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China's M&A challenge

(China Daily)
Updated: 2009-07-06 07:56

China's extraordinary economic growth over the past two decades has made it a world power, allowed it to accumulate nearly $2 trillion in foreign exchange reserves and elevated hundreds of millions of its citizens into the middle class.

It has also prompted Chinese businesses to invest in companies overseas, particularly in the natural resources sector where China hopes to secure long-term access to domestically scarce commodities.

However, initial attempts by Chinese industrialists to invest abroad have met with mixed success.

Some market analysts believe Chinese foreign investment efforts are encountering subtle resistance or outright discrimination by overseas governments and businesses.

Others point to Chinese corporations' lack of familiarity with the "rules of the game" in international mergers and acquisitions (M&A) activities.

Are Chinese firms facing a Great Wall of Resistance with overseas investments?

All in all, Chinese companies have completed a broad array of foreign acquisitions in recent years.

The first prominent successful overseas investment by a Chinese company was Lenovo's acquisition of IBM's PC operations for $1.25 billion in December 2004.

Haier, SAIC (Shanghai Automotive Industry Corp), TCL and Huawei, among others, have also made overseas investments or acquisitions without undue opposition.

The most controversial deal was CNOOC's attempt to acquire Unocal in mid-2005. CNOOC's bid ran into a political firestorm when some members of the US Congress voiced concerns that the deal might compromise US national security.

Fears that China's State-owned enterprises (SOEs) were attempting to lock up long-term oil supplies to the detriment of US interests also came into play. In the face of vehement opposition, CNOOC withdrew its bid.

In October 2005, another attempt by a Chinese oil company to acquire foreign petroleum resources succeeded when a Canadian court approved a $4.2 billion offer from China National Petroleum Corp to buy PetroKazakhstan, a Canadian oil and natural gas company with key reserves in central Asia.

In February 2009, Chinalco agreed to spend $19 billion to increase its stake in Rio Tinto, the world's third-largest mining company, to as much as 19 percent.

The deal would have made Chinalco Rio Tinto's dominant shareholder with two board seats.

But resurgent commodities prices and the Chinalco bid itself led to a significant rise in Rio Tinto's share price, derailing the bid and enabling the target company to announce last month that it would raise capital from the equity markets, instead.

Before the deal collapsed, Rio Tinto shareholders and Australian government officials complained that the deal would have given the company's largest client, Chinalco, undue influence over pricing of its iron ore assets. In addition, Chinalco was forced to deny charges that it was acting on behalf of the Chinese government.

Later this year, MinMetals offered $1.7 billion for Oz Minerals. The Australian government initially blocked the bid, citing a key asset located in a military zone.

However, a restructured $1.4 billion bid excluding the sensitive asset was submitted by MinMetals and approved by shareholders in a proxy vote on June 11.

The successful Chinese acquisitions of Lenovo, Oz, and PetroKazakhstan show that large-scale purchases of foreign businesses and assets can be completed, even when sensitive resources are involved, if Chinese companies learn the "rules of the game" and play by them diligently.

Chinese companies must first enlist local emissaries to build support for their deals. They must develop strategies anticipating possible alternative outcomes and lay the groundwork for appropriately influencing public shareholders of target companies and local regulators.

Related readings:  How far will China's expansion bids go Time for investment overseas  Rio Tinto-Chinalco $19.5B deal foiled  Firms in fight to shake off 'China Inc' image

In CNOOC's attempt to acquire Unocal, an effective public relations strategy might have given CNOOC time to structure a deal more palatable to US legislators and Unocal's board.

Chinese bidders also need to learn from their failures and profit by them, rather than accept simplistic post-mortems blaming them on anti-Chinese discrimination.

For example, when restructuring its bid for Oz Minerals to accommodate local concerns this year, MinMetals seemed to have learned a lesson from its unsuccessful attempt to acquire Noranda Metals of Canada in 2006. That was a deal that had foundered, in part, over similar Canadian national security concerns.

Simply submitting the highest bid for a company will not always be sufficient to seal a deal, particularly if investors believe that government ownership is permitting a bidder to offer a premium price in order to secure captive supply sources.

To overcome such resistance, SOEs will need to better publicly define their operating independence from the government and more clearly promote the economic benefits of proposed mergers to shareholders of target companies.

The Chinese government can help pave the way for a better reception for Chinese acquirers overseas through inter-governmental discussions on the concept of a "level playing field" in global M & A.

China could make clear that its continued investments in US government debt merit Obama administration support for direct Chinese investments in the United States in areas not impinging on US military security.

Chinese companies also need to work on their reputations in overseas markets. In countries where they have made acquisitions, Chinese SOEs are often regarded as non-adaptive employers who import Chinese workers rather than integrate themselves into local communities.

However, if Chinese companies want to be welcomed as buyers, they will need to figure out how to better fit into those environments.

If China expects its companies to be treated equitably when they invest abroad, it will need to insure evenhanded treatment of foreign enterprises seeking to invest in China.

In the long run, economic value generally trumps politics in M&A, especially when transactions are handled optimally.

The author is the founder and principal of Balaban Associates, a China-focused strategic advisory firm based in New York City. The views expressed here are his own.