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Friday, September 01, 2006

Wall St Journal editorial on China

The Wall Street Journal has an editorial (by Weijian Shan of TPG Newbridge, a private equity firm) on Chinese business that's very interesting. The editorial is here, but probably requires a paid subscription. It's also here, but that requires registration and who knows what else.

The World Bank's China Delusions

Basically, the editorial argues that the story about China circulating around the world is that Chinese businesses are extremely profitable and their retained earnings, rather than massive amounts of bank loans, have fueled China's industrial expansion. The World Bank believes that return on equity by state-owned businesses increased from 2% in 1998 to 12.7% in 2005 and that nonstate-owned business return on equity increased from 7.4% to 16%. However, the editorial provides a lot of examples of how these numbers exagerate the profits, such as by not accounting for income taxes paid, not accounting for government subsidies, and not accounting for accounts receivable being written off.

The reality is that Chinese businesses are being squeezed by increasing comodity prices (which are largely caused by the massive amount of Chinese expansion) causing costs to go up, and flat or even decreasing prices for finished products. Raw materials prices are up an average of 37% since 2002 while the Chinese internal consumer-price index is up only 6.2% while prices of exports to the US are down 5.2%.

The editorial argues that the actual return on equity could be around 9%, which is only 3 to 4 percentage points above the best lending rate. This is well below the spread in Hong Kong and US companies which are around 6 to 9 percent.

The editorial argues that a clear sign of overheating expansion in China is the increase in receivables. It argues that China's growth is being financed by banks and not profitability (estimating that re-investment likely accounts for no more than 20% of total fixed asset investment). Bank loans are greater than China's GDP and total bank credit is probably twice as big as the GDP.

China needs to be led by consumption gains and productivity gains rather than bank loans. Chinese leaders know this and are taking appropriate action.

The Orange County equity investment Firm invests in network-enabled service companies, specifically those that leverage networks to enable communication, deliver content and facilitate commerce. Meritage is stage-agnostic; seeking opportunities where the Firm's operating expertise and sector knowledge can guide the strategic direction of its portfolio companies and create sustainable value.
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