Shortly after China normalized relations with South Africa in 1988, the state-owned Shanghai Industrial Investment Corporation (SIIC) made a dozen investments in South African industries in areas as diverse as light manufacturing, property and electronics.
Over the next two decades, nearly every venture failed.
The experience left a deep impression on Chinese firms. “In China, the sense became that South Africa is a tough market,” said Martyn Davies, CEO of Frontier Advisory, a consulting firm based in Johannesburg.
“If SIIC can’t succeed, how can the rest of us?”
According to a recent study by Stephen Gelb, professor of economics at the University of Johannesburg, some 29% of all Chinese firms that entered the South African market later withdrew.
A combination of South Africa’s heavy government regulation and sophisticated competition in several mature sectors has thwarted the ambitions of many Chinese companies. But the country also serves as perhaps the best proxy for Africa’s growth, and is a useful training ground for Chinese firms looking to expand across the continent and elsewhere.
Mistakes were made
Part of the reason why Chinese firms have found themselves hobbled is reflected in the broader trade picture. Sino-African trade is expected to have totaled around US$120 billion in 2010, of which South Africa accounted for about 15%. Yet despite relatively high trade volumes, the investment makeup is markedly different in South Africa than the rest of the African continent.
“The number of Chinese companies is very small, and the firms are thinly spread across many sectors, so the investment relationship is not ‘dense’,” said Gelb.
This is unusual: Chinese capital in the rest of Africa has overwhelmingly targeted infrastructure and the extractive industries. At first glance, this would seem a tempting opportunity in South Africa as well, which boasts enormous supplies of resources, including platinum metals, manganese, chrome, vanadium and gold.
Yet the Chinese mining firms that dominate entire economies elsewhere on the continent are often mere bit-players in South Africa. “At present, the kind of Chinese mining merger and acquisition deals we are seeing are restricted to second-tier acquisition deals for junior miners,” said Craig Bond, head of China operations for Standard Bank (SBK.JNB), South Africa’s largest financial firm.
He points out that unlike in other African countries, South Africa’s mining sector is large – with around 460,000 employees – and has a history dating back to the colonial era. Major multinationals like BHP Billiton (BHP.NYSE, BLT.LSE, BHP.ASX), Anglo-American (AAL.LSE, AGL.JNB) and De Beers have the heft, expertise and capital to face down large but often clumsy Chinese competition, creating high barriers to entry.
Other challenges in South Africa cut across industries. Labor markets are strongly regulated, and powerful labor unions, such as the two million-member Confederation of South African Trade Unions (COSATU), prove tough bargainers for wages and work conditions. This can present a steep learning curve for Chinese firms that have no experience negotiating with independent unions at home. Gelb says managing non-Chinese labor is a tremendous challenge for new firms, particularly in manufacturing.
Chinese firms in other countries may also face problems with non-Chinese labor, but South Africa presents unique challenges: Black Economic Empowerment (BEE) laws require a certain proportion of every level of a company’s workforce be Black – an official government designation – from senior managers down to wage workers.
This has proven particularly difficult for many Chinese companies to grasp. “Selecting a good, reputable Black economic partner is very important,” said Bond. “I know one big Chinese state-owned enterprise (SOE) that entered the market with a poor choice of partner. It failed badly.”
Moreover, Chinese infrastructure projects have in the past become enmeshed in politics. A contract awarded by the government to China Overseas Engineering (a subsidiary of China Railway Group; 601390.SH, 0390.HK) in February 2006 was greeted with howls of protest by local competitors who claimed that Chinese government subsidies and support allowed the company to place an unfairly low bid.
Pressure on the political front is likely to continue amid real unemployment rates as high as 40%. Chinese imports are widely blamed for the collapse of the local textile industry, which precipitated further job losses. As a result, elected politicians are in no mood to stand behind Chinese investment that does not lead to tangible employment benefits for their constituents.
However, this protectionism has been partially blunted by growing political links between China and the ruling African National Congress (ANC) party over the past two years. Since Jacob Zuma took over the presidency in 2009, South Africa has been actively seeking to better align its diplomacy with international trade goals. To that end, China has become a bigger diplomatic priority as Zuma seeks to wean his country from the recession-stricken West.
ANC cadres were sent to Beijing last year to study China’s economic development strategies, and the Sino-South African relationship was officially upgraded to a “comprehensive strategic partnership” last year. South Africa was also formally invited to become a permanent member of the annual meeting of the BRIC group of countries (Brazil, India and China) in December 2010, a decision that many saw as driven by China.
Door to Africa
Commenting on the country’s BRIC invitation, South Africa’s Trade and Industry Minister Rob Davies said that South Africa could be the gateway for emerging market investment into Africa. “The African continent is the next great economic story,” he said in late December.
The gate is already opening as companies adapt to the challenges of the South African market. “Many of the multinational firms we see operating [in Botswana] have their [regional] headquarters in South Africa,” said Leonard Muza, a senior tax consultant at KPMG in Botswana.
For Chinese companies, the same regulations that have hampered their growth in South Africa can also ensure a safe base for economic expansion. “The rule of law and tighter regulations than elsewhere in Africa can slow investment,” Gelb said. “But they are a big reason for South Africa’s position as financial gateway to the rest of the continent.”
This goes some way to explaining the slew of recent investments that led trade between the two countries to rise almost 60% to US$2.6 billion in 2010.
In the infrastructure sector, China Railway Group began talks in August 2010 with South Africa’s government over a proposed US$30 billion high-speed rail project between Johannesburg and the eastern port city of Durban. Energy firms have also been active: China National Nuclear Corp announced it was in talks to build a nuclear power plant in South Africa last year, and Standard Bank is advising China Guangdong Nuclear Power in similar negotiations. Other major deals have been signed in the mining, consumer goods and auto industries.
Chinese firms have also proven particularly competitive in South Africa’s light electronics “brown goods” sector, especially television sets. China’s Hisense Group (parent of Hisense Kelon; 0921.HK, 000921.SZ; and Hisense Electric; 600060.SH), SVA and Sinotec (CTE.NASDAQ) are three of only five TV manufacturers in South Africa, and have maintained operations in the country for over a decade.
Learning from the past
Analysts expect 2011 to be a bumper year for Chinese investment in South Africa as deals keep coming. A large power generation project is widely expected to be announced in March, and a raft of new Sino-South African deals are likely to be unveiled during Jacob Zuma’s state visit to Beijing in April.
How well these new ventures will fare is open to question. Skeptics point out that recent investments may simply reflect global economic shifts, not the increased competitiveness of Chinese firms.
Michael Solomon, senior adviser to the Raw Materials Group, a mining consultancy, says that the sudden spree of mining and infrastructure deals – not traditionally China’s forte in South Africa – is because the global downturn has meant Chinese firms have the capital to negotiate favorable deals.
Perhaps, but there are still some reasons for optimism. Gelb suggests that South Africa’s Western legal and financial systems make it a “classroom” for Chinese firms to learn how to operate in the US and Europe. And Bond notes that Chinese negotiators are significantly more mature and sophisticated than even just a few years ago as they become more savvy to the nuances of the South African market.
“Right up front the companies are asking us, ‘What are the labor laws? Do we have to hire local labor? How do we bring Black partners in?’,” said Bond. “I think there is a genuine intent to do the Africa thing well. I think there is a coming of age here.”
Davies at Frontier Advisory says that existing Chinese operations in the country have become smarter as well. “I’ve been pretty critical of the China-South Africa relationship’s direction because of opportunities lost in the past, but I’m now very positive that it will expand and, more importantly, deepen in the coming months,” he said.
Much of this deepening may come in the form of increased sourcing to Africa. While in the past many Chinese investments in Africa have imported Chinese labor and parts, Davies notes that higher tariffs and political pressure have convinced many firms of the need to manufacture and source components and labor locally.
There are clear benefits for both sides: While Chinese firms will still have access to these markets, sourcing labor and components locally creates jobs and provides an economic boost for South Africa. At the same time, South African firms have found Chinese technology and cheap capital to be useful complements to their local business savvy, as in the case of Standard Bank in its deal with Industrial and Commercial Bank of China (ICBC; 601398.SH, 1398.HK). For the South African government, heavily subsidized and relatively experienced Chinese firms are useful in correcting infrastructure inequalities left behind by apartheid, despite occasional political sensitivities.
South Africa’s crash course in regulated and often sophisticated markets may be a struggle at times, but a gradual shift up the value chain among Chinese firms investing in the country is a sign that it remains a powerful draw. As Africa’s growth story continues, more Chinese companies will find South Africa an ideal launching pad for their global ambitions.