A long-awaited tie-up between Sinochem and ChemChina looks closer, but the timing is precarious.
Better late than never?
Three years of efforts to combine China’s giant state-owned chemicals companies Sinochem Group Co. and China National Chemical Corp., or ChemChina, may finally be paying off. A merger between the two unlisted companies is at last “in progress,” Frank Ning, the chairman of both companies, said last week.
Such a deal would create a behemoth with about 1.04 trillion yuan ($152.2 billion) of revenue. If it was ever listed, that might result in a market capitalization of 777 billion yuan on the 0.75 times price-sales multiple typical of large chemical businesses — roughly the size of BASF SE, Dow Inc., and Nutrien Ltd. put together.
Size isn’t everything, though, and any completed SinoChemChina deal is likely to look less like a triumph than a limp to the finish line.
The debts taken on in ChemChina's takeover of Syngenta were just the start of its borrowing spree
The reason is ChemChina’s vast and growing debt mountain. Since its $43 billion takeover of Swiss crop-science giant Syngenta AG at the height of China’s outbound acquisitions spree in 2017, the company’s borrowings have only grown, thanks to ongoing capital spending far in excess of operating cashflow. The $20 billion that funded the Syngenta deal looks modest next to net debt which stood at 434.23 billion yuan, or $63.6 billion, at the end of June.
Operating income barely covers the interest bill and the company hasn’t made a profit since the takeover was completed. Despite hopes that owning one of the world’s crop giants would allow China to drastically increase the productivity of its domestic farming industry and food security, Syngenta’s mainland sales have barely risen, with the biggest jump in revenue coming from Latin America. No wonder’s China’s ambassador to Switzerland labeled the takeover a mistake.
Putting It on the Credit Card
ChemChina's slim or negative operating cashflows aren't sufficient to cover its vast investment spending
Note: Figures show trailing 12-month cashflows.
A spinoff will go some way toward winding back the debt clock. Ning has already been working to combine ChemChina and Sinochem's agricultural assets into a vehicle that would be suitable for listing on mainland exchanges. Pre-IPO financing from state-backed investors could provide $10 billion in return for 20% to 30% of the company, Reuters reported last year citing people familiar with the situation. If a similar amount could be raised from smaller shareholders, SinoChemChina could end up with $20 billion while still holding onto a majority stake in its listed agritech business.
There’s no time like the present to get that long-awaited initial public offering done. China’s equity markets are in a frothy state these days, as my colleague Shuli Ren has described — perfect conditions for raising cheap money. The multiple on the CSI 300 index of large companies recently broke through 16 times for the first time since the 2015 market bubble.
The price-earnings multiple on China's CSI 300 index of large companies is at its highest levels since 2015
There’s been another bit of news that may throw a wrench in the works, though. The U.S. Department of Defense last month added both Sinochem and ChemChina to its list of entities it considers “Communist Chinese military companies.” That gives the White House broad powers to impose crippling sanctions on any company doing business with them. Just consider the $1.19 billion fine the Trump administration levied on ZTE Corp. in 2017.
That's some risk factor to add to your IPO documents. On one hand, SinoChemChina’s bankers will have to hope that the febrile conditions in China’s equity markets hold out long enough for them to do the remaining work on the share sale. On the other, they’ll be looking nervously over their shoulders for signs of a late-night Trump tweet that could sink the whole show. More than 97% of Syngenta’s business is outside China. If sanctions were imposed, nothing less than full separation from SinoChemChina would be sufficient to preserve it from ruin.
China is still a tiny part of Syngenta's business, based on its 2019 revenues
Source: Company reports
Sanctions hold a sword of Damocles over what would remain of the business, too. The billions that ChemChina has been dedicating to capital investment is just a small part of the constellation of new chemical plants under construction in China in recent years, with vast complexes being planned or built by Hengli Petrochemical Co., Rongsheng Petro Chemical Co. and even BASF. Despite rapid increases in domestic demand, these plants need robust export markets to soak up their product — but that route would be closed off to SinoChemChina if Washington was to unleash its thunderbolt.
A better prospect would be to junk plans for a domestic IPO and sell Syngenta back to the market in its entirety, along with ChemChina’s 45% stake in tire maker Pirelli & C. SpA and Sinochem’s oil-trading unit. That would give up on SinoChemChina’s grand strategic ambitions, but would at least salvage the maximum amount of cash from the wreckage.
Ning, who earned his MBA at the University of Pittsburgh, could then turn his entrepreneurial skills to a task even more important than doing mega-deals: Getting China’s newborn chemicals giant to live within its means. Once upon a time, Sinochem itself was a candidate for a stock market listing. If it’s to get in the sort of shape necessary to attract investors, a thorough clear-out is in order.
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With tensions between the U.S. and China heating up, there are increasing calls for expelling or barring Chinese nationals from U.S. universities and corporations. Whatever the national security justification for these moves, policy makers should be aware of the potential downsides -- loss of economic vitality, and the potential for a wave of racial discrimination.
Over the past few years, U.S. public opinion of China has soured dramatically, accelerating a trend that began with the accession of Chinese leader Xi Jinping in 2012. The trend is bipartisan and holds across age groups. The reasons for it are varied and manifold.
Many Americans blame China for failing to contain the initial Covid-19 outbreak, while long-simmering touchpoints such as job competition, industrial espionage, trade disparities, and environmental concerns are also coming back to the fore. On top of these things, there’s the actions of the Chinese government itself: The assumption of control in Hong Kong and the repression of the Uighur minority have reached many American ears. And China’s maritime expansionism and clashes with neighbors such as India provide uncomfortable parallels to aggressive rising powers of the past.
In this climate, perhaps it’s no surprise to see growing suspicion of Chinese nationals working or studying in the U.S. This summer, President Donald Trump issued an executive order suspending visas for many Chinese graduate students and post-doctoral researchers, and urged the State Department to consider revoking existing visas. Republican Senators Tom Cotton and Marsha Blackburn would go further, introducing a bill that would ban Chinese nationals from studying STEM subjects such as math and engineering at the graduate level in the U.S.
Chinese workers, too, are feeling the heat. Under long-standing U.S. government rules, hiring foreign workers in certain high-tech industries is considered an export, since those workers could then move back home and take back the technological knowledge they learned in America. In recent years, as the trade war with China has heated up, the government has become much more willing to deny companies approval to hire Chinese nationals. Meanwhile, a number of universities have expelled professors with ties to certain Chinese government organizations.
Some of these moves doubtless have national security justifications. China has been found to conduct espionage at U.S. universities and companies, attempting to nab the latest U.S. technologies cheaply. As security competition between the two countries intensifies, it makes sense to intensify U.S. efforts to keep sensitive technologies secret -- both to preserve a military edge, and to retain U.S. companies’ competitive advantage so that the country doesn’t become too reliant on Chinese national champions such as Huawei Corp.
Banning Chinese graduate students and researchers en masse, though, is a blanket move -- an extreme response to the espionage problem. It’s possible that this sort of nuclear option is the only way to avoid critical security lapses, but it may constitute an overreaction by an administration that has already shown a tendency toward xenophobia and poor policy judgment in many other areas. When considering whether these policies make sense, it’s thus important to also consider the economic and social costs.
Some of those costs will fall on the U.S.
One cost will be weakened U.S. research capabilities. In many STEM fields, foreign students -- of whom Chinese students are a large portion -- are absolutely essential:
The U.S. wouldn’t be able to replace these students quickly. The closest substitute would be foreign students and researchers from other countries, but even if this were possible in the age of Trump and Covid-19, switching to new personnel would entail the loss of months or even years of experience and knowledge. Inducing native-born students to fill these fields in large numbers would be an even slower and more costly process. A mass expulsion of Chinese students would thus hamper STEM research efforts at a large number of university research labs, as well as the companies with whom those labs partner.
That, along with the expulsion of Chinese workers, could cause the U.S. to stumble in some critical fields such as artificial intelligence. It also would hurt college towns, which lure corporate investment by having a large pool of research workers, and who are key drivers of economic investment and prosperity in otherwise declining regions.
In addition to the economic costs, there’s also the danger of sparking a racist backlash against not just Chinese nationals, but also Asian Americans. Reports of anti-Asian hate crimes and harassment have already soared, due to antipathy toward China over the coronavirus. A nationwide campaign to expel Chinese students or workers could exacerbate the problem. After the Sept. 11, 2001, terrorist attacks, President George W. Bush went out of his way to stress that the U.S. was not in a civilizational conflict with Islam; this may have helped to tamp down the wave of anti-Muslim sentiment that bubbled up. The Trump administration is unlikely to display the same foresight.
It’s very difficult to weigh potential economic losses and social dangers against the imperatives of national security. But U.S. policy makers need to understand the trade-offs involved.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.