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Michael McGaughy
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Michael McGaughy is a Hong Kong based consultant. He was previously a managing director at StoneWater Capital, a New York based fund-of-funds that specializes in allocating capital to Asian managers. In addition to establishing their Hong Kong office, he was responsible for sourcing, evaluating,... More
My blog:
Mike's Blog
My book:
Inside China's Corporations
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  • One Of Global Capital Markets Most Powerful People Lost His Position

    China's central government news agency, Xinhua, yesterday announced that the head of SASAC, Jiang Jiemin, is under investigation for 'serious discipline violations'. Typically just being under investigation is enough for a high-ranking official to lose his/her position. This seems to be the case, as references to Jiang on SASAC's website have been removed.

    For those that don't know, SASAC stands for the State-Owned Assets and Administration Commission of the State Council. It supervises and manages non-finance state-owned assets owned by China's central government.

    On paper, the head of SASAC is one of the most powerful people in global capital markets. Companies under SASAC and its finance company equivalent, Huijin, control more listed equity by value than any other organization in the world. By my calculations these and other SOEs directly under the Ministry of Finance, typically account for 4-5% of global equity.

    Here is the breakdown. The three stock markets in China (HK, Shanghai, Shenzhen), account for some 9-10% of global market capitalization. About half of these consists of Chinese Central Government controlled companies. This means at any given time about 4-5% of global market cap is owned and controlled by the Chinese Central Government. The bulk of this come under SASAC (see table below).

    SOEs typically make up the majority of stocks in China indexes and ETFs. This includes the FXI, the largest China ETF traded in the US.

    SASAC's function is repeated at the provincial and local level, which increases its influence on global capital markets a bit more.

    Take it all with a grain of salt. SASAC does not appear to be as powerful as one would expect given its responsibility and the fact that some of the world's most valuable companies are - on paper - under its domain.

    The reason for this has to do with the government's structure and hierarchy.

    The head of SASAC is at the Vice-Minister level. This is the same level as the SOE heads. Thus, the head of SASAC has little sway over the SOE bosses, as they are both at the same level. This is like one employee at the same level as his colleague telling the other what to do, instead of a boss telling his/her employees what to do.

    Secondly Jiang Jiemin has only been at SASAC for 6 months having been shifted there from the head of CNPC/PetroChina this March. I've not heard or read of any changes he has suggested or instituted in his short time leading the organization.

    The big question going forward is the structure of the government's ownership and control of its SOEs. China's SOEs are criticized for getting the majority of bank loans and crowding out privately-owned SMEs. The bosses of the largest SOEs are seen to be more powerful than many politicians. In every SOE I researched for my book on China's corporations, all were involved in scandals. Many times these scandals went on for several years before the accused was finally investigated.

    My general feeling is that there will be little reform of the SOEs in China in the near term. There are likely high-powered vested interests and ghosts in the cupboards that will resist any change. I suspect it will be a longer, drawn out-process more similar to Taiwan's privatisation. There are many similarities between Taiwan some 20-25 years ago and China now; and I think Taiwan's development and reform may be a good road map for things to come.

    Politics however is impossible to predict, and the news that Jiang Jiemin and other senior officials at CNPC/Petrochina are under investigation is surprising.

    Hope springs eternal however. Xi Jinping took over the central military command much sooner than his predecessors. Recent investigations into high ranking party, government and SOE leaders could signal that he has more power and leverage than many pundits originally thought. I am halfway through his biography which indicates that despite spending most of his career outside of Beijing, he is very well connected with senior military, business and political leaders.

    The Third Party Plenum is due to take place in November this year and there could be more interesting investigations and personnel changes over the next few months.

    * Notes to graph above. The last time I updated these numbers was in Fall 2012 so the slide is out of date. I've updated my numbers several times however the overall percentages do not change much.

    Sep 02 6:50 AM | Link | Comment!
  • Cut Out The Middle. People = Equity

    Cut Out the Middle. People = Equity

    I'm still searching for a way to best explain the philosophy behind my 'group' research and why it is important. My research starts with the looking at the background and history of the controlling shareholders, as well as all the companies he/she/it controls. I do as much research on the listed and unlisted companies and spend as much time on the non-core businesses as the core businesses.

    There are likely many different ways to explain what I do depending on the listener's background.

    My last post was written for financial professionals. In that article I introduced two expressions - "research beta" and "research alpha". I contrasted the type of research used to generate consensus earnings forecasts - "research beta" - with the more background, people and structure focused research that I emphasize - "research alpha' (see:

    After posting this, I thought of another, non-investment-jargon way of explaining the philosophy behind what I do. Here goes….

    Firstly, has been written many times before that business is about people.

    Secondly, equity represents an investment in a business. By definition equity represents a legal claim on a business. Or at least the difference between assets and liabilities of that business.

    Cut 'business' out of the middle and we are left with a direct link between people and equity. People represent equity. Equity is about investing in people.

    From this simple equation it becomes clear that equity investors should evaluate the people behind the business' they own. However this is rarely done for listed companies. When was the last time you saw a research report with an objective or even critical assessment of the key family, people or entity that controls a listed company?

    Visiting and meeting management is different than objectively evaluating their background and history. It is a good data point, but a meeting or two does not replace looking at someone's past actions and background. Bernie Ebbers (Worldcom) and Eka Tjipta Widjaja (Asia Pulp and Paper) likely charmed the socks off many corporate and investment bankers while building their companies. At the end of the day they were behind two of the largest corporate defaults before the 2008 meltdown.

    I would also argue that people are more important in emerging markets where the legal system, regulatory agencies, and business infrastructure are not as entrenched as in more developed countries.

    In my experience more emphasis and attention is placed on people in South East Asia, the Indian-subcontinent, and greater China than in the West. In most developed Western countries the emphasis is comparatively more focused on institutions and rules.

    Another reason that people are more relatively more important in Asian and emerging markets is that many of the largest listed companies are relatively young. They are typically majority owned by their founders and their descendants, and are tightly controlled by the founding family. Think of Li-Ka Shing and his Cheung Kong group, the Lim family's Genting group, or Guo Guangcheng's Fosun International group.

    Luckily there is a lot of information about most 'tycoons' publicly available. In many Asian countries wealthy tycoons get as much press coverage as rock and movie stars do in the US and Europe.

    There is also a wealth of publicly available data as reporting requirements have increased in most Asian and other markets in the last three decades. Insider buy-and-sell data can be can be important trading signals. Related party transactions provide a window into the tycoons' non-listed businesses.

    Even in the West individuals are important. Think about Steve Jobs and Apple. His history as an innovator, businessman and marketing guru were well known when he returned to Apple in 1996. Betting on him and his background turned out to be of the better investments of all time with shares increasing from their 1996 range of US$4.50 - US$8.50, to over US$700 in 2012.

    People also impart their culture and values on the companies they lead. This can be especially true of the founders. This initial corporate cultures can take a life of its own with older employees reinforcing existing culture and corporate history to newer ones; or only hiring new employees that fit-in. One of my favorite examples of this is Astra International, which was started by the very honorable Soeradjaya family. It remains one of the best-managed companies in Indonesia despite the founders having sold their stake over 15 years ago.

    Research also bears this out. I forget the exact reports I read, and I may be rusty on the numbers, however I remember several stating that share prices decline by something like 50% on average within five years of the founder's death. (Apple shareholders take note?)

    People are important in every occupation, but especially in business. Decisions have to be made and people are behind each and every one of these decisions. Understanding the business from the controlling owners perspective is something that is overlooked by many analysts and should be emphasized more.

    (click to enlarge)

    Apr 15 10:22 PM | Link | Comment!
  • Asian Conglomerates - View Them As PE Alternatives

    Originally written as comment to Marc Gerstein's 11 March 2013 very good post on Busines Development Companies -

    Many family owned and controlled conglomerates in Asia are criticized for 'asset-trading'. But if viewed and analyzed like a private equity alternative perhaps they look better.

    In addition to the obvious - local connections/network, inside industry knowledge and experience - local conglomerates are not subject to selling or listing an investment in the 7-10 years PE time-frame. Thus the PE fund is giving up the option to hold its investments past the life of the fund. To raise the next fund, there is a powerful incentive to sell by a given time; and forced selling is not a very good way to get top dollar.

    Asian markets tend to be more volatile and less efficient than those in the US so putting a time-frame on selling could lead to diminished returns for investors. Thus the PE fund gives up the option of when it wants to sell. And options have value.

    People like Li-Ka Shing and his Cheung Kong Holdings as well as many other family-run conglomerates, have done very well by retaining and acting on this 'option' at the right time.

    Perhaps BDC companies have an advantage over PE funds as they also seem to have the option of retaining assets as long as they want. Would love to hear peoples thoughts.

    Apr 05 1:08 AM | Link | Comment!
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