China Mergers and Acquisitions to Heat Up in 2016

In an effort to combat sluggish growth and a collapsing stock market, the Chinese government will turn to merger and acquisition activity next year.

That represents the assessment of analysts at Standard Chartered, a London-based bank that has a substantial presence in Hong Kong. The Standard Chartered report noted that most of the activity will revolve around commodity firms, and will involve state-owned enterprises (SOEs) that have already begun to privatize through equity offerings in recent years.

In an effort to combat sluggish growth and a collapsing stock market, the Chinese government will turn to merger and acquisition activity next year.

That represents the assessment of analysts at Standard Chartered, a London-based bank that has a substantial presence in Hong Kong. The Standard Chartered report noted that most of the activity will revolve around commodity firms, and will involve state-owned enterprises (SOEs) that have already begun to privatize through equity offerings in recent years.

“We expect rapid progress in M&A in China’s oversupplied sectors, such as steel, non-ferrous metals, petrochemicals and electricity generation, in the year ahead,” the report said, adding that these industries have seen pressured profitability as a result of falling commodity prices. The report attributes this to overcapacity, a problem throughout China that has caused producer prices to fall for over three years.

The deflationary trend was largely offset by retail spending expansion throughout the early 2010s, but Standard Chartered believes that a number of factors have limited the company’s ability to rely on average Chinese people to prop up the market through domestic demand. Instead, the falling PPI that once made consumables cheaper for most Chinese consumers is now insufficient to offset weak demand from limited wage growth and economic expansion. “A combination of sluggish demand and large oversupply – caused by overcapacity in China’s traditional sectors – is the main drag on its economy,” the report said.

Bankruptcies on the Horizon

The report partially addressed the solvency of many Chinese companies. While government support propped up these firms, as SOEs become more private, they will rely more on internal efficiency and productivity gains to remain solvent. This awkward shift, combined with the fall in prices, leaves many companies vulnerable to defaults and layoffs.

“An abrupt shutdown of these industries could potentially lead to a sharp rise in unemployment and defaults in the financial market,” the Standard Chartered report said.

Current standards for SOE operation closure remain overly generous according to many external analysts, which warn that some restrictions, such as that SOE factories are required to close after three years of profitability, artificially prop up inefficient parts of the market and distort the country’s long-term growth.

Analysts and industry insiders have increasingly warned that SOEs will need to learn to compete more aggressively and focus on profitability as China attempts to compete with foreign producers and cheaper manufacturing hubs in Southeast Asia, such as in Indonesia and Vietnam. The growing competition in Asia has also caused capital flows to decline into China, while smaller countries to the south are seeing inflows rising sharply.