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Chinese Whispers

What lies beneath the increasing Chinese interest in mergers & acquisitions, and is it opportunity or threat?


Geopolitics, oil, national debt and national security: never the best mix for business. This heady cocktail was 'forced' down North American throats earlier this summer, when the China National Offshore Oil Corporation (CNOOC) tried to take over Unocal.

The $18.5 billion takeover bid for the US's eighth largest oil and gas producer may have stalled, after Congress drafted a law to study the deal, but the storm it left in its wake has yet to fully die down. Some American commentators saw this as a new form of "unrestricted warfare" between the USA and the emerging power of its Chinese rival.

Mainland China's top companies are becoming increasingly ambitious and aggressive in their pursuit of foreign assets. Their competitiveness has been boosted by ready access to (effectively free) state cash and all those dollars accruing from burgeoning exports. Add to this all that US government debt held in Chinese hands and you can see why some politicians get nervous.

In May this year, computer maker Lenovo completed its $1.75 billion acquisition of IBM's personal-computer operations. The success of Lenovo – formed by 11 researchers in 1984 – in acquiring the IBM PC business was likened to a snake swallowing an elephant. In June, Haier, China's leading white-goods maker, launched a $1.3 billion cash offer for Maytag, an ailing American rival, trumping Ripplewood, a private-equity firm. The bid ultimately failed, but sent ripples of tension through the States.

Western firms have long been entering China, drawn to the consuming potential of a massive 1.3 billion population, an emerging economy and a cheap labour force. Joint ventures have become almost commonplace. Yet Chinese corporations have been reaching outwards too, and not just towards North America.

In 2003 French electronics maker Thomson SA and China’s TCL International Holdings combined their TV and DVD businesses to create the world’s biggest television maker. The business later became fully owned by the Chinese. Last year, TCL also acquired the PDA business of French manufacturer Alcatel.

Then, of course, there were the shenanigans surrounding the collapse and possible purchase of Rover by Shanghai Automotive, then Nanjing Automobile. But Chinese firms have been looking further afield than Europe and North America: witness the pursuit of oil concessions in Central Asia, Latin America or Africa; or other examples, such as the heavy investment by China Travel Service, China's largest tourism operator, into the Thailand Priviledge Card (TPC) Company, showing Thailand's ever-increasing popularity with Chinese tourists.

Some, such as Canonbury Group's president, Philip Malmgren, have written warnings about this trend: "Do you believe that the best business managers in the world are the Communist leaders of China? Most investors seem to think so. Who really makes the decision to invest when Chinese state-owned or state-backed firms start to engage in foreign deals or make acquisitions of a foreign company? That would be the Politburo."

The position of the Chinese government in all this – it effectively owns many enterprises – clearly does cause some nerves. But a few still dispute the notion of a trend in all this, such as Chris Devonshire-Ellis, senior partner at Dezan Shira & Associates: "Contrary to popular media reports, China is not going through a major boom in international M&A activity. Acquisitions that are taking place - or not in the case of Unocal - are largely strategic plays funded by the central Government and mainly energy-related. It is important when it comes to China that businessmen do not get carried away - there is a fundamental difference between Government-backed investments in any country and those lead by the private sector."

Philip Isherwood, economic strategist with Dresdner Kleinwort Wasserstein, believes: "The most obvious comment is that Chinese companies are increasing their share of global M&A by number of deals [but] China has a domestic bias to its M&A, with an above average number and value of deals done within its own borders."

Ambrose Lam, chairman of Access Capital in Hong Kong, thinks that the trend for foreign M&As is increasing: "Absolutely. China has been very successful as the workshop of the world for the last 10-15 years. We need to move up the value chain now. The quickest way to do that is to acquire – brands, etc – than to build from scratch. Having a brand is very likely to increase the value of your product, though the efforts here are probably overshadowed by the mega deals such as the Lenovo/IBM and the Haier/Maytag type of deals."

For Simon Perry, senior transaction advisory services partner at Ernst & Young, this is a "growing trend but not a massive wave. It's being driven by a need for better control of resources and security of supply. There's a desire to acquire intellectual property, too. But you have to remember there's still an enormous potential for Chinese companies within China itself."

Ambrose Lam agrees. "We are seeing the momentum of deals coming from two areas. Firstly, the acquisition of resources/energy or commodities businesses to support the huge growth of the Chinese economies. Secondly, as Chinese companies mature to move up the value chain, they are hungry for upstream acquisitions which can enhance their profit margins and improve their knowledge base. We expect to see Chinese companies acquire Western consumer brands (in consumer electronics, white goods, automotives) where there is clear potential of capturing higher profit margin through brand ownership, and also to market these brands to the growing consumer market in China – probably shifting the manufacturing aspects of these acquisitions into China, thus extracting further profit in the process."

"Chinese companies are looking to acquisitions as a way to capture global brands and international distribution networks," says Gavin Geminder, partner at KPMG Corporate Finance in Hong Kong. "Since China was opened up to foreign investment many domestic companies have been bought by overseas bidders and inbound activity is set to continue. But Chinese companies are now fighting back and becoming more active acquirors abroad.

"However, the jury is out as to whether this is the best strategy. Are they paying too high a price to secure intangibles such as established brand names? For example, was the IBM deal good value for Lenovo? It may be too early to tell but the market share for the IBM division is declining."

It's only in the last couple of years that intermediate and larger Chinese corporations started requesting information on public equity markets, says Alex Tamlyn, head of corporate finance, DLA Piper, and that "this surprised me."

"What we see is that they're moving very cautiously, spending their cash wisely," thinks Guy Facey, head of Corporate and International Department at London-based KSB Law and member of international legal network Consulegis. "The Chinese will make mistakes in M&As, but the situation has some similarities to what Japan and Japanese companies went through in the 1970s." He adds that the botched Rover deal, with all its tooing and frowing, speaks volumes about cross-cultural issues that still need to be resolved in any future deals.

Should we welcome or be afraid of these changes? "I don't think anyone should be afraid of Chinese companies looking at opportunities around the world," says Gavin Geminder. "They have broad aspirations: it's part of globalisation. But clearly right now the majority of Chinese companies are very inward-looking and investing inwardly." KPMG is dealing with 90-95 percent inward investment into China right now.

Another issue holding back Chinese corporations in foreign expansion is their lack of western-experienced managers – those who hop onto planes and are used to dealing with different organisations across various territories, according to Tamlyn, who also believed the corporate governance issues caused by Sarbanne-Oxley would give pause for thought.

Overcoming these cultural issues and differences in management style, understanding of compliance, even understanding of the various foreign markets to raise capital, will be crucial. "One needs to bear in mind that China is still very much a closed economy and that offshore funds may not be readily available for acquisition, and if they do, probably Chinese government approval is required. It is therefore important to establish from the outset, the source of funding and what approvals may be required."

"Right now, Chinese companies need good advisers in their overseas acquisition. M&A activities are relatively new to most Chinese companies; hence advisers can really add value to navigate them through the process, especially in structuring and valuation."

Perry doesn't see any negatives in this. "The more links China has, the better. And anyway, just what is a 'British-owned' or 'US-owned' business these days? Today we can see foreign companies in China making money using the country as a high-quality, low-cost manufacturing base," says Perry.

"Sustained economic growth will create a stronger economy with growing domestic demand and the need to access expertise, know-how and raw materials, as well as markets for goods and services outside of China. This represents a real opportunity for advisers. So, over time, will China live up to the hype and will foreign companies make money? The answer to both is: yes."

This article first appeared in Corporate Financer magazine ©2005



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