On the same day that Uber China agreed to merge into Didi Chuxing, plans to merge some of China’s largest steel companies also became public. China’s #1 steel producer, Hesteel, decided to merge with its large local rival Shougang, while Baosteel of Shanghai agreed to merge with its regional rival WISCO.
Two very different industries, with very different paths to these merger decisions. One driven by the market and private investors, the other driven by the government from start to finish. Both have the same objective: Less competition, and therefore less need for low prices and subsidies to sustain volume. In the end, both will lead to the consumer paying more, whether it is for the car or washing machine built from steel or their ride in the morning to the office.
We have experienced a remarkable period in the Chinese car ride sector over the last several years with subsidies being offered to drivers for each passenger they carried and to passengers for every ride they took. Sometimes it seemed like drivers spent more time trying to work out how to game the system through “fake rides”.
Even for Uber, subsidizing maybe 40 million rides a week turns into significant amounts of cash quite quickly. And don’t forget this entire industry developed in a legal grey area (which in China de facto means is illegal, if we (the government) want it to be illegal) until just this week. Is there a link between the publication of a policy explicitly permitting ride sharing and Uber China selling to Didi Chuxing in the same week? Legalization of the operating model certainly reduced uncertainty over valuation of the business.
Yet in some ways the outcome was inevitable; it was the direction the sector was already going. Didi Chuxing itself was formed from the merger of the two largest Chinese ride sharing internet companies and it has a roster of China’s internet royalty as its investors. Many of these investors have seen the benefit of merging or acquiring to reduce competitive intensity in their own core markets, just recently in music and in classified advertising, for example. It’s likely that boardroom discussions would have focused on just when and how the ride share market could become more orderly.
With so much capital available in China, investment in overcapacity and investment in price wars in a bid to become the “last man standing” is inevitable and happens in many industries, at a regional, and increasingly, at a national level. An industry sector shows fast growth for a few years, many investors pile in, all assuming they will end up with a leading market share. The market matures, growth slows, capacity overshoots, and the shakeout theoretically commences.
But if banks (in the case of state-owned enterprises) and private investors (in the case of internet companies) continue to provide funds, this can be a slow process during which billions and billions of dollars are passed to the consumer in lower prices.
Local governments strongly resist mergers involving their local state-owned champions fearing a loss of tax revenue and jobs. The steel industry has theoretically been encouraged to merge with each other since 2009, but in reality few substantial mergers have happened. Workers have been let go incrementally, capacity has been used less efficiently, and regional price wars have continued as operators price to marginal cost, supported by continued loans from their local state-owned banks. What will happen at the mill level, should these newly discussed mergers take place? In reality, a limited amount to reduce employment or capacity, reductions will be very incremental in order to minimize the chance of any social unrest. But perhaps a larger step change in prices upward?
Mergers have been discussed but not yet implemented in other sectors dominated by state-owned enterprises. Telecom operators, all state-owned, compete against each other for the same consumers, they build networks to the same places, and they purchase the same equipment from the same suppliers. There are only three and they are all nationwide in reach, so they’re much easier to consolidate than the steel mills. Maybe even the banks. When the next banking crisis comes, I believe it is highly likely we will see many banks merged with each other as a major restructuring lever.
Could China end up as a series of de facto monopolies across many industries? If it did, I don’t think that large parts of the Chinese government would mind that much. It would make it much easier to implement industrial and social policy and it would feel much more like the industry structures they fondly remember from the 1980s.
Such companies would likely be very attuned to government policy and become expert at communicating their actions in a way that is seen to support government policy. For example, Didi Chuxing will now be able to raise even more aggressively its argument to the government that it is helping to reemploy many workers laid off from steel mills and coal mines.
Didi Chuxing has recently stated that it already has more than half a million laid off coal and steel workers as drivers (and more than 1 million from all heavy industries). I expect to hear them talk soon about how the merger will allow them to invest more in bringing more laid off workers into their driver community, with perhaps a new goal of employing 1 million former coal miners by mid-2017.
But not everyone in central government would be excited by these kind of outcomes. Those who see the need for greater productivity in many Chinese sectors and for greater innovation understand the role that competition plays in delivering these and will want to ensure that mergers don’t lead to the survival of the fattest rather than the fittest.
Read more of my views on China business over on my blog, Gordon's View, and please follow me on Twitter @gordonorr.
