there’s no mining, so we have no jobs,” said a 48-year-old farmer who gave only his surname, Kang, as he hoed a hillside cornfield across a gully from the back of the mine. “If we had jobs, we’d have some money and wouldn’t be doing this.”

The Hong Kong lawsuit asserts that the seller, a privately held company called Shanxi Jinye Coking Group, had held only mineral exploration rights for the mines it sold, as opposed to mineral production rights. And before the venture involving China Resources acquired the mines three years ago, according to the lawsuit, even those exploration rights had expired. Thus, the lawyers for the shareholders say, China Resources paid heftily for assets that the seller did not have the right to sell.

The company has not publicly responded in detail to the claims. In a statement on July 18, China Resources Power said that the transaction was aboveboard and that it was in the process of obtaining mining rights for two of the three mines; it obtained mining rights for the third this spring and is now starting mining there.

A few days after the initial statement, the parent company, China Resources, said on its site that the accusations were part of “a carefully planned, organized and concerted campaign of vilification orchestrated behind the scenes and using big rewards to buy off Internet enablers.”

On Wednesday, the chairman of China Resources, Mr. Song, issued a statement on the company’s Web site, denouncing the accusations of improper dealing as “utterly false charges.” Mr. Song called the mines purchase a “normal business activity,” and said he could take legal action against his accusers.

The big question now lies in how widely an official inquiry will extend and what it will disclose. The national audit office has said that it is reinvestigating the deal, and the Communist Party commission for investigating corruption has also said that any misdeeds will be punished.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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