China’s Tobacco Industry Steps Up Structural Reform

by

By Tobaccochina Online

Amid a slowdown in the development of Chinese economy, the tobacco industry is stepping up structural reform in line with central government planning, with both separations and mergers of existing tobacco manufacturing enterprises to sharpen its competitive edge.

On August 24, 2015, the Central Committee of the Communist Party of China and the State Council (the Cabinet) jointly issued the Guiding Opinions on Deepening Reform of State-Run Enterprises (hereinafter referred to as “the Guiding Opinions”), as a program document for guiding and promoting the reform process of state-run enterprises in China during the current period.

Since the Guiding Opinions have been issued, both industrial administrative authorities and all sectors from the central government to local authorities have launched efforts to study and implement it in earnest. As far as the tobacco industry is concerned, the State Tobacco Monopoly Administration (STMA) – the regulator of the tobacco industry – and China National Tobacco Corporation (CNTC) have launched an exclusive study of the Guiding Opinions, in order to contribute to further deepening of structural reform of the tobacco industry and promote its development.

Within this context, tobacco manufacturers enterprises have seriously quickened their pace of structural reforms.

First, China Tobacco Chuanyu Industrial Co., Ltd. (CTCI) – the operator of the tobacco business of Sichuan Province (Chuan) and neighboring Chongqing City (Yu) announced a plan to separate itself into two independent entities.

Shortly afterwards, China Tobacco Yunnan Industrial Co., Ltd. (CTYI ) – the operator of the tobacco manufacturing sector in Yunnan Province, known as China’s kingdom of tobacco – completed the process of merging its assets dedicated to non-tobacco trade in business diversification.

The separation and the merger have demonstrated the determination and efforts of the tobacco industry to step up and promote its structural reform in an in-depth way.

Separation of CTCI

Incorporated in August 2003, CTCI is the first large-size interprovincial tobacco group of the nation. It is also the No. 1 corporate taxpayer in Sichuan and Chongqing. CTCI has 2 wholly-owned subsidiaries under it, in Sichuan and Chongqing respectively; 7 cigarette factories in Chengdu, Shifang, Mianyang, Xichang, Chongqing, Fuling, and Qianjiang; and 1 cigar factory in Shifang. CTCI has a total workforce of more than 8,000. Annually, the company produces and sells more than 150 billion cigarettes (3 million cases), and has an annual cigar making capacity of 5 billion. Major tobacco products of CTCI include Tianzi and Pride cigarette brands and Great Wall and Lion cigar brands.

Official data indicate that in 2014, the company produced 157.95 billion cigarettes (3.159 million cases), with its subsidiary in Sichuan producing 100.35 billion cigarettes, and the subsidiary in Chongqing producing 57.6 billion cigarettes. In one year, CTCI produced 46.24 billion cigarettes in joint-venture operations, accounting for 29.3% of its total cigarette output. After the latest round of integration of the existing cigarette brands, the annual cigarette output of its leading brand, Pride, reached a high of 80.35 billion cigarettes in 2014, accounting for 50.9% of the annual cigarette output of the company that year.

On October 12, 2015, STMA deputy director-general Zhao Hongshun announced a decision to deeply reform CTCI, which entails the separation of the company into two independent entities – China Tobacco Sichuan Industrial Co., Ltd. and China Tobacco Chongqing Industrial Co., Ltd. Both new entities will be subsidiaries wholly owned by CNTC. By then, CTCI had already started the process, 12 years after its incorporation.

No matter whether it comes to reorganization or separation, the development of CTCI has been closely linked to the general reform of state-run enterprises in China, increase of the distribution efficiency of tobacco industry resources, and the conception and requirement of market-oriented reform in the country. Just like what Zhao said, CTCI was incorporated at a time when the regional economies of Sichuan and Chongqing were undergoing reform leading to integrated development, when the tobacco industry was undergoing separation of its manufacturing sector from the commercial sector, and when the regional tobacco industries of the two provinces were actively exploring ways to restructure and integrate their resources.

In comparison, STMA’s decision to separate CTCI into two independent entities is practically required, first of all, by the increasing growth of the annual cigarette production capacity in both Sichuan and Chongqing, secondly, by the separate administration of Sichuan and Chongqing, and thirdly, by further deepening of reform of management by CTCI itself.

This change is just a reflection of the “giving priority to capital management” requirement prescribed by the Guiding Opinions in terms of improving the system of state-owned asset management. The principle was put in place in order to promote a shift of functions of state-owned assets regulation institutions, reform the system of authorized operation of state-owned assets, promote effective flow of state-owned capital, improve distribution of state-owned capital, and promote centralized regulation over profit-making state-owned assets.

In discussing the course of the reform following the CTCI split, tobacco industry sources believe that it will enable Sichuan Province and Chongqing City to each have an independent operator of the manufacturing sector, and that the newly established entities will strive to implement the reform of their management and rectify the relations of their assets. Experts also say it is very likely that both provinces will seek association with other powerful large enterprises. So far, the enterprises that have established production cooperation with CTCI include those based in Yunnan, Hubei, Zhejiang, and Hunan provinces.

After the separation, it will be inevitable for both the newly established CTSI and CTCI to independently face serious challenges brought about by a general slowdown in growth on the part of the entire tobacco industry. Meanwhile, they will have to bear risks of internal friction and a series of costs to newly arise. In future, as far as the cost of hardware is concerned, as well as purchase some equipment. As far as the cost of software is concerned, both will have to give much consideration to expanding their marketing channels, introducing human resources, increasing the influence of their competitive brands, and improving their management, etc.

However, in the long run, the separation seems to be more beneficial to the development of the tobacco industry of Sichuan, as there exists vast potential of the local market yet to be tapped. If Sichuan can swiftly rectify the relations of its management and assets, develop the local market and, at the same time, vigorously develop markets in other Chinese regions, it can fully expect to achieve rapid development in the very near future. In comparison, following the separation, the challenges faced by the tobacco industry of Chongqing will outweigh the advantages. Therefore, it must step up efforts to develop domestic markets in order to provide guarantees for future sustainable development. Only by doing so, can it stabilize its position in the market and seek greater development in the future.

Presently, it remains unknown how CTCI will divide up its relevant brands, assets, human resources, etc in the separation. However, under the megatrend of deepening reform by the tobacco industry, it is undoubtable that the separation of the company will be playing a model, guiding role in eliminating regional trade monopoly and promoting market-oriented reform.

CTYI integrates Non-Tobacco Operations

In stepping up the reform of their state-run enterprises, the tobacco industries of southwest China have made rapid progress and have virtually taken the lead. On October 16 – just four days after STMA announced the decision to separate CTCI, Yunnan Hongta Group Co., Ltd. – the subsidiary wholly owned by Hongta Tobacco Group in Yunnan – announced that it would merge into Yunnan Hehe (Group) Co., Ltd. (YHGC) This development signifies a smooth completion of the process of integration of the non-tobacco businesses operated by tobacco manufacturers under CTYI.

As far as YHGC is concerned, it is a unified platform for managing investment in business diversification jointly incorporated in February 2015 by Hongta Tobacco Group (HTG) with a controlling stake of 75%, HongyunHonghe Tobacco Group (HHTG) with 13% of the shares and CTYI with 12% of the shares, in efforts to integrate projects of non-tobacco businesses in the wake of the launch of a CTYI reform campaign leading to “two integrations and two unifications”.

The “two unifications” refers to the merger of management by CTYI over the businesses of marketing on the part of its affiliated HTG and HHTG and the merger of the r&d of the two groups. Meanwhile, “two integrations” refers to the integration of the existing cigarette brands and integration of the existing enterprises. The “two integrations and two unifications” are both intended to further optimize the distribution of resources in the interest of realizing sustainable, healthy, and steady development.

Today, YHGC is mainly responsible for the operation and management of non-tobacco operations and equities owned by CTYI, including those in the financial sector, the real estate sector, the energy industry, and the hotel industry. It is under obligation to keep and increase the value of CTYI’s non-tobacco assets. After the integration is complete, YHCG will be in possession of RMB85 billion (US$13.5 billion) in total assets, including RMB64.3 billion in net assets.

After it completed the integration of non-tobacco operations of CTYI, YHCG announced that it would, in accordance with the requirement of the principle of “giving priority to capital management” outlined in the Guiding Opinions, and with “capitalization of assets and securitization of capital” as an orientation, implement effective integration between production and financing, make good use of its existing assets, increase the value of its assets, strengthen its financial sector, develop its support sectors, consolidate its basic sectors, stabilize the development of its hotel and real estate operations, and participate in investment into national strategic emerging industries in an appropriate and timely manner, in order to gradually transform from a comprehensive investment company into a financial holding group, and enhance the core competitiveness of CTYI. The smooth completion of the integration process has contributed to laying a solid foundation for standardization of the management and operation of CTYI and increasing the efficiency of its capital operation.

The 12-year course of development of CTCI is the epitome of modern development of the tobacco business China. Its separation into two independent entities is a momentous decision to meet the new trend of development. The merger of YTG into YHGC is of landmark significance to the tobacco industry as it tries to vigorously promote investment in non-tobacco operations and realize value keeping and appreciation of state-owned assets. The separation and merger of existing tobacco manufacturing enterprises both reflect the endeavor to further deepen the reform of its state-run enterprises and accelerate its reform at a higher level. It is part of a bold drive by the tobacco industry to promote a major transformation of the management of its assets and other resources, and, even more significantly, self-improvement of its corporate operation model and the management.