Going overseas is key for development

China has entered new phase of outbound investment, says author of KPMG report

Private companies are set to spearhead China's overseas business expansion over the next decade, according to a new report.

While privately-owned enterprises contribute 60 percent to China's GDP, they only account for 14 percent of China's overseas M&A deals, with state-owned enterprises contributing the rest.

But, according to research by international business adviser KPMG in The Dream Goes On: Rethinking China's Globalization, 75 percent of respondents believe they will play an increasing role over the next 5 to 10 years.

Vaughn Barber, head of China Outbound for KPMG based in Beijing and co-author of the report, which will be published in English soon, says many private businesses now see going overseas as a key way of developing their businesses.

"Many of the POEs have reached a stage where ODI is a channel to achieve a transformation in their business.

"They see it as a way of overcoming skills barriers and problems of access to finance that they have in the domestic economy. ODI is also a key route for them to achieve their goals of upgrading."

The increasing dominance of private businesses can be seen in the number of overseas mergers and acquisitions deals they have recently carried out.

Private companies accounted for four out of the top 10 Chinese outbound M&A deals in the first half of this year, compared with just one in the same period of last year.

The largest such deal was, in fact, carried out by a POE - Shuanghui International Holdings proposed acquisition of Smithfield Foods in the US for $4.7 billion (3.5 billion euros) in May.

Other large POE deals in the first half included Sungate Trust's purchase of a 40 percent stake in General Motors building in Fifth Avenue in Manhattan; WSP Holdings', owner of Wuxi Seamless Oil Pipes Company, merger with WSP OCTG Group, again in the US; and China Fishery Group's purchase of Copeinca, the Peruvian fish feed maker.

"Our hypothesis in the report is that ODI is a key way to achieve the transformation of the economy that is mentioned in China's Five-Year Plan (2011-15)," says Barber.

"The Shuanghui deal is in itself evidence of the need and desire to acquire leading brands, experience and technology relating to the production process."

The report highlights that there have been three historic stages of Chinese overseas investment: the first in the 1970s and 1980s focusing on state-owned companies setting up overseas branches, representative offices and foreign trade companies; the second between 1991 and 2003 involving large SOEs setting up overseas purchasing channels and sales networks and now the third, from 2004, with increasingly strong enterprises taking advantage of favorable policies and the rise in the value of the yuan to make overseas acquisitions.

"China has entered a new phase of outbound investment where the amount, structure and quality of Chinese outward direct investment will improve," he says.

Chinese ODI at $84.2 billion in 2012, according to KPMG's own analysis in the report, is now almost a third higher than the $63.7 billion average of G6 nations (the G7 excluding the US).

This has been a remarkable turnaround with the G6 average in 2003 of $29.2 billion being 10 times that of China's $2.9 billion at the time. China's ODI only began to rise above that of the G6 average shortly after the onset of the financial crisis in 2009.

"What we have found out is that China's ODI caught up to the average of the G6 in a very short period of time. There was a massive gap and now its ODI is above the value," Barber says.

Some commentators insist that China's ODI has largely been driven by rising labor costs and the ever increasing value of the yuan which has driven manufacturers to set up bases in Southeast Asia and now also increasingly Africa and Latin America.

The report, which interviewed 159 representatives from Chinese companies as well as 169 from overseas, revealed that this was very far from the real picture.

Only 8.2 percent of the Chinese respondents said it was about reducing costs. Almost a fifth (19.2 percent) said the drive was seeking out new markets, 16.6 percent on building international marketing networks and 15.7 percent about becoming an internationally competitive global company.

"For certain sectors, where labor costs are an important component, you would, however, expect them to transfer some of their production capacity to lower cost centers. If, however, the question is whether they should do that, the answer has to be 'not always'. I think to do it for costs alone is not sustainable," Barber says.

Barber, 42, has had an involvement with China since the age of 12 when he began studying Chinese, leading him to spend a year in China on a scholarship before studying for a commerce degree in Australia.

He came to work for KPMG in Hong Kong in 1996 and moved to Beijing in 2011 with his team because of the need for tax advice on overseas acquisitions in the mainland. The firm advised on nine of the top 20 China overseas deals last year.

Now a partner in the firm, he worked on the China oil giant CNOOC's $15.1 billion takeover of Canadian rival Nexen, the largest Chinese takeover of any foreign business.

Another co-author of the report is Iris Chen, 40, manager of KPMG Global China Practice, who joined from Boston Consulting Group three years ago.

Chen says a number of Chinese POEs are deciding that their best route overseas is to acquire stakes in overseas companies since this often helps them to localize better.

"If you acquire a minority stake and build up confidence you can then acquire more stakes. Even if you acquire a controlling stake you don't necessarily have to bring in Chinese management but set KPI (key performance indicators) for the local management team," she says.

Barber says that establishing joint ventures with overseas companies could be increasingly a way forward for Chinese private businesses.

"It is an emerging paradigm. Developing more cooperative relationships with foreign companies is an evolutionary next step," he says. "Some deals in the past were very high profile and met with great resistance and I think Chinese companies are now learning from that experience."

Chinese POEs still face many challenges in going abroad, according to the report.

Many see it as a high cost endeavor and almost a quarter (23.2 percent) say raising capital and financing is the biggest issue.

Lack of experience (cited by 16.4 percent), absence of long-term strategy (15.9 percent) and fear that their brand is not well known enough for these companies trying to sell their products overseas (10.6 percent) are still major barriers.

Far from being unwelcome, the report found that Chinese companies were welcomed overseas. Of the overseas respondents, 92.2 percent said they brought competition and more choices for consumers with a further 77.2 percent saying they also created more employment opportunities. Only 12.5 percent of those surveyed thought they were a threat.

Nearly nine out of 10 (86.8 percent) said that China now had outstanding global enterprises with the three of the top four best known being private businesses, the telecommunications company Huawei, computer giant Lenovo and electrical goods maker Haier.

Barber says Chinese companies are often looking to acquire technology or brands that can be used to give them a competitive advantage in the domestic market and that their target companies often enter into deals with Chinese companies to also get access to that market.

"One of the motivations for the deals is often to acquire technology or brands that can be used in China and therefore increase their success in the China market," Barber says.

"For some of the deals we have been involved this is very much what the foreign party was looking for as well, getting their products or technology into China."