Share reform in China

With the deadline for reform of A-share listed companies fast approaching, companies that are still looking for the best restructuring path are running out of time.
While the Japanese stock market is witnessing more and more family mergers for the sake of operational flexibility, the Chinese A-share market is also being fundamentally restructured. This has not only sped up many state-owned giants to take their listed subsidiaries private but also motivated blue chip companies to launch reverse takeovers to expand and consolidate themselves and distressed companies eager to find potential backdoor listing bidders.

The market-wide restructuring process, or the so-called non-tradable share reform, started in May 2005 when heavy equipment maker Sany and three other companies became the first group to enter into share reform in China. The process is almost complete. So far 1,235 listed companies in the Shanghai and Shenzhen markets have completed or entered into share reform, 92.1% of the total that should carry out share reform. There are still 53 Shanghai-listed companies and 53 Shenzhen-listed companies left unreformed, which are all identified with an ôSö in front of their respective initial stock names.

Before the share reform, the Chinese stock market was split into floating shares and non-floating shares. The largest shareholders of listed companies all held non-tradable shares according to the old law and therefore did not care about the share price performance or the public shareholdersÆ interests. The four-year Chinese stock market decline, starting from the June 2001 peak when ShanghaiÆs composite index reached 2200 and fell to a low of 998 in June 2005, led to the Chinese State Council and securities regulatory body to decide on a solution to the shareholding-split structure problem of the stock market. ôThere can be no turning back,ö said Shang Fulin, the chairman of China Securities Regulatory Commission (CSRC) in a speech to express his ôdo-or-dieö decision. As a result, the non-tradable share reform, which features shareholders who hold a non-floating stake pay certain compensation shares or cash to public shareholders to buy the right of floating their shares, was launched and gradually became a must or a ôpolitical taskö for all the A-share listed companies.

Large state-owned listed companies including Baosteel, and China Unicom took part in the share reform actively in response to the State CouncilÆs request. However, some large-sized companies like Sinopec faced a dilemma: to take private its listed subsidiaries to fulfill the promise of structure simplification, or let its subsidiaries implement share reform. As share reform will dilute the stake held by Sinopec in its subsidiaries, it is considered a countermove towards taking private the subsidiaries which feature Sinopec offering to buy back the outstanding shares of the subsidiaries. For the same reason, the ongoing dynamic share reform forced large companies to speed up the restructuring process.

In October 2005, PetroChina, the Beijing-based oil giant, announced a buyout and delisting of its three listed subsidiaries including Jinlin Chemical, Jinzhou Petrochemical and Liaohe Oil Field for $758 million. PetroChina said the move was to resolve industry competition conflicts and reduce and standardise related trading between PetroChina and the listed subsidiaries. Analysts believed PetroChinaÆs move would be followed by similar deals in China. Hong Liang, an industry analyst from China Galaxy Securities, Jilin ChemicalÆs financial advisor, predicted PetroChina's delisting of Jilin Chemical would be a breakthrough in Chinese stock market history.

As the market expected, in November 2005 Sinopec announced it would buyout and delist the Shanghai and Hong Kong listed subsidiary Zhenhai Refining and Chemical (ZRCC) by absorption of ZRCC into Ningbo Yonglian, a subsidiary of Sinopec. Three months later, in February, Sinopec again bought back and delisted another four key listed subsidiaries including Qilu Petrochemical, Shengli Oil Field, Yangzi Petrochemical and Zhongyuan Petroleum. The two oil giantsÆ restructuring led to market speculation on the remaining unreformed subsidiaries of Sinopec including Shanghai Petrochemical and Yizheng Chemical Fibre as well as with Beijing-based Hong Kong listed alumina giant Chalco and its two major subsidiaries Shandong Aluminum and Lanzhou Aluminum. The market believed the share reform proposal by Sinopec and Chalco for their subsidiaries might be related to some restructuring opportunities, said Ben, a fund manager of a Shanghai-based private-owned institutional investor.

Unlike the worries about minority shareholdersÆ interests in the Japanese market, public shareholdersÆ interests are well protected in ChinaÆs share reform. As CSRC ruled that all share reform plans need to get public shareholdersÆ approval, public minority shareholders have the right to veto any share reform plan they oppose. And the non-tradable shareholders have to offer more to ensure the second round of share reform proposals being approved by EGM.

Hong Kong listed diesel engine maker Weichai Power gave in when the first round of share reform with its Shenzhen-listed subsidiary Torch Automobile was vetoed by EGM. Weichai Power finally proposed to take Torch private via a share swap and delist it in the second round of share reform, in response to the public shareholdersÆ requests. Chalco also gave in when the share reform plan of its major subsidiary, Shandong Aluminum, was vetoed by EGM in October as the public shareholders were disappointed that Chalco did not take Shandong Aluminum private as they expected. Chalco now has started the second round of share reform with Shandong and Lanzhou Aluminum. In the related announcement, Shandong Aluminum and Lanzhou Aluminum said the share reform plan would be related to the Chalco asset and equity restructuring.

Apart from the large Chinese listed companiesÆ family mergers, some blue chip companies that have finished share reform are high on reverse takeovers of their parent companies. After Taigang Stainless Steel first declared a reverse takeover of its parent company Taiyuan Steel Group on 16 June 2006, other blue chip companies like Shanghai Port Container, Shanghai Automotive, Yunnan Copper and Conch Cement all followed suit to issue new shares to their parent companies and swap out for core assets from the parent. A senior executive at Shanghai Automotive said the reverse takeover aimed to expand and strengthen the company. ôAfter share reform, blue chip companies all pay much attention to its market capitalisation and share price performance. A reverse takeover will help them expand the market capitalisation and enable them in their goal to rank among the worldÆs top 500 companies,ö said an analyst in Shanghai-based Guotai Junan Securities.

As for Hebei-based Handan Steel, issuing new shares to its parent and swapping for better assets is not only a way to strengthen itself but also an effective way to fend off BaosteelÆs acquisition threat. Handan Steel GroupÆs controlling stake in Handan Steel was diluted by the share reform to 58.823% from 64.435% and if after the call warrants are executed next year, the controlling stake in Handan Steel held by its parent company will be greatly diluted to 25.56%. On the other hand, Baosteel and its related companies have aggregately increased their stake in Handan Steel to 5% at very low costs via share reform. The call warrants of Handan Steel will enable Baosteel to build up its stake in Handan to at least 10.69% at a very low price. Threatened by BaosteelÆs takeover potential, Handan steel launched its plan to issue 700m new shares to its parent and swap for assets worth Rmb1.5 billion ($191 million). After the rights issue, Handan Steel Group can significantly build up its stake and maintain its position of controlling stakeholder. Yunnan Copper had the same experience when it received offers from two Chinese giant companies Yunnan Copper defended itself in the same way as Handan Steel.

Despite blue chip companiesÆ zeal for reverse takeovers, Guangfa SecuritiesÆ success in a backdoor listing via Yan Bian Road Construction highlighted the Chinese stock market in September. Following Guangfa Securities, Changjiang, Everbright, Haitong and Sinolink Securities all considered back door listing shells while Beijing Huaer, Wuhan East Lake High Technology Group, Hubei Mailyard Share, Shanghai Urban Agro-Business and SinopecÆs subsidiaries, including Wuhan and Taishan Petroleum were all rumoured as back door listing shells.

So far, CSRC the regulatory body has set the deadline for all the A-share listed companies to finish the share reform by the end of 2006. Those that cannot carry out share reform before the deadline will be subject to punitive measures of some sort, including being restricted in stock trading or kicked off the index. Therefore, more and more unreformed companies are looking for the best way to deal with share reform. ôMost of the unreformed companies are facing various difficulties in carrying out the share reform. Only restructuring or M&A can bring them a solution to complete the reform. And there are not much time left for these companies,ö said a Shanghai-based private-owned institutional investor the fund manager.

During the first week of December, Chalco and Sinopec declared they would begin the share reform with the rest of their unreformed subsidiaries. A source close to Sinpec said Sinopec is going to sell its seven trading suspended subsidiaries as back door listing shells. And Shandong and Lanzhou Aluminum also said in their announcements that the share reform will be related to parent ChalcoÆs assets and equity restructuring. ôThere are only three weeks left. Obviously Sinopec and Chalco will push the unprecedented share reform to a climax and draw it to a beautiful end,ö said the fund manager. What else can be expected from other unreformed companies? Will there be any M&A opportunities coming from that group? These are questions the fund manager presented, adding that the next market opportunity after the share reform might be the merger of the A-share and B-share market, which has already been put on the working agenda of the Chinese securities regulatory body CSRC.
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