Power plants in Australia, telecom networks in Asia, TV manufacturers in Europe and raw materials wherever they are available. Encouraged and assisted by the government, Chinese companies are increasingly looking abroad for opportunities to expand and secure a global future for themselves and their brands. The controls are being loosened on the domestic stockpiles of corporate wealth that have accumulated over the last quarter century of economic reforms and the world's number one destination for global direct investment is for the first time contemplating its prospects as an exporter as well as an importer of capital.
While multinational corporations flood in, a growing number of China's would-be MNCs are thinking global. But China has a long way to go before it can boast its very own stable of Sonys and Samsungs. Of the global Fortune 500 companies, only 11 of them are from China and none of them yet has any major global reach or brand recognition.
With over US$53 billion of foreign direct investment (FDI) in 2003, China was expected to be the largest FDI recipient in the world for the second year in a row. By comparison, the total volume of Chinese direct investment to foreign countries between 1979 and 2002, excluding investment in the field of finance, reached US$29.9 billion, according to Chinese Ministry of Commerce figures.
"We are witnessing the beginning of the internationalization of China's economy, we are right at the start of this trend," said Andrew Godwin, a partner at Linklaters law firm in Shanghai who assists Chinese companies with their offshore mergers and acquisitions.
"Historically the concern was that foreign investments could be used as a vehicle for capital flight," said Godwin. "But that is no longer as much of a concern and the fact that the government is relaxing controls on offshore activity is a sign of the general maturity of the companies and the government's economic policy."
China's insatiable appetite
The huge increase in Chinese offshore investment has been most obvious in the raw materials sectors. "What the Chinese companies are doing is very similar to the historical experience of Japanese companies – securing supplies and raw materials," said Christopher Lee, head of research for Standard & Poor's in Hong Kong.
From being a net exporter of oil in 1993, China became the world's second largest oil importer in 2003, when the country was forced to import 30% of its oil needs. That percentage is expected to increase to 50% by 2010. With dire shortages predicted in the near future, the country's massive state-owned oil companies are constantly scouring the globe for potential sources of 'energy security.'
China's top offshore oil and gas producer, China National Offshore Oil Corp (CNOOC), spent almost US$2 billion in 2003 buying oil and gas assets in Indonesia and Australia, where it picked up a stake that will eventually be worth US$21 billion in the massive Gorgon liquefied natural gas (LNG) field.
Chinese state oil companies went as far abroad as Ecuador, where Sinochem paid US$100 million to acquire a 14% share in an oil field operated by US firm ConocoPhilipps. It is not only oil that China is looking for. Chinese companies bought large holdings in a sylvite (used to make fertilizer) mine in Thailand and various metals mines and refineries in Australia. In December, domestic power giant China Huaneng became the first Chinese company to acquire major overseas assets in the power-generating sector by buying two Australian power plants for US$227 million, and in January Aluminum Corporation of China (Chalco), the country's biggest aluminum and alumina producer, announced plans to invest US$1 billion in an alumina mining project in Vietnam. The company has another 10 planned alumina exploration projects in other countries, including Australia, Guinea, India, Brazil and Jamaica.
China's insatiable appetite for raw materials and its apparent economic expansionism have naturally made some competitors uneasy. Last year, a proposed pipeline from Siberia into China was cancelled by Russia in favor of a more costly one to supply Japan. In a separate incident, state oil companies CNOOC and Sinopec were blocked by partners ExxonMobil and Shell from buying into a massive oil and gas field in Kazakhstan.
Acquiring a car company
Government policy and the companies involved in offshore mergers and acquisitions may be more mature but that does not mean all the deals make sense. In late December an acquisition was announced that left many observers scratching their heads. A stateowned company called Bluestar, with no car manufacturing facilities of its own, became the first Chinese owner of a foreign carmaker when it signed a US$1.5 billion deal buy a 55.4% stake in South Korea's fourth-largest automaker Ssangyong. The first visit by Bluestar officials to the Ssangyong plant in Korea in early January was accompanied by worker protests that blocked entrances and prevented the Chinese visitors from entering.
"That deal was really an oddball. I think it had more to do with politics and prestige building than common sense," said Standard & Poor's Lee.
Bluestar beat out General Motors (GM), DaimlerChrysler and Shanghai Automotive Industry Corp (SAIC) to take control of the SUV maker despite the fact that its only connection to car manufacturing is a chain of auto repair shops from which it derives about 16% of its sales. The rest of its business comes from detergents, petrochemicals and a chain of noodle shops.
An interesting twist was added to the affair by an SAIC announcement that the government had anointed it as the sole Chinese bidder for the deal and Bluestar did not have permission to take over Ssangyong. Bluestar said it expected to get all written approvals for its purchase by late January.
Beijing's 'Go forth' policy
A telling sign of government enthusiasm for offshore acquisitions and mergers is Bluestar's confidence that it will receive regulatory approval after the deal is already done and despite the questionable logic of a chemical company acquiring a carmaker.
"It's not only offshore acquisitions of raw materials that are being encouraged, the government has been relaxing the rules for all industries and encouraging banks to provide cheap credit for overseas activity," said Michael Ho, senior manager of PricewaterhouseCoopers in Shanghai.
The State Asset Supervision and Administration Commission (SASAC) was set up in April 2003 with the mandate of turning the country's top state-owned enterprises (SOEs) under its control into 50 global multinational corporations that feature on the global Fortune 500 list.
It is not only the biggest SOEs that are being encouraged to go abroad. Every company that wants to invest overseas must get regulatory approval, but in 2003 the Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange (SAFE) introduced a program that allowed overseas investments of less than US$3 million to be approved at the local government level rather than through the lengthy and complicated process of applying to Beijing.
As a result, in the first 11 months of 2003, Chinese companies invested 92% more in offshore acquisitions and mergers than in the same period in 2002, according to MOFCOM statistics. Because this figure only included deals registered through the ministry, MOFCOM said that the actual rise in investments was estimated to be much higher.
There are a number of reasons why the government is so interested in getting Chinese companies to head out into the world. Firstly, according to promises China made to lift regulatory restrictions under its WTO succession agreement, foreign multinationals are rapidly gaining access to China's vast potential market. In order for Chinese companies to be able to compete at home they must be able to punch their weight in a global setting. That means quickly bringing companies up to global standards in terms of management, marketing and technological expertise and what better way than to buy all those things in the form of an already functioning foreign company?
Many Chinese corporations have been doing just that. Electronics producer TCL bought bankrupt German TV maker Schneider Electronics for US$10.4 billion in 2002 and in November signed a deal with France's Thomson to combine their television and DVD businesses.
Thomson will leverage China's cheap production capabilities and TCL will take advantage of Thomson's technologies and research and development (R&D) capabilities to increase market share in high-end markets.
D'Long International Strategic Investment is a privately owned Shanghai-based company that has been very successful in offshore mergers and acquisitions. It targets companies in traditional manufacturing industries (auto parts, lawnmowers and gardening equipment) in the US and Europe and, once it has merged with or bought them, it uses China's natural advantage of low-cost labor and moves over as much production as it can in order to maximize profits.
"The government is encouraging Chinese companies to do any overseas investments that they can," said Tom Shao, D'Long's executive president. "In Shanghai they have even set up a government department with the sole responsibility of helping Chinese companies invest overseas."
While D'Long moves the majority of production to China, it generally replicates, rather than replaces, the established company structures. "It is a delicate balance consolidating a company, we come up against culture and union problems in the US for example and so often try to keep high-end production in the States and use US managers to acquire management expertise," said Shao.
Many Chinese CEOs, including Shao, are also looking to developing countries and regions like Vietnam, the Philippines and South America where competition is not so fierce and markets are similar to those in China. "We're not so concerned about which industry or where we invest, we're just looking for opportunities to make money," he said.
By taking on faded foreign brands and reducing their cost structure, companies like D'Long can make a healthy profit for as long as the brand does well. "The danger is if that brand then gains a reputation for being of lower quality then you may actually destroy it," said Arthur Kroeber, an economist with the China Economic Quarterly. "By buying up brands in developed markets, you're not necessarily rescuing the brand, you're just squeezing more profit out of it by lowering the cost structure." He points out that it is not just Chinese acquirers that are capable of moving production to China to lower costs, any company can do it. China's would-be multinationals need to find some source of competitiveness other than cheap labor costs. When Japan began its major period of mergers and acquisitions abroad in the 1980s, the country's main advantage was superior management techniques and more efficient manufacturing structures and processes. These advantages were transferable, but the key advantage of Chinese companies – cheap labor costs – relies on physically locating production in China.
Political production facilities
Some of the biggest state-owned enterprises from China have set up their own factories with full production facilities in target Western markets. Haier, the world's fifth-largest maker of white goods and China's most valuable brand, has a factory in South Carolina employing American workers making refrigerators. One thing is certain, setting up full production facilities in the US is not a move designed to lower costs. S&P's Lee believes that Haier set up production in such a high-cost location like South Carolina to gain the political prestige back home of having firstworld facilities and to reduce pressure from tariffs and trade protectionism."
Companies like Haier who set up production facilities overseas do so for the same reason that Japanese companies did in the 1980s – to get around customs duties and for tax reasons," said PwC's Ho. By acquiring or establishing subsidiaries in overseas markets Chinese companies can channel profits to lower tax jurisdictions, creating tax efficiency and converting RMB in to freely convertible currencies.
Because of the stringent controls on RMB convertibility, Chinese companies looking to invest offshore must apply to SAFE. At present, the approval is very easy to get. "The government wants to use offshore investment as a way of reducing the foreign reserves," said Shao.
From a macroeconomic perspective the government is encouraging overseas investment as one way of reducing the country's ballooning foreign currency reserves which put increasing pressure on China's RMB to revalue. When companies buy factories or other assets abroad they generally pay for it with US dollars, which ultimately come from the country's foreign exchange stockpile.
"If you want my opinion as to whether the offshore investment trend will have an impact on the level of foreign reserves, then I think the answer is no because the forces driving the buildup are much, much stronger," said Kroeber. Despite the jump in the number of offshore acquisitions and mergers the amounts involved are still too small to have an effect on China's reserves, which actually grew by a year-on-year 50% to US$401 billion at the end of October 2003.
Razor thin profits
From the perspective of Chinese companies there is ample motivation to expand overseas. As markets have been deregulated, competition has heated up in many sectors to the point where slim and vanishing profit margins and oversupply are constant features of the economic landscape. The government released figures at the end of 2003 that showed supply exceeds demand for 78.8% of China's main indicator commodities. Add to that the fact that procedures for bankruptcy are primitive at best and it is clear that many large companies are heading abroad out of desperation rather than as the result of solid growth plans.
The telecommunications sector is one area seriously affected by competition and oversupply and French-owned credit rating agency Fitch Ratings expects Chinese telecommunications operators to lead a trend of mergers and acquisitions in the Asian region in 2004.
In March 2003, China Network Communications Group led a consortium to buy bankrupt Asia Global Crossing for US$120 million, making it the only mainland Chinese operator so far to buy a telecommunications asset in the region.
In August, China Unicom indicated it hoped to explore investments in India, Indonesia and Vietnam, while fixed-line giant China Telecom is interested in acquiring Indonesia's Excelcomindo Pratama.
Some telecom companies are looking beyond Asia and thinking global. Huawei, China's largest networking equipment maker, joined with US corporation 3Com in November in a global JV deal designed to leverage cheap labor costs in China.
The company, which reported an 81% jump in overseas sales to US$1 billion for 2003, has been sued by Cisco over intellectual property infringements and 3Com has seen falling sales for 17 consecutive quarters.
Cisco commanded a 60% share of the US$1.6 billion market in China last year and it is largely this encroachment on the home front that has forced Huawei to form the new alliance in hopes of challenging Cisco's dominance.
It is still early days for Chinese offshore investment and as China's economy continues to expand rapidly competitive friction will no doubt increase. Regulatory controls on outward investment will remain in place for the foreseeable future but as the door opens for more companies to invest offshore the trend can really only go in one direction.
SASAC will definitely get its 50 members on to the Fortune 500 list – the question is how long it will take and when China will come up with a source of international competitiveness that goes beyond lower labor costs.
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