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China’s globalization efforts move full steam ahead

by CKGSB Knowledge

February 27, 2011

While throngs of Chinese shoppers are buying up Louis Vuitton bags, iPhones and Rolex watches as fast as they can get their hands on them, more Chinese firms abundant with capital are also rapidly buying foreign companies amid the stagnating US and European economies.

This trend shows no signs of slowing down.

State-controlled energy giants have been the most prolific buyers of oil and gas companies and oil fields internationally, spurred by a government policy designed to secure resources in order to fuel the country’s economic boom.

Sinopec Group, Asia’s biggest oil refinery, successfully acquired Occidental Petroleum Corp’s Argentine oil and gas unit for $2.45 billion in February and the Chinese chemical conglomerate Sinochem Group paid $3.07 billion in April to Statoil ASA to acquire a 40 percent stake of its Peregrino field offshore of Brazil. Both of these acquisitions are clear signs of China’s growing appetite for energy assets, which shows no signs of easing in its intensity.

China’s Haier Corporation signed a final agreement on 18th October 2011 to acquire Panasonic Corp’s Sanyo Electric washing machine and refrigerator units in Japan and Southeast Asia for about $130 million, which gives the Chinese appliance giant better access to the world’s third-largest economy.

Within the finance sector, the Industrial and Commercial Bank of China Ltd., agreed in August to buy assets in Argentina for $600 million, and China Construction Bank Corp. has been negotiating terms to buy a small Brazilian lender.

“Many companies are trying to seize the opportunity to obtain cheaper assets partly as a result of the current global market volatility and re-tightening of capital,” said Li Zhongming, a researcher with the Institute of World Economics & Politics at the China Academy of Social Sciences.

Zhang Zhihao, CEO of Halter Financial Group (China), a leading consulting firm specializing in assisting companies in going public through the reverse merger process, agrees with Li Zhongming’s assessment.

“It’s the perfect timing, even better than the golden period in the 1980s when dozens of Japanese enterprises purchased US companies,” he said.

China became the world’s fifth-largest international investor last year as its overall overseas acquisitions totaled $87.7 billion from 2004 to 2010, according to the country’s National Development and Reform Commission.

Companies in Zhejiang Province, the home base for thousands of Chinese private entrepreneurs, completed a total of 25 overseas acquisitions for $1.05 billion, a record high since last year, according to the figures provided by the Zhejiang Commerce Bureau.

Nationwide, Chinese firms made a staggering 169 overseas acquisitions totaling over $28.5 billion by November of this year, according to Zero2IPO, a leading integrated service provider for the Chinese venture capital and private equity industry.

The Thinking behind the Boom

Overseas investments can be a wise strategy since they often represent short cuts for Chinese companies that can barely afford sustained investments for gradual expansion over a long period of time, says Teng Bingsheng, associate dean and associate professor of strategic management at the Beijing-based Cheung Kong Graduate School of Business (CKGSB).

“By acquiring a high-end foreign brand name, piece of technology, or distribution channel, a Chinese company gains an immediate leg up on its competitors both domestically and internationally – exactly the type of advantage that would likely not be gained without global acquisitions, and would be too difficult and time-consuming for any advantages to develop on their own initiative,” Teng explains.

He puts the Chinese overseas investments into three major categories: acquisitions of natural resources companies such as mining operations or oil suppliers; value-based transactions; and growth-based investments.

“As the country’s industrial conglomerates started to realize their growing weakness regarding iron ore price negotiations and similar dealings, the number of acquisitions of this type started to noticeably increase,” Teng stated.

Chinese buyers planning overseas acquisitions in the mining and metals sector will have even more opportunities as prices and valuations have been declining steadily since early October of this year, according to the November report released by the accounting firm Ernst & Young.

“When a Chinese company buys or invests in a foreign company for the purpose of gaining access to its technology or brand name, the purchasers are usually looking to acquire something of current and intrinsic value from the sellers,” Teng explains.

However, few Chinese buyers would look at a company’s future growth potential, mainly because the buyers “lack both the money and the international expertise to successfully engage in growth-based acquisitions,” Teng concludes.

“Most Chinese companies have become especially adept at singling out the high-valued assets of the parent companies that have run into trouble,” he said.

An example of this is the $1.3 billion acquisition deal of the Swedish carmaker Volvo by Hangzhou-based Geely Automobile Co. The deal was a clear bargain for the company’s use of the Volvo brand, its technology and its distribution channels.

Teng expects similar deals to predominate until the Chinese economy becomes more globalized.

Fishing for Trouble Unintentionally

However, overseas acquisitions can be fraught with difficulties, and sometimes, unforeseen dangers, insiders say.

Sunny Chow, risk services manager for Ernst & Young in China, warned that even though the current global economic slowdown could result in lower prices for overseas acquisitions, Chinese companies should be “cautious in making overseas investments and examine the feasibility of any desired company on a case by case basis before making a move.”

As an example, China Investment Corporation has already lost a substantial $3 billion after investing in Blackstone Group and Morgan Stanley, according to Accenture, a global management consulting, technology services and outsourcing company.

The new capabilities were not developed within the company but were acquired externally, said Teng, comparing the process to an organ transplant.

“Just like with the case with surgery, if the procedure is done neatly and solves the ‘patient’s’ most urgent needs, the procedure is not finished when the acquisition target is in place,” Teng said. “Great care must be taken while integrating the new purchase into the acquiring company, to avoid provoking an adverse reaction to the “alien tissue” that can end up being damaging or even fatal.”

“Some Chinese companies have bought ‘shells’,” remarked Barter Woo, executive chairman of the US-China Economic & Trade Promotion Association, indicating that the companies found themselves in an undesirable position where they paid the overhead costs of the acquired company including payroll expenses without gaining the benefits of its core technologies.

“Many firms have no clear development strategy and are expanding without a clear focus, which can bring sizable risks in the future,” said Liu Wenbing, deputy director of the reform office of the State-owned Assets Supervision and Administration Commission.

“To succeed in the long run, Chinese corporate leaders must completely abandon these attitudes,” Teng suggested.

Chinese CEOs are also aware of the risks of overseas acquisitions.

“It’s not only a matter of money, but also political, legal, cultural and market uncertainties that must be taken into account,” said Jack Ma, founder of Alibaba Group that is seeking up to $4 billion in debt financing, for a deal expected to help the Chinese e-commerce giant buy back a 40 percent stake in the company owned by Yahoo Inc.

“Chinese firms should patiently and cautiously conduct thorough research, crisis appraisals and follow-up strategies before considering acquiring a foreign company,” said Yang Yuanqing, CEO of Lenovo Group that bought IBM in 2006. “It’s not a showcase, but a bloody war.”

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