(Bloomberg) -- Zhang Shiping may have won an epic victory against short-sellers, but the self-made billionaire faces a much more formidable player in the battle surrounding the world's biggest aluminum producer: China's President Xi Jinping.
China Hongqiao Group Ltd. resumed trading in Hong Kong on Monday, ending a seven-month hiatus during which Zhang contested a research report that questioned his group's famously low costs. The aluminum giant's shares jumped 77 percent this week, making up ground lost to industry peers that have benefited from rising metal prices. Among the buyers was Zhang himself.
Much has changed in China during those seven months. Xi's campaign to rein in businesses that boomed after the market reforms of the 1980s has revived the power and influence of the state in the economy. Supply-side structural reforms are reshaping basic industries like steel and aluminum.
In August, Hongqiao shut nearly a third of its capacity to comply with government edicts, ending a decade of aggressive expansion that had shocked Zhang's global rivals. This month, Xi's supply-side policies were enshrined in the Communist Party constitution, making them “holy writ,” according to Jude Blanchette, an associate director in Beijing at Conference Board Inc. The Party Congress pledged it would have dominance “over everything.”
“There is a much more concerted effort to reassert control over the commanding heights of the economy,” said Blanchette, who leads Conference Board's research on China's politics. The Party is setting national objectives that not only state-owned enterprises, but “increasingly the nominally private companies look to align with.”
Read more on how big businesses are preparing for President Xi's priorities
About 88 percent of aluminum plants shut under those reforms last year and this year belong to private firms, according to Beijing-based industry consultancy AZ China Ltd. And some 75 percent of projects planned in the next three years are by state-owned groups, about a third of them by the biggest state producer, Aluminum Corp. of China.
Shifting Power
“The balance of power in the market over the next decade is definitely shifting,” said Paul Adkins, AZ China's managing director, who has tracked the aluminum sector for decades. There is “a gradual shift where the SOEs are pushing the private companies out,” he said.
The change has repercussions for Hongqiao, the behemoth that grew from a single small plant in 2001. Shutting down smelters, some of which were installed only a few years ago, reduces its ability to generate cash just as it needs to repay billions of yuan in debt.
“The key question is whether they can generate sufficient cash flow going forward or issue new onshore bonds as they have a lot of onshore bonds that are maturing soon,” said Annisa Lee, head of Asia ex-Japan flow credit analysis at Nomura International (Hong Kong) Ltd.
The group has more than 4 billion yuan ($605 million) of onshore bonds that will mature before the end of this year, with about 17 billion yuan of debt coming due next year.
In response to questions about the debt and suspended production, a spokesman for Hongqiao referred to comments the company made in its interim financial report last week, including a statement that the group will be able to fulfill its financial obligations as they fall due. China's National Development and Reform Commission, the body responsible for long-term economic planning, didn't respond to questions sent by fax.
Zhang, who began his career hauling bales of cotton in rural Shandong, made full use of the market reforms ushered in by former leader Deng Xiaoping to build not one, but two world class businesses. He became the richest person in Shandong province, with a fortune estimated at $7.5 billion.
Rags to Riches
His first fortune was in cloth. At the age of 35, Zhang was made general manager of Zouping's No. 5 Cotton Ginning Plant in 1981, putting him in the perfect spot to take advantage of China's transition from the chaos resulting from Mao Zedong's Cultural Revolution.
Zhang's cotton factory was a Mao-era hangover, deep in rural Shandong. It employed some 100 people in “a classic socialized enterprise that gave a lot of jobs to people who probably didn't really do anything,” said Andrew Kipnis, an anthropologist at the Australian National University who visited Zouping regularly from the 1980s and wrote a book on the town's transformation.
After Zhang became the boss, “it was success after success after success,” Kipnis said in a phone interview. Zhang and the management eventually established their own cotton processing business, and through the 1990s and early 2000s built the world's biggest textile firm -- the kind of low-value, labor-intensive operation that catapulted China into the top tier of the global economy.
Then Zhang surprised almost everyone with a decision to turn Zouping into the world's biggest aluminum complex. Up against big state-run metal makers and more efficient overseas producers keen to sell more aluminum to China, Zhang began an aggressive expansion that made Hongqiao the largest and most profitable producer in the country.
His key to cutting costs included building his own power plants -- a major component of aluminum production -- and trucking molten metal in huge crucibles direct to its customers, cutting out a section of the supply chain which shipped solid ingots that had to be reheated. His was the first Chinese company to set up major mines in Guinea for bauxite, the raw material for aluminum.
By 2015, Zhang had overtaken United Co. Rusal, the Russian firm owned by billionaire Oleg Deripaska. Last year, Hongqiao produced about 6 million metric tons of the metal, compared with Rusal's 3.3 million. China's aluminum output almost doubled from 2010 to 2015, while output elsewhere was largely stagnant and many producers shut smelters to curb losses.
Negative Report
Hongqiao's rapid ascent was halted this year when its stock tumbled following a negative report from anonymous research group Emerson Analytics Co. The report accused Zhang of under-reporting production costs to inflate profitability by purchasing electricity and alumina from connected parties at “exceedingly” low prices.
Hongqiao replaced its auditor, delayed its 2016 financial results and sought government help. In June, the company gained a $3 billion credit line from China's biggest bank, which also agreed to take a 10 percent stake in the company.
An auditor hired by Hongqiao found no evidence to support the allegations, the company said last month in a statement that paved the way for it to publish the delayed financial results and recommence trading in its shares. The firm has filed a defamation suit against the researcher in Hong Kong.
Hongqiao agreed to close 2.68 million tons of capacity in August, about 29 percent of its total, after a related company “misconducted the construction” of five plants. The closures came as China's government sought to rein in overcapacity by making inspections to weed out facilities constructed without the correct licenses or environmental approvals.
Aluminum is the London Metal Exchange's top performer this year with a gain of about 28 percent as investors bet on China's curbs boosting prices. Hongqiao said in August that higher prices resulting from the government's supply constraints would support profitability.
Family Affair
“Even after taking out 2 million tons of capacity it's going to account for about 10 percent of the entire world's output,” Adkins said of Hongqiao. “It's still roughly double the size of its nearest competitor.”
As Xi claws back control of industry for the Party, the challenge of navigating China's new economic model may fall eventually to the next generation -- Zhang's son Bo, the chief executive officer of Hongqiao, and his daughter Hongxia, who runs Weiqiao Textile.
When Hongqiao's workers were ordered to switch off the smelters in August, some of them cried, Zhang Bo said in comments posted on the firm's website in September.
“Everyone's feelings were understandable,” he said. But “the decisions of the Party Central Committee and the State Council must be implemented, without compromise.”
--With assistance from Lianting Tu and Judy Chen
To contact Bloomberg News staff for this story: Martin Ritchie in Shanghai at mritchie14@bloomberg.net.
To contact the editors responsible for this story: Alexander Kwiatkowski at akwiatkowsk2@bloomberg.net, Adam Majendie, James Poole
©2017 Bloomberg L.P.
With assistance from Martin Ritchie
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