China Revs Up Its Dealmaking MachineBy and
Triggering BacklashesYet the deals will be no smooth ride for either Chinese acquirers or their targets. Although they are learning fast, the Chinese are not yet pros at M&A, and they often trigger backlashes from investors or voters in the countries where they show up. Plenty of blowups and setbacks are likely. China has many incentives to keep playing the M&A game, however. China's companies are often flush with cash. Loans are not an issue when state-connected enterprises have Beijing's approval to invest overseas. "Most Chinese banks are state-owned, of course," says Zhou Chunsheng, a professor of finance at Cheung Kong Graduate School of Business in Beijing. "So companies find it very easy to raise money to expand their business into other countries." Officials also want to stem the resentment evident in Internet forums and campus seminars against parking most of China's $2.1 trillion in foreign exchange reserves in low-yield, inflation-sensitive U.S. Treasuries. "Why would we want to keep subsidizing irresponsible U.S. behavior that will inflate the dollar and hurt us?" asks Wenran Jiang, a political science professor at the University of Alberta. Better, says Jiang, to purchase companies. Beijing has backed overseas expeditions before. But "there's been a step-up of support since early this year," says Robert L. Kuhn, an American China consultant who knows the senior leadership well. "The support extends all the way to the Politburo." On Mar. 16 the Commerce Ministry announced that, starting in May, only provincial-level approval would be needed for overseas investments below $100 million. After Aug. 1 companies can more easily purchase foreign exchange to fund foreign acquisitions. Regulators "are giving the green light," says Guo Tianyong, a professor at the Central University of Finance & Economics in Beijing. They're prodding companies to act, too. At a July 4 Beijing conference of top politicos, Li Rongrong, the head of the agency responsible for China's top state enterprises, publicly complained that too few companies had reached global scale. "We must encourage our top enterprises to go out and enter overseas markets and expand their business," he told his audience.
Avoiding Too Much CompetitionThe biggest investments have been in natural resources companies that can help slake China's energy thirst. Such deals require precise handling. "To avoid potential political and commercial backlash, Chinese oil and commodity companies often select their targets carefully," says Luke Parker, head of the M&A Service at Edinburgh energy consultants Wood Mackenzie. "The Chinese have tended to favor acquisitions where they are not competing head to head with the majors." Buying Switzerland's Addax Petroleum, for example, gave Sinopec access to Nigerian and Kurdish oil but ruffled few feathers. When the Chinese do stumble, the results are spectacular. The latest example is the planned $19 billion-plus investment by Aluminum Corp. of China (Chinalco) (ACH) in Anglo-Australian miner Rio Tinto (RTP). Rio Tinto needed the cash, but its shareholders questioned the wisdom of selling an 18% stake to Chinalco, one of Rio Tinto's biggest customers. Most politicians openly condemned the transaction. "[China's] state-owned entities are nothing more than an arm of the Communist Party," says Australian Senator Barnaby Joyce. Stung, Rio backed off, opting instead for a $15.2 billion rights issue and a joint venture with BHP Billiton (BHP). Beijing Times was scathing: "Rio Tinto is just like an unfaithful woman. Once she loved the money in Chinalco's pocket, but she actually didn't love the man himself." In July, Beijing authorities arrested a Rio Tinto employee in China on accusations of industrial espionage, leading many to speculate China was retaliating. Some observers wonder how long it will take for the Chinese to get their dealmaking right. "The finance skills at the top of Chinese companies are not likely to be as developed as [at] U.S. or European or even Indian companies," says Anil Gupta, a professor of strategy and organization at the University of Maryland's Smith School of Business. The result, he says, is that the Chinese often overpay or fail to grasp the challenges involved in a takeover.
Skills and KnowhowThe Chinese can also scare potential targets. Take the investments by Chinese manufacturers and retailers. "A number of these transactions are about getting skills and knowhow to use in China," says Matthew Phillips, a partner at the Shanghai office of PricewaterhouseCoopers. That was part of the logic behind Haier's stake in Fisher & Paykel Appliances of New Zealand: The Kiwis can teach the Chinese about design. This logic can backfire, as in the case of Beijing Auto and Germany's Opel. "Beijing Auto looks at Opel and sees this as a game-changer," says Mike Dunne, managing director of J.D. Power & Associates in China (like BusinessWeek, a division of The McGraw-Hill Companies). Opel's skills would give Beijing Auto a critical edge in China's car wars. But the Germans fear the Chinese are interested in Opel only as a technology resource, not as a brand to revive. That's limiting Beijing Auto's chances in the bidding, sources say. Other Chinese missteps include Shanghai Auto's 51% purchase in 2004 of Korea's Ssangyong Motors (which is now bankrupt) and television maker TCL's acquisition of RCA Thomson (generally seen as a failure). The jury is still out on the acquisition of IBM's (IBM) PC business by China's Lenovo. But the Chinese are learning. Analysts think Chinese authorities probably froze a deal for GM's Hummer by construction equipment company Sichuan Tengzhong out of fear the Chinese outfit lacks the expertise to run a U.S. company (the other reason for examining the deal is fear of the Hummer's environmental impact). PwC's Phillips says energy companies "have moved up the learning curve very quickly." Bain's Leung describes how executives from a Chinese consumer-products marketer recently traveled to the U.S. to meet with suppliers, customers, and executives of a target company. The thorough due diligence convinced the Chinese to back out. One area where the Chinese tread softly is in the U.S. They recall the abortive 2005 bid for Unocal by China National Offshore Oil (CEO), which ignited a firestorm in the U.S. Congress. "The Chinese perception is that they are trying to acquire companies using market mechanisms, yet they get caught up with political controversies," says Evan Feigenbaum, an ex-Deputy Assistant Secretary of State under George W. Bush. Still, U.S. concern hasn't held back the Chinese elsewhere. Acquisitions have gone ahead in Australia, including a $1.4 billion takeover bid by China Minmetals for Oz Minerals and a $770 million investment in Fortescue Metals by Hunan Valin Iron & Steel. "It is natural for companies when they grow up to find new opportunities outside," says finance professor Zhou. "There will be more Chinese acquisitions abroad. And the world will get used to it."
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There is no shortage of Asia boosters these days. Minxin Pei is not one of them. In an essay titled "sia' Rise," appearing in the July/August issue of Foreign Policy, the scholar cautions readers not to believe the hype. Pei debunks an assortment of widely parlayed myths, such as that Asia will lead the world in innovation, that its brand of capitalism is more dynamic than the West's, and that the U.S. is losing its influence in the region.
To read Pei's essay, go to http://bx.businessweek.com/china-business/reference/.