Closer Ties for China and Russia

Trade links between China and Russia are set to increase along with cross-border M&A activity, delegates at a Eurasian energy conference indicate

It's no secret that China needs energy and natural resources to sustain its industrialisation and urbanisation path, nor that it has to look for them abroad. For security reasons it makes sense for the country to diversify its sources, and there is plenty of evidence that it has been actively doing so for several years by forging ties in Africa, Asia, Latin America and Europe.

But more than that, China is looking for non-traditional export markets, as it moves up the value chain by seeking next generation technologies in advanced manufacturing, electronics and aerospace.

At the Eurasian Energy Summit held at Hong Kong's Le Meridien Cyberport hotel on December 12, delegates from China and Russia/CIS, including a large representation from energy companies, discussed the potential for extending links between the two vast, emerging regions.

After two decades of rapid export-led economic growth, China has established a leading position in manufacturing and low-level technologies, and now has a corporate sector with experience in accessing global markets for both capital and goods. It also has a large and growing domestic consumer sector.

Chinese exports to Russia have risen from just $2.7 billion in 2001 to $28.5 billion in 2007—although as a percentage of its total exports, the increase from 1.4% to 2.4% is perhaps less impressive. Textiles, machinery and electrical equipment make up 55% of those exports, with the rest ranging from umbrellas to transportation equipment.

But, in terms of absolute value, China's import bill owed to Russia dwarfs its export receipts. Even in 2001, it was buying goods worth about $79 billion from its western neighbour, and last year it paid $196 billion for imports, more than half of which were made up, unsurprisingly, of minerals. Other significant goods included base metals, wood, chemicals and animal products. As a proportion of total imports, however, Russia's share fell from 3.4% to 2%.

Possibly, the greatest potential lies in corporate mergers and takeovers. China's share in the global M&A market is growing. Last year, the country's enterprises participated in deals worth nearly $4.5 trillion or 9% of the world's M&A value, according to data-provider Dealogic. This compares with a share of just over 2% worth $1.23 trillion in 2002.

Cross-border activity is also increasing rapidly. Between 2002 and 2007, deal value has shown a compound annual growth rate (CAGR) of 47%. But Sino-Russian tie-ups barely register. In terms of deal size, 2006 has been the peak year so far with seven deals valued at $6.23 billion. Cross-border deals between Chinese and Russian companies are also lopsided. Since 2006, 79% of transactions by value have been Chinese companies buying Russian or CIS firms. And the industry focus of M&A deals has been overwhelmingly in the oil and gas sector, which make up nearly 77% of all transactions.

According to Stephen Cao, executive director in the investment banking department at China International Capital Corporation (CICC), Chinese enterprises have quite a clear wish-list. In the oil and gas sector, they want overseas partners who can provide access to probable reserves of more than 100 million barrels of oil equivalent per field, are already in or close to production, and can offer participation rights in operations and management.

Deals which have already met these criteria include CNPC's $4.2 billion acquisition of PetroKazakhstan in August 2005 and Sinopec's purchase of Udmurtneft OAO for $3.7 billion in June 2006.

In the mining and metals sector, the preference is for companies with a market capitalisation or potential deal value of more than $500 million, and a leading franchise in aluminium, coal, copper, gold or nickel. Cao points to Aluminum Corporation of China's joint purchase with Alcoa of a 12% stake in Rio Tinto for $14 billion in February this year as an example. Another requirement is a skilful and experienced management team.

But China's acquisitive ambitions extend beyond the primary sector. The country's firms are also looking at opportunities among financial groups and in technology, using traditional assessment measures such as market position, track record, asset quality, profitability and growth potential. Again, a controlling stake is the usual objective, or at least significant operational participation. Cao names China Mobile's purchase of Pakistan's Paktel at an enterprise value of $500 million in May 2007, and China Merchants Bank's acquisition of Hong Kong's Wing Lung Bank for $4.65 billion earlier this year, as two examples.

But there have also been notable transactions where the buyer has been a Russian or CIS firm. In 2007, Eurasian Natural Resources Corp paid $1.3 billion for a 49% stake in Jiuquan Iron & Steel, and in February this year, Evraz Group bought the whole of steel products maker Delong Holdings for $1.6 billion.

Of course, any Sino-Russian corporate tie-up faces challenges. Political issues will always intrude, differences in legal and regulatory regimes, which in both countries are considered to be opaque and often capricious, need to be tackled, and less tangible issues such as business practices and culture have to be resolved, particularly with regard to the sharing of operational and managerial control, and post-transaction integration and cooperation. Or, put more simply, the parties need to trust each other and be prepared to work together.

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