June 19,2009

China's Global Buying Spree - Risky Business

By CT Johnson

In recent months a little-known Sichuan heavy-machinery firm bought one of America’s best-known automobile brands.  China Investment Corp. (CIC) doubled its stake in Morgan Stanley and announced plans to expand its staff globally to support its growing international portfolio.  China Minmetals beat out Australia’s Macquarie Bank to buy OZ Minerals for $1.4 billion.  Aluminum Corporation of China (Chinalco) made an audacious bid to increase its share in Rio Tinto, another Australian mining concern.  Since January, China’s largest companies have plunged into the global M&A market, seizing opportunities created by the worldwide economic downturn.  The world’s bankers and dealmakers are abuzz with speculation about the emerging economic dominance of China on the world M&A stage.

Until recently, Chinese companies have been extremely reserved in their overseas investment strategy, focusing instead on internal projects and domestic acquisition targets.  A number of failed high-profile international transactions, including the disastrous performance of China’s $3 billion investment in the private equity firm Blackstone (with  an 83% decline in value between mid-2007 and early-2009) and China National Offshore Oil Company’s (CNOOC) unsuccessful $18 billion bid for American oil company Unocal, seemed to dampen China’s enthusiasm for foreign investments.  Even Lenovo’s dramatic turn-around of IBM’s personal computer business has been tarnished by recent losses. 

Now such cautionary tales are being set aside as Chinese firms move aggressively to purchase foreign brands, technology and resources.  Today, China is less focused on Deng Xiaoping’s famous dictum to, "never take the lead" than on the second half of the same quote, "aim to do something big." 

China’s government has done much to facilitate this transformation.  In December of last year, the central government changed financial regulations to allow banks to lend money for acquisitions, a practice that had hitherto been forbidden.  In March, the Ministry of Commerce relaxed its rules for approving overseas acquisitions, delegating approval for deals under $100 million to the provincial governments.  The government even launched a public relations campaign to encourage companies to make overseas acquisitions and "go global."  These policy changes have appreciably simplified the process for Chinese firms to engage in cross-border M&A deals.

All this is a dramatic change from China’s previous strategy of sticking to its own knitting.  Sichuan Tengzhong Heavy Industrial Machinery (Tengzhong), the company that bought Hummer, was virtually unknown outside the country before announcing its deal with GM and appears to have no experience in car manufacturing or cross-border transactions.  While the latest moves by Chinalco and Minmetals are in keeping with China’s quest for the resources needed to fuel its 8% annual growth rate, the scale of these investments is surprising; Chinalco’s $19.5 billion bid for Rio would have been the largest acquisition in China’s history if it had gone through. 

China is also displaying greater tenacity in its hunt for overseas assets.  Whereas CNOOC’s 2005 withdrawal from the Unocal deal was followed by a three year stretch of inactivity, less than a week passed between the failure of Chinalco’s bid for Rio and Minmetal’s consummation of the OZ deal.  Nor has Chinalco’s setback done nothing to slow Sinopec’s $8 billion pursuit of Addax Petroleum.  Or the Industrial and Commercial Bank of China’s (ICBC) $73 million acquisition of the Canadian arm of Bank of East Asia.  Or CIC’s $400 million investment in Australia’s Goodman Group.  Or a dozen other deals being mooted between Chinese buyers and Western targets.

With so many high-profile deals on the table, many in both China and the West have questioned whether China has the marketing and management talent to make these acquisitions work.  China’s record on this topic is mixed.

Despite its troubles, Lenovo is widely seen as a success story.  After acquiring the troubled personal computer business from IBM for $1.7 billion in 2004, by 2008 Chinese managers had transformed the struggling brand from a $3 billion loss-making enterprise into a profitable $17 billion business.  The computer maker’s recent decline in fortunes ?it announced a $264 million loss and the elimination of 2,500 jobs in its most recent quarterly report - is less a function of bad Chinese management than of declines in the PC market that followed from the economic crisis. 

On the other hand, CIC’s performance in managing its Blackstone investment is hard to justify as anything other than incompetence on the part of CIC investment managers.

A fact that has been widely overlooked in this discussion is China’s amazing success in managing domestic companies, sometimes in the face of tremendous adversity.  In 1999, ICBC’s nonperforming loan ratio was 47.5% and the bank was widely written off as bankrupt.  Today, ICBC is the world’s largest and most profitable bank, with total assets of more than $1.4 trillion.  Tengzhong, widely criticized in the Chinese and American press for buying Hummer despite its lack of automotive experience, has made several successful domestic acquisitions since its inception in 2005.  Long-time China-watcher Jack Perkowski argues that Tengzhong’s move was shrewd ?the company has already announced plans for a fuel efficient model based on Hummer’s existing engine technology and, even if such development proves difficult, a cheaper, China-manufactured all-terrain passenger vehicle may be just what brand-conscious Chinese consumers want for tackling poor Chinese roads.

All of which points to an uncertain future for China’s latest acquisitions.  What remains to be seen is whether China can translate its genius for operating domestic companies into a successful, large-scale cross-border management strategy.  For better or worse, the current rash of purchases will give Chinese managers many opportunities to make that leap.

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