China’s army of small and medium enterprises (SMEs) makes up as much as 70% of the country’s economic output, but has been hit disproportionately hard by government steps to slow rampant investment and soaring inflation. “SMEs in general have a huge hurdle to clear to secure bank lending and investment in China,” said Tian Wenwei, vice president of Puda, a supplier of coking coal, used in steel making. “But with steel prices rising, we have had no problem finding foreign investors.”

Foreign funds now own 35-40% of Puda — which has previously said it was eyeing a Nasdaq listing — even as domestic share flotation’s have been going through a rough patch. Chongqing Machinery & Electric Co Ltd shares fell 19% on their debut this month in Hong Kong, putting a damper on other issues.

While it’s difficult to track SMEs because investments are often under $50 million and fly under regulatory radar, those that cater to the vast and varied sector are upbeat. “China is still a hot investment place,” said Kent Kedl, the Shanghai head of consultancy Technomic Asia, which helps US and European clients find investment partners in China. Kedl said a quarter of the deals he closes are now some form of merger or acquisition, a ratio he reckons will grow to two-thirds in the near future. 

 
HUNGRY FOR CASH

Announced cross-border M&A activity for mainland companies — both inbound and outbound — tripled to $48.6 billion in 2008 through June 18, according to Thomson Reuters data. In comparison, M&As in Asia Pacific including Japan “The real funds that understand China are still hungry for investment,” said Joseph Meuse, founder and managing director of Belmont Partners, a specialist in US reverse mergers. “How could you not be interested in a company growing at 30%.” rose 8.9% to $350.3 billion. 

Belmont helped Shanghai Medical Technology Co raise $12.5 million earlier this year in a reverse merger, a move that helped the Chinese company secure an over-the-counter listing much faster than the traditional initial public offering route. Meuse, now involved in opening a consulting firm in Shanghai to increase the deal flow to Belmont, said the US financial turmoil would have a small impact on business this year.

China’s economy has shown resilience even as the US economy lists on the brink of recession and global markets are battered by soaring oil prices and the credit crisis. To prevent overheating, China has raised banks’ required reserve ratio 17 times in a two-year monetary tightening cycle and ordered banks to limit new loans this year at 2007 levels. In other moves aimed at smaller firms and to encourage the production of higher value-added goods, Beijing has reduced export subsidies and stiffened pollution standards.

 
GOING IT ALONE

But the less stringent bookkeeping and opaque ownership structure that often characterize Chinese SMEs can turn due diligence into a lengthy exercise for investors. “These are pretty nervous people,” said Technomic’s Kedl, referring to his clients. Direct investors are not the only ones looking to China. As investor appetite for global IPOs has slowed amid turbulent financial markets, the world’s bourses are competing more aggressively for business from China.

Canada’s biggest stock market operator, TSX Group Inc, said last month it was looking to open an office in China — its fastest growing source of new listings — which would be its first outside North America. The TSX is home to most of the world’s listed mining and energy firms — key target sectors for resource hungry China. TSX is hoping for 25-40 listings annually from China within five years, compared to seven last year.

It is not alone. The London Stock Exchange opened a Beijing office in January, following similar moves by the New York Stock Exchange, a unit of NYSE Euronext, and Nasdaq. But despite all the attention they are attracting from the world’s investors, most of China’s SMEs will find it difficult to secure overseas backing. “The larger and better managed SMEs will be able to attract foreign investors, but there could be millions of them,” said Tang Min, the deputy secretary of the cabinet’s China Development Research Foundation. “The government needs to open access to big state banks to improve their funding channels.” (Reuters)