China’s outbound investment activity has posted notable growth, and the subject is regularly explored in conferences, government offices and corporate strategy meetings. For 18 months it has been of intense interest to directors of distressed companies around the world.
Building state-owned enterprises (SOEs) into large, globally competitive enterprises was always an integral part of Beijing’s "Go out" campaign. Over the last decade, the buoyancy of domestic stock markets and credit windows at the large state banks provided capital for SOEs to buy commercial assets they had not developed organically. Outbound M&A was the next phase of enterprise reform.
As the program evolved, the State-Owned Assets Supervision and Administration Commission (SASAC) clarified the strategic goals of outbound investment activity to include brands, technology, innovation capability, channels to market, and global management skills.
How can we assess the progress and direction of this campaign?
It is important to recognize two different kinds of outbound initiative. China has a long and largely successful history of outbound investment, but it was almost exclusively to purchase energy and mineral resources. This was and remains a different agenda from the SASAC enterprise reform goals. The principal goal of energy and mineral acquisitions is to bring resources to China, not project local goods, services, or soft power outward.
China bought over US$52 billion worth of assets overseas last year, up considerably on 2007. But 2008 saw the virtual shutdown of the one category of investment that was robust in 2007: financial services. Tempting as the pricing was in the wake of the global crisis, China was not buying.
Between 2003 and 2009, 73% of China’s outbound investment went into energy and minerals. In 2009 alone, that share rose to 94%, a dramatic shrinking of investments primarily supporting the SASAC agenda. The regulator had both encouraged overseas purchases and cautioned the need for governance improvement and improved M&A capability before undertaking it. China’s outbound investment activity seems to be moving away from the cause of enterprise reform.
All categories of outbound investment will grow in China, and many agencies and institutes are contributing information and training on good practices. But given the importance of both kinds of outbound activity to China, it is worth asking: Why are the present flows so unbalanced? And what can be done about it?
Simple and tangible
It’s important to note that energy and mineral asset acquisitions present a very straightforward valuation process. These involve tangible assets. Negotiations are fixed in a simple calculus: reserves multiplied by market price, minus recovery costs. Of course, in reality it is not that easy, but determining a fair value of energy and mineral purchases is simple compared to doing so for intangible assets important for enterprise development, such as brands.
Add to that, non-tangible asset acquisitions present formidable operating challenges that go beyond resource extraction, and overseas operations to develop market presence in foreign countries is an area where even the largest Chinese enterprises lack deep experience. Closely related are the difficulties in post-deal integration that the recent record has made clear.
We can expect three developments in outbound M&A focused on the SASAC reform agenda.
First, large Chinese firms will increasingly cooperate with global strategic and financial partners in acquiring assets. In doing so, they can combine resources for valuation and negotiation and find synergies in post-deal integration. A model for this is Industrial and Commercial Bank of China’s acquisition of a 20% stake in Standard Bank of South Africa.
Secondly, enterprises looking at sizeable non-resource deals will likely become more open to professional outside assistance, from banks, accounting firms, and law firms that can lend assurance to various stages of the process and identify risks.
Finally, there will be more experiments with integrating existing overseas management teams, akin to Lenovo’s purchase of IBM’s PC division, but guided by lessons learned in that case.
China’s outbound campaign will grow, but achieving the balance demanded by the enterprise reform agenda will bring innovations yet to be imagined.