Amid the most severe crisis on Wall Street in more than half a century, the Bank of China announced on September 18 that it will take a 20% stake in La Compagnie Financière Edmond de Rothschild of France, a family-held wealth management and banking business. This €236.3 million (US$341 million) investment — representing the first large-scale move by a Chinese bank into Europe — was big news on its own. But it also was the latest example in a huge wave of investment by Chinese enterprises in foreign-based firms.
In the first six months of 2008 alone, Chinese outbound M&A reached US$32 billion in 102 deals. The numbers eclipse the entire year of 2007 (US$26 billion from 166 transactions) and dwarfs preceding years by a significant magnitude. As of mid-2008, China’s total cumulative outbound investment approaches US$150 billion, and the rate of growth is unlikely to slow in the near to medium term.
Chinese companies have many reasons for undertaking cross-border deals. Some of the most common motivations include gaining access to resources, brand building and strategic rationale. Recent cross-border deals outside of the resources arena have also stemmed from Chinese firms wanting to move up the value chain or marching into international markets to serve their clients who are already outside of China. For example, Lenovo’s acquisition of IBM’s laptop business allowed it to gain access to global branding and distribution. Still other Chinese companies have made acquisitions in order to enhance their operations, with such notable examples as Chinese car manufacturers acquiring U.S. or European auto parts companies and even well-known car brands (such as Rover and MG).
“A growing number of Chinese companies realize that their customers are globalizing and require services overseas,” notes Raphael (Raffi) Amit, professor of management and academic director of The Wharton Global Family Alliance. “In order to remain competitive and hold on to their customers, these companies must establish a global footprint. Consider, for example, the issues faced by a leading IT services company based in mainland China whose customers include financial institutions that are establishing a global network of branches…. The IT services company is following its clients and through M&A activity will be establishing its capacity to service the financial institutions and remain competitive. This example illustrates the foresight and strategic thinking of senior managers of leading Chinese companies who are, in many cases, learning how to operate outside of China. In my view, we are at the beginning of a globalization trend of Chinese enterprises.”
So far, most of the cross-border deals have involved large, publicly traded Chinese firms that used to be state-owned enterprises. For most of these companies, the Chinese government is still a substantially large shareholder (in some cases up to 70-80%). “Because of these companies’ critical mass, and given that they enjoy government policy directives and support, it is logical that they have been on the forefront of China’s globalization efforts,” says Erik Bethel, vice president of Shanghai-based merchant bank ChinaVest.
Fighting for Resources
The bulk of China’s outbound M&A activity is in natural resources, whether in Australia, Africa or Latin America. Chinese acquirers have been especially active in offshore mining, with some US$16 billion worth of transactions in the first half of 2008 alone. Behind this activity lie a few simple facts: China has 20% of the world’s population, a meteoric growth rate, and yet relatively few natural resources. “This trend,” according to Rajith Sebastian, a South African native and an investment manager at ChinaVest, “is not likely to dissipate in the near future. It’s the story of the world’s fastest-growing consumer market meeting the world’s largest untapped commodity reserves.”
China’s current nominal GDP per capita stands at around US$2,500, according to the IMF (International Monetary Fund). If the country is to continue developing at the same speed as in recent years, China’s imports of iron ore, copper and aluminum will need to increase astronomically. Meanwhile, with increased spending power, Chinese consumers will acquire more automobiles, electronic goods, home appliances and other products. At the same time, the Chinese government will continue to invest in infrastructure and build schools, roads and power plants. These massive socioeconomic changes require resources that China does not have in great abundance. Clem Sunter, a noted South African futurologist and Head of the Anglo American Chairman’s Fund, notes: “The game is simple but unprecedented. Whereas Britain put 30 to 40 million people through an industrial revolution in the mid-to-late 19th Century and had the colonies to draw its raw materials from; whereas America put 150 million people through an industrial revolution at the turn of the 20th Century and had its own raw materials; China is putting 1.3 billion people through an industrial revolution with neither colonies nor substantial indigenous resources besides coal.”
Over the past few years, Chinese companies have launched an unparalleled assault on natural resource firms across the globe. In Latin America, Peru Copper was acquired for US$800 million. In Australia, the list includes Midwest, Murchison Metals, Gindalbie Metals and Australian Resources. This year, China even went into Afghanistan, spending roughly US$4 billion on the Anyak copper mine — the largest single investment in the history of that country.
In large part due to the US$14 billion equity purchase of mining giant Rio Tinto, the UK (Rio Tinto’s headquarters) has been the most targeted destination country by Chinese acquirers so far this year. Singapore was second, with US$3.6 billion in several energy-related deals. The most acquisitive company in recent years has been Chinalco (China Aluminum Corp), but almost any of China’s resource firms are potential M&A acquirers, including Petrochina, Baosteel, China National Petroleum Corporation (CNOOC) and China Minmetals, which mines and trades metals. Minmetals already has a copper exploration division in Chile — part of a venture with Chilean mining giant Codelco. Minmetals entered the Fortune 500 this year at #435, with sales of US$17 billion. Agricultural firms are not far behind. COFCO, China’s leading grain, oils and food company, acquired a 5% stake in Smithfield Foods Inc., the largest pork processor in the United States in July 2008, right after Beijing relaxed its limit on the agricultural investment abroad. COFCO is #405 on the Fortune 500 list, with sales of US$18 billion.
While Chinese resource companies often have government-backed mandates for going overseas, evidence suggests that once an overseas M&A deal is completed, profit trumps national strategy. For example, about two thirds of the oil from China’s overseas assets does not get sent back to China. Instead, it is sold in the global marketplace at spot prices. Gasoline prices in China are capped, therefore oil refineries in China (unless heavily subsidized by the government) operate at a loss.
Tables Turn in Financial Sector
Not long ago, Chinese banks were investment targets for foreign acquirers. Today, they are buyers. This shift came about as Chinese banks cleaned up their balance sheets, took on foreign shareholders and conducted IPOs. Several years ago, Chinese banks had balance sheets with extremely high percentages of non-performing loans (NPLs). These loans have been reduced from roughly 30% of total loans in 2001 to only 7% in 2007. As the NPLs continue to drop, the higher performance has catapulted the four largest Chinese banks to rank among the global top 10 in terms of stock market value. Meanwhile, the insurance industry has undergone a similar transformation, and China’s two largest insurers are also now among the global top 10.
With large amounts of liquidity at their disposal, Chinese financial institutions have been on a buying spree. Some of the more notable acquisitions over the past few years include China’s sovereign wealth fund China Investment Corporation’s (CIC) US$5 billion stake in Morgan Stanley at the end of 2007, a US$3 billion stake in The Blackstone Group, and China Development Bank’s US$3 billion stake in Barclays (which itself was buying up some assets of U.S. financial institutions in wake of the meltdown on Wall Street this month).
“Seeking more than just financial returns, Chinese financial services companies are making global acquisitions with a strategic rationale in mind. These companies hope to learn from their global peers and to gain access to best practices in areas spanning from IT to risk management,” says Bethel of ChinaVest. In addition, owning regional banks, such as Standard Bank in South Africa (ICBC acquired 20% of Standard Bank for US$5 billion), provides access to a strategic client base that China needs — in this case African mining, energy and other resource companies. The ICBC-Standard Bank venture recently spawned an Africa-centric private equity fund which seeks to make investments in regional resources businesses. “The Standard Bank deal was brilliant,” adds Sebastian, “because it provides China with unparalleled relationships in the region.”
With an initial endowment of US$200 billion, CIC is China’s most visible institutional financial investor; however, there are other important entities that have also made significant foreign investments. One of these is SAFE (State Administration of Foreign Exchange), which manages China’s US$1.8 trillion in foreign exchange reserves. For a long time, SAFE invested mainly in U.S. Treasuries; however, it has recently begun to diversify its holdings, partly over concerns that a falling U.S. dollar reduces the purchasing power of its U.S. Treasury holdings. In the first half of 2008, SAFE invested US$2.0 billion for a 1% stake in British Petroleum (BP), acquired a US$2.8 billion (1.6%) stake in French oil giant Total, and invested US$2.5 billion in U.S. private equity firm Texas Pacific Group (TPG).
Risks to Overseas Investments
“Chinese firms are in an interesting situation”, notes Bethel of ChinaVest. “Their increasing wealth means they can afford to make acquisitions, but oftentimes Chinese buyers are regarded with suspicion. After a series of high profile failed attempts (including CNOOC’s failed Unocal bid in 2005), many of China’s state-owned giants have been cautious about being too visible in bidding for American firms. Instead, they are on an acquisition spree in places like Latin America and Africa where there are abundant natural resources and where building roads, bridges and schools helps foster political goodwill.”
But while Chinese firms are aggressive in emerging markets, they seek to maintain a low profile in the developed world. To fly below the radar screen, Chinese enterprises have recently sought to partner with Western firms when bidding for foreign companies. Yet the failure of Chinese telecom infrastructure giant Huawei (who partnered with Boston-based private equity firm Bain Capital) to acquire U.S.-based 3Com has largely discredited this strategy. Although many similarly structured deals are still in the works, a number of others have been dropped. Another approach has been to make minority investments; Chinese state investment funds have bought chunks of Blackstone, Morgan Stanley and Barclays. However, these investments in public companies, particularly with the recent market turmoil, have actually lost money and have caused political fallout in Beijing.
One of the greatest barriers to the globalization efforts of Chinese companies is a dearth of employees with the right experience. Lacking human resources with the proper knowledge of international economic environments, Chinese companies face difficulties both negotiating deals and operating their overseas acquisitions. As Wharton’s Professor Raphael Amit notes, “There are of course numerous challenges that globalizing companies are facing. These include the managerial and organizational challenges of running an international company. In addition to the need to overcome language and cultural barriers, senior management needs to develop its capacity to manage and control global operations. There are also the challenges of doing business in foreign counties with different norms, different laws and regulations, pay scales for employees, and more.”
Moreover, Professor Amit says, “creating an organization that functions effectively and seamlessly and is able to deliver the same quality of service or product around the world is another big challenge that needs to be overcome. In addition, the need to create a state-of-the-art financial management and control system that enables corporate headquarters to effectively manage the finances of the firm is critical to the success of a globalizing company. I believe that with some coaching and learning many Chinese companies will be able to overcome these challenges and be very successful in their attempt to globalize.”
Despite these challenges, Chinese outbound M&A is likely to grow. Given a backdrop of large domestic savings and huge foreign currency reserves, Chinese companies have great potential to reach beyond their home market. As more companies succeed internationally, others will follow. In recent interviews conducted by Business Week with executives at 39 Chinese companies, nearly 80% cited globalization as a strategic priority. Having already witnessed the massive influx of foreign firms into China, Chinese companies searching for raw materials, talented employees, technologies, brands or customers are themselves now looking to become multinationals.