A Yorkshire menswear chain may seem like an unlikely target for Chinese ownership, but that was the fate of Greenwoods. Founded in 1860 as a family-run hatter’s shop in Bradford, Greenwoods took pride in reshaping the headwear of the city’s well-to-do. More than 130 years later, with hats out of favor and menswear faring little better, the struggling firm followed the lead of many others and began sourcing from China.
Now Greenwoods’ Chinese supplier has become its owner. The company was already discussing a possible joint venture with Harvest Fancy, a Hong Kong-based subsidiary of supplier Bosideng International. Last fall, with Greenwoods teetering on the brink of bankruptcy, the conversation turned toward acquisition. Harvest Fancy bought the company in January, securing a distribution network for Bosideng products through Greenwoods’ 87 branded shops.
Shanghai-based Bosideng hopes to grow its own brand overseas and has chosen the northern UK market – where Greenwoods helped Bosideng open two branded shops prior to the takeover – as its starting point.
"The plan is to go from two stores to 40 within two years,"said John Hanson, managing director of Greenwoods and formerly chairman of the investor group that sold out to Harvest Fancy.
Hanson believes that Greenwoods’ fate will soon be duplicated around the world. As Chinese firms focusing on a wide range of consumer products develop their businesses, more will inevitably turn outward, he says. "China has to change its outlook and focus on brand development. There will be more people doing [what Bosideng has done]; there must be."
Hanson’s predictions aside, there has been little evidence to date that suggests an impending rush overseas by Chinese firms outside of the strategic sectors of energy and natural resources. Despite being linked to all kinds of foreign brands – from autos to apparel – in the much the same predicament as Greenwoods, the vast majority of consumer-oriented Chinese companies have laid low.
Outbound mergers and acquisitions outside of energy and resources were worth more than US$43 billion last year, up from US$24 billion in 2007. For the first five months of this year the figure was just US$2.3 billion.
The economic crisis has encouraged conservatism as much as it has created opportunities, but the reasons for China’s hesitance may run deeper. A lack of strong brands and inexperience in foreign markets remain significant obstacles, while the strength of the domestic consumer market encourages an inward focus. That trend may be reversed as regulatory easing and a resilient domestic consumer market combine to create a platform for companies to expand overseas. But at the same time, many firms tend to prefer incremental change, and then only when necessary. This helps to create a nearly systemic bias against overseas investment.
"For the size of [China’s] economy, the amount of inward investment they attract and the amount of trade they have, the size of their outward investment is very small,"said David Marchick, managing director for global government and regulatory affairs at the Carlyle Group. "The Chinese share of global FDI in 2007 was 0.6%, which is just above Luxembourg. China and other economic powers would both benefit from significant growth in Chinese outbound FDI."
The thin history of Chinese outbound investment makes many of the Chinese firms going overseas pioneers of a sort. True to their nature, many are trying to minimize their risks. "They are being smart. This is not Japan in the late 1980s and 1990s buying trophy properties for the sake of it because they are flush with cash,"said Ivan Schlager, Washington DC-based partner at Skadden Arps. "What we are seeing is smarter, more strategic investments."
Also favored are smaller and geographically remote investments. Shaun Rein, managing director of China Market Research (CMR), notes that Chinese companies have preferred investing in emerging markets in Africa, the Middle East and Eastern Europe over higher-profile desinations in the United States and Western Europe. "They’re going intentionally toward cheaper places, and the reason is because they’re trying to compete on price. They’re still not great at building up global brands,"he said.
Big red and big blue
Given the previous experience of Chinese firms trying to expand their brands in developed markets, that may be a wise strategy. The 2005 purchase of IBM’s personal computer unit by Beijing-based Lenovo has become widely seen among Chinese firms as an example of how not to conduct overseas acquisitions.
"In the couple of years prior to the acquisition … there was a vigorous debate inside of the company about how to go international."said David Wolf, president of Wolf Group Asia, a corporate advisory firm. "The question wasn’t about going global, it was ‘which markets do we pick to make our first beachheads overseas?’.
"And they never really came to a positive conclusion on that. When the IBM acquisition came along, it seemed to them an opportunity to become a global company in one fell swoop."
Lenovo’s decision to quickly drop the IBM brand name, which it had rights to use for up to five years, was viewed with hindsight as a strategic misstep. Rather than gradually introducing global consumers to the Lenovo brand, that decision made it difficult for the company to overcome consumer preconceptions about the Chinese firm, said Wolf.
While Lenovo, which declined to comment for this article, remains the world’s fourth-largest PC maker, it still suffers from poor customer perceptions. CMR’s Rein said excessive attention to cross-cultural management integration and rebranding hurt quality control, design and innovation after the purchase.
Lenovo was fortunate, however, in that it was actually able to buy its target. Ongoing protectionist policies in developed markets such as the US have meant that is not always guaranteed. Wu Meng, deputy director of international relations at the China Council for the Promotion of International Trade, said that while there has been some relaxing of political challenges to Chinese acquisitions in the US, investment remains difficult.
Political opposition may be difficult to understand in the context of low-tech consumer goods such as menswear, but becomes clearer given the focus of many investments. As they seek to strengthen their companies and brands, Chinese firms looking overseas frequently hope to acquire foreign manufacturing assets, technology, expertise and distribution networks that they lack on their own.
"The more sophisticated the manufacturing becomes, the closer it gets to defense technology and it is difficult to get transactions done in this area,"said Schlager at Skadden Arps.
The US illustrated this clearly in March 2008. Telecom equipment firm Huawei Technologies and American private equity firm Bain Capital were forced to abandon their bid for 3Com after the Committee on Foreign Investment in the US (CFIUS) said it intended to block the deal for the network hardware company. CFIUS had earlier cited national security concerns in explaining its opposition.
Other companies get bogged down in legal and regulatory issues separate from the acquisition itself. With relatively little experience in overseas transactions, many fail to anticipate legal requirements following a successful purchase.
"If you buy a company in California, it may be under California tax rules and you may have to report your worldwide income,"said Maurice Hoo, a partner at Paul Hastings’s corporate practice in Hong Kong.
"Are you prepared to convert all your numbers into US [Generally Accepted Accounting Principles] in order to do this tax return in California? … These are the things the things that you want to be prepared for. And that is sometimes very overwhelming for [Chinese companies]."
Battles at home
Companies heading overseas must also contend with domestic regulation. In that respect, China’s Ministry of Commerce (MofCom) earlier this year made an encouraging step with the introduction of new Administrative Measures on Regulation of Outbound Investment, which took effect in May.
By simplifying approval processes and decentralizing MofCom’s authority, the new rules are intended to encourage domestic companies to invest internationally. While the measures are too new to have produced any significant effects to date, observers say they are a positive development.
But Ian Lewis, partner at JSM in Beijing, notes that further regulation is likely. Furthermore, the National Development and Reform Commission (NDRC) also has rules covering outbound investment, and in fact remains the primary regulatory body for such activity. "Although MofCom has brought out more regulations, there are still regulations issued by the NDRC that need to really be made consistent with those,"Lewis said.
Dissuaded by the difficulties of going overseas, companies, particularly in the consumer sector, may question the need to look beyond China’s borders. As export markets have suffered, the domestic picture has remained relatively sanguine. Beijing’s stimulus plan is expected to help the country reach its GDP growth target of around 8%, and consumers are spending more. Retail sales rose 15.2% year-on-year in May, 0.4 percentage points higher than the April figure.
But companies that concentrate solely on building up their domestic presence while forgoing any international investment may find they are at a disadvantage. With many domestic firms competing on little more than price, there are few opportunities for differentiation. Many of the overseas acquisitions that have taken place were driven by a need to compensate for specific shortcomings and help firms to stand apart. Expanding internationally, in other words, can help companies compete more effectively at home. MofCom’s new regulations are a sign that Beijing generally supports this expansion as a way for domestic companies to climb the value chain.
"Even though the local market is robust, the China price has killed the China market to a certain extent,"said Wolf of Wolf Group Asia. "[Companies] continue to look overseas as really being the solver of their profitability over the long term."
Companies may share a general goal, but that does not mean they employ common strategies in their investments. Each firm has a different set of challenges to address, which can result in the targeting of very different assets. In the case of Greenwoods, Bosideng was keen on securing a distribution network for its clothing line, thus protecting its orders, while giving it the local knowledge to expand in the UK and Europe.
Access to distribution networks was also the rationale behind Nanjing-based electronics retailer Suning Appliance’s investment in Japanese retailer Laox, announced in June. The Chinese firm has paid US$8.4 million for a 27.36% stake in Laox to become the largest shareholder in the company.
Analysts see the deal as an opportunity for Suning to expand overseas while exposing itself to minimal risk. "Even if it fails, [Suning] will only lose US$8.4 million,"said Hu Hongke, an analyst with Guosen Securities. The company posted a net profit in 2008 of US$317 million on revenues of US$7.3 billion.
China Dongxiang, a sports apparel firm, has taken a different approach. The company gained recognition for its licensing in China of the sports-linked Kappa brand after a management buyout from domestic sportswear firm Li Ning. Under Li Ning, which had signed a long-term licensing agreement with Kappa’s Italian owners, the brand had stagnated, but Dongxiang proved to be more successful.
"They changed the product image from more of a performance-based to a fashion-based company,"said Jessie Qian, an analyst at Macquarie in Hong Kong. "They’ve done a good job so far."
According to research firm Zou Marketing, Kappa took 4% of the sportswear market in 2008, and made up more than 80% of Dongxiang’s total sales that year.
An R&D short cut
However, a lack of homegrown research and development prompted Dongxiang to look outward again in 2008 with the purchase of Phenix, a Japanese skiwear brand suffering from thin margins and weak distribution in Japan. The company is now planning to introduce a line of high-end skiwear under the Kappa brand using Phenix’s expertise in fabrics, materials and design.
"Dongxiang was desperately in need of R&D resources,"said Qian. "Without that I just don’t think they could survive more than five years on what they have. This is a very important strategic turning point for them."
R&D and technology are also seen as driving forces behind the bids by Chinese automakers for struggling foreign firms. Beijing Automotive Industry Holding Corp (BAIC) recently entered a US$2.25 billion bid for General Motors’ (GM) Opel unit, though it is not expected to succeed. According to the terms of the bid, GM would be required to license alternative propulsion systems to Opel and its Chinese subsidiaries, giving BAIC a technological boost.
Also in the auto industry, the high-profile attempt by Sichuan Tengzhong Heavy Industrial Machinery to buy GM’s Hummer brand was seen by some analysts as a way for the company to broaden its expertise into the auto sector.
A key similarity in the investments, real or attempted, by BAIC, Tengzhong, Suning and Dongxiang is that none involves the spread of the company’s own brand. In Dongxiang’s case, its efforts are focused on the development of a brand it doesn’t even control, except through license in China. This reflects the reality of many Chinese brands as having little cachet, even within their home market.
"It takes [Chinese companies] forever to build brands, and when they do they’re not very good, usually,"said Paul French, chief China representative at market research firm Access Asia and a regular columnist for CHINA ECONOMIC REVIEW.
All about the brand
Poor brand image is a particular problem in the consumer sector, where CMR’s Rein says trust in foreign brands outpaces trust in local brands. Last year’s tainted milk scandal – which brought down dairy giant Sanlu and damaged its competitors – was just one of a number of safety scares that have hurt consumer perceptions of Chinese brands over the years.
But companies hoping to leapfrog the brand-building process by simply acquiring a foreign brand – even if it is only for the name – do so at their own peril.
"Managing a brand is ultimately about the structure of the organization, corporate governance, investment in research and development, the nature of the hierarchy, and the ability to embrace intangible assets,"said Tom Doctoroff, North Asia CEO for communications firm JWT. "All of these things are fundamentally incompatible with the way most Chinese run their business… You can’t outsource the soul of a brand."
Another danger lies in companies unfamiliar with foreign markets attempting to take shortcuts in choosing an acquisition target. A source involved in overseas M&A gave the example of one North American deal gone wrong.
"The Chinese purchaser had gone in, hadn’t looked around properly, hadn’t taken the right advice, hadn’t used the right sort of advisers to help him, and had really bought the first thing that came along and looked attractive,"the source said. While the target was not a dud, neither was it an excellent investment value.
As more Chinese firms gain experience overseas, such horror stories will become less common, and most observers see a widespread trend toward increased outbound investment as inevitable. CMR’s Rein notes that in a survey his company conducted with 500 executives in 10 sectors, 70% of large companies had already gone abroad, and more than 50% of small- and medium-sized firms had already or were planning to go abroad.
With women under 35 as China’s most optimistic shoppers, Rein expects consumer sectors such as food and women’s clothing – both of which benefit from higher trust ascribed to foreign brands – to see acquisitions of brands and technologies.
Expansion in the cards
Doctoroff of JWT has broader expectations for the direction of foreign investment. The common element, he says, will be growth in "transactional"deals, including financial services, resources and manufacturing.
"Chinese are powerfully crawling their way up the value chain,"he said. "There is a huge opportunity for Chinese companies, with their cash, to be complementing the resources of international companies."
Growth in investment will not come rapidly, but given the amount of money coming into China and helping build companies, it is simply a matter of time. The firms in question are unlikely to grab the immediate headlines tied to China’s resource and energy deals, but their long-term impact will be no less impressive.