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Grow Big or Go Home

July 16, 2010 – Comments (2) | RELATED TICKERS: GSI

It’s no secret that Chinese companies are obsessed with growth.  As one exec at a Shenzhen-based travel services firm jokingly told us, “if you are not growing at 100% a year, you are not a Chinese company.”

(Global Gains members can click here to see my complete notes from the meeting: )

It’s perfectly understandable why companies want to grow large quickly: bigger companies tend to enjoy scale advantages that create a sustainable competitive advantage over their smaller peers.  That’s just as true in the U.S. as it is here in China.  However, there are additional factors at play that make size even more desirable in the Middle Kingdom:

Government Connections:  As the Chinese government looks to privatize inefficient state-owned enterprises (SOEs) by selling off their assets, it’s seeking buyers that have serious financial muscle and operational know-how.  Strong Chinese companies like General Steel (NYSE: GSI) can often score a sweet price when purchasing inefficient state-owned assets.

Status:  It’s clear from the number of shiny black Audis on the highways here that China is a very status-oriented country.  Several of the companies that we met with indicated that they were able to win new customers due to their impressive facilities, or their listing on the New York Stock Exchange.  Larger companies are seen as stronger partners.

Growth at any cost is costly

Don’t get me wrong, growth is important.  But as a long-term-oriented, business-focused investor, I’m looking for prudent, profitable growth, and not just growth for growth’s sake.  Unfortunately, it seems that many Chinese companies fail to make this distinction.

For example, the travel services exec I mentioned earlier told us that his company recently cut its prices on packaged tours in order to meet its quarterly earnings guidance.  Sacrificing your profit margins and brand equity in order to meet an arbitrary short-term target is simply not a shareholder-friendly method of doing business.  Needless to say, we won’t be highlighting his company in our report at the end of the trip.

However, not every Chinese company suffers from the same “growth at any cost” syndrome.  We have found a few companies on our journey that understand the importance of intelligent growth, and have been very disciplined with their future expansion plans, despite the tremendous market opportunity and Wall Street pressure.  We’re much more excited about the long-term prospects of these organizations, and we’re currently kicking the tires on their financials to make sure they can walk the walk in addition to talking the talk.  Stay tuned to see which of these companies will make the cut!

Thanks for reading,

Rich