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Mark Mobius: Buy China SOEs As Government Reforms!
Aspire, Investments | 24 June 2015
By: Lim Si Jie
Articles (169) Profile

Chinese stocks have been soaring for the first half of this year. Many investors are asking whether the market should expect a correction or is there still more room to run? Given the extent of the market’s rally this year, Mark Mobius believes that it would not be “surprising” to see more volatility ahead in the China markets.

Many investors’ increasingly strong interest in the Chinese stock market is attributed to China’s State-Owned Enterprises (SOEs).

The increased attention on China’s SOEs has no doubt been piqued by guidance from sources close to the government that reform plans are beginning to assume a more concrete shape, which has drove the recent gains in the Shanghai and Hong Kong share markets.

Chinese Government Determined In SOEs Reform

The SOEs are a crucial instrument of Chinese government policy and represents about two fifths of China’s economic output and a fifth of the country’s jobs. SOEs have been a key mechanism in driving China’s wider economy through mandated investment plans that are financed through preferential loans from state banks.

However, ill-thought out and politically motivated investment has caused returns on SOE assets to fall below private businesses. On top of that, a number of SOEs appears to be in financial difficulty due to rising debt loads and weak profitability.

But Mark Mobius observes that the Chinese government now appears “more determined than ever” to tackle management shortcomings within SOEs. They are trying to reshape China’s economy to a more “market-oriented and entrepreneurial mould”. According to Mark Mobius, this reform is “crucial to the overall improvement of the economy”.

Pilot Schemes For SOE Reforms

The Chinese government announced six enterprise pilot schemes of SOE reforms in April 2014 to attract private investment and improve corporate governance, as the government pushes ahead with reforms aimed at raising economic efficiency.

Chinese investment conglomerate Citic Group, whose businesses span property, mining, energy, banking and a soccer team, is planning a massive restructuring that will allow it to tap more overseas capital. As part of the SOE reform, Citic group will inject nearly all its assets into the unit in return for cash and new stock in Citic Pacific, to be issued at HK$13.48 a share.

Railway Mergers To Propel Economy

In recent months, the Chinese government seems to be leaning towards another route to reform: a merger. The merger of two state railway engineering businesses, China Railway Construction Corp (CRCC) and China Railway Engineering Corp (CREC), was carried out in order to avoid duplication of resources to create greater scale in overseas markets.

Judging by the reception of the railway merger between CREC and CRCC, Mark Mobius foresees a wave of SOE corporate activity that could potentially create significant opportunities for investors.

The combination of willing, albeit some even forced sellers and abundant of potential investment capital available, could drive a steady stream of deals. Sellers will become more familiar with SOE privatisation and regulator recognition of the needs of investors potentially improves.

SOE reform in China is likely to progress quite rapidly and the potential benefits both for China’s economy and for investors could be considerable.

Mobius: Capitalise On SOE Reforms

As Free Trade Zones become more established, Mark Mobius forecasts that China could well become centres for privatization. Although there is a delay in increasing China’s weightage in the MSCI, the number of potential foreign buyers will be increased.

This is particularly because the potential of China’s domestic stock markets are becoming sufficiently open to foreign investors and allow their admission to international stock indexes (such as MSCI). Moving forward, Mark Mobius believes that investors can capitalise on potential SOE mergers.

However, Mark Mobius warns that the centrally owned SOEs may not be the right place to anticipate early and ambitious reforms as most centrally owned SOEs are in sectors regarded as strategic, creating a reluctance to relinquish management control to private interests. In addition, the central government has no immediate need for cash injections.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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