CONTENTS ACKNOWLEDGMENTS 4 EXECUTIVE SUMMARY 5 INTRODUCTION 2 1 THE STATUS OF CHINESE OUTBOUND INVESTMENT 6 1.1 Private Companies Position Within Chinese Outbound Investment 1.2 Taking Control: a Softening Trend 1.3 The Industry Sector Perspective 1.4 The Geographical Perspective 1.5 Observed Key Drivers of Chinese Outbound Investment 1.6 Note on Greenfield Investments 2 POLICIES AND PROCEDURES 19 2.1 The Chinese Perspective 2.2 The Foreign Perspective 2.3 The Financing Aspect 3 OUTBOUND INVESTMENT: FLAWS AND SUCCESSES 23 3.1 A Lack of Proper Information and Concern 3.2 Integration Failures: The Cross-Cultural Issue 3.3 The Specific Environment of Chinese Outbound Investment 3.4 Learning From Certain Companies 4 FUTURE TRENDS & KEY SUCCESS FACTORS 27 4.1 Drivers of the Continuing Increase in Private Outbound Investment from China 4.2 Industries with High Prospects in Private Outbound Investment 4.3 Geographic Aspects of Private Outbound Investment from China 4.4 Key Success Factors to Look For 4.5 Not on Time Frame: Still the Era of Big Groups CONCLUSION 37 APPENDICES 39 REFERENCES 67
EXECUTIVE SUMMARY In 2009, Chinese Outward Foreign Direct Investment (OFDI) amounted to US$56.5 billion. It ranked number five worldwide. This achievement is no less than exceptional in light of the fact that it accounted for less than a tenth of it just five years earlier. While such a development remains essentially the product of the powerful state-owned companies, Chinese private companies have started to contribute significantly if not yet in transaction value, in the number of deals to this trend. The contribution of Chinese private companies to Chinese outbound investment has been very little analysed so far. This report aims at providing a summarized yet complete summary of this development. From a control perspective, private companies generally reproduce the common Chinese strategy of acquiring foreign entities in their totality. However, acquiring minority stakes represents today a third of all their transactions. Most industry sectors are concerned by this new trend, and generally invest in a similar sector to their own. This shows a clear corporate strategy, rather than a simple financial incentive. Furthermore, these companies have several interests: apart from those within the national strategic sectors of energy and raw materials that try to secure access to reserves and get strong incentives from the government itself, Chinese private companies generally invest overseas to acquire either technology, reputation or a distribution network. An additional motivation is the pursuit of low-cost business models by investing in other low-cost areas. Finally, it must be noted that private outbound investment is difficult to quantify. Its Greenfield component is not always taken into account, either because of the level of investment involved or because it does not follow the standard procedure channel. Policies and procedures have evolved over the last few years, yet they remain very bureaucratic. Today, three organisations matter for any Chinese company looking to invest abroad. The National Development and Reform Commission (NDRC) is responsible for approving the project related to the outbound investment. The Ministry of Commerce of China (MOFCOM) is in charge of approving the outbound investment agreement. The State Administration of Foreign Exchange (SAFE) regulates the inflow and outflow of foreign exchange. Depending on the nature of the investment and its amount, local or national branches, as well as the State Council, may have to get involved. But while domestic policies may slow down or jeopardize the investment deal, foreign policies may have a similar impact: some countries remain cautious of Chinese investment and may make a protectionist move, depending on the type of investment. Finally, private companies and especially Small and Medium Enterprises (SME) may face financing issues, limiting their ability to conclude interesting deals. Chinese companies have experienced different outbound investment situations, some of which were good and some of which were bad. A stress can be made on the importance to collect and understand the
maximum information about the business and the social environment of the target company. Crosscultural aspects have been underestimated and have inevitably led to complications. Chinese companies must be aware of the targeted country s sensitivity towards China, as well as of any social resentment that may exist or develop as the country becomes a major powerhouse in the global economy. Finally, the talent level of the management team is a strong indicator of the readiness of Chinese private companies to invest abroad. The future of Chinese private companies is bright. The current drivers of Chinese private outbound investment are likely to remain: an aggressive national energy and raw material strategy, the need for topedge technology, the attraction to worldwide brands, the access to a distribution network or simply the necessity to keep a low-cost business model. More and more industry sectors are likely to play a part in Chinese outbound investment, although they will probably remain within sectors that are mature enough to make an overseas move. ASEAN is likely to profit the most from Chinese outbound investment, but other regions will increasingly benefit over the coming years. Finally, while private companies outbound investment starts to grow, it is likely to remain essentially a strategy of the larger groups in terms of transaction values at least in the short-term. SMEs will make less exposed, less striking deals, as the issues they have to overcome are more important.
INTRODUCTION Key Points: There was a record number of cross-border acquisitions by Chinese companies in 2009. Chinese outbound investment is still mainly the product of stateowned companies in national strategic sectors, such as natural resources. Private companies outbound investment represents an increasing part of Chinese outbound investment. While foreign direct investments to China have been widely discussed over the last ten to twenty years, the reverse process Chinese companies outbound investment is a more recent topic. Much has been written about Lenovo buying the Personal Computer (PC) division of IBM in 2005 or about Geely acquiring Volvo in August 2010, but such large acquisitions have brought an entirely new dimension to the phenomenon. In 2009, Chinese companies made a record number of cross-border acquisitions, no less than 298 of them(1). However, we are only still observing the onset of a trend, which remains to this day essentially driven by the state-owned companies need for energy, oil and raw materials. Firstly, it is important to understand what is meant by outbound investment: the concept has been defined in so many ways that it can be difficult to compare information from different sources. In this study, we will refer to outbound investment as overseas investments made for the purpose of increasing shareholders wealth and based on corporate strategy rather than on pure financial return on investment reasons. It must be noted that not all financial institutions overseas investments outside of Mergers & Acquisitions (M&A) have been analysed. In China, the difference between private and state-owned companies remains vague. Previous studies have shown that no more than 12.8% of Chinese-listed companies could be considered as private.
Moreover, the purpose of this report being to understand private companies outbound investment, we have deliberately screened out state-owned companies M&As in the sectors of raw materials and energy. However, anybody familiar with the Chinese business environment knows that the difference between private and state-owned companies remains vague, to say the least. Previous studies have shown that no more than 12.8% of Chinese-listed companies could be considered as privately owned, while 61.4% were under local government control, 15.3% under central government control and the remaining percentage by some association of different levels of government(2). Therefore, even though the present study focuses on outbound investments made by private companies, certain examples or arguments may be based on cases involving the central, provincial or local governments. In the first part of this report, we will draw a broad picture of Chinese outbound investment, in order to introduce the topic and understand the present situation. In the second part, we will develop the current aspects of Chinese procedures and regulations and develop the process followed by Chinese companies who invest overseas. In a third part, we will discuss the difficulties encountered by Chinese companies inherent to outbound investment everywhere yet that could be decisive in the Chinese cultural environment. Finally, the fourth part provides a short-term vision of Chinese private outbound investment in the future, as well as a list of its key success factors.
EXTRAITS PART 1 THE STATUS OF CHINESE OUTBOUND INVESTMENT In 2009, while the world was struggling to recover from the financial crisis, Chinese companies invested overseas more than ever before. The Ministry of Commerce (MOFCOM) recorded an unprecedented US$56.5 billion of OFDI, a +1.1% year-on-year increase (3), representing more than ten times the amount of OFDI realised just five years earlier (see appendix 1). Even more astonishing was the growth of nonfinancial OFDI that reached over the same period, despite the globally fragile economic environment, US$47.8 billion (3), a +14.2% year-on-year increase. But regardless of the different classifications, there is no doubt that Chinese outbound investment is rising and that the present accomplishments are simply a beginning to further success stories. Indeed, while China reached the top fifth position in the 2009 worldwide outbound direct investment ranking (3) as calculated by UNCTAD behind the United States of America, France, Japan and Germany (see appendix 2) a closer look at statistics show room for future growth. Indeed, China ranked only number thirteen of the G20 countries with a mere US$36.29 OFDI per capita, almost half of Mexico s at number twelve, and sixty three times less than France s at the top of the list (see appendix 6). Second, Chinese OFDI was just 2.56% of the Gross Fixed Capital Formation (GFCF) 1, while the average for the remaining G7 countries was over 19% (see appendix 7). The following work consists of a statistical analysis of data extracted from the Thomson s SDC Platinum M&A database. For the purpose of this study, a time frame between 1 January 2004 and 31 August 2010 was chosen. Furthermore, the analysis is solely based on Chinese companies moves towards non- Chinese targets. It must be noted that this database provides only a subset of all Chinese outbound investment over the selected period. However, this subset is representative enough for the conclusions to provide a comprehensive idea of the general trends and developments in Chinese outbound investment. To avoid discrepancies with other data, the analysis essentially focuses on deals identified as completed (the others being either intended or pending ). In 2009, China OFDI was just 2.56% of the Gross Fixed Capital Formation (GFCF), while the average for the remaining G7 countries was over 19%. 1 Gross Fixed Capital Formation: a macroeconomic concept, component of the expenditure on GDP, and reflecting how much of the new value added in the economy is invested rather than consumed (wikipedia)
1.1 Private Companies Position Within Chinese Outbound Investment While it is obvious that Chinese OFDI has not yet reached its peak, it is interesting to observe that until very recently most Chinese OFDI figures were related to the activity of state-owned companies. A thorough analysis of data extracted from the Thomson s SDC Platinum M&A database over the last six years (see appendix 8) shows that out of the 635 completed deals, 171 were identified as made by stateowned companies. Out of those 171 deals, there were 104 recorded transaction values with an average US$672 million each. Of the remaining 464 deals (not identified as made by state-owned companies, thus considered as private), there were 289 recorded transaction values with an average US$69 million each. Therefore a deal made by a state-owned company contributes to Chinese outbound investment over ten times more than a deal made by a private one. While private outbound investment is rising, it is important not to generalise: SMEs have not contributed to this new trend as much as big companies have. While the latter have already developed activities overseas, making them both more inclined to consider and more prepared for outbound investments, SMEs have not yet acquired basic experience and are still focused on the wide range of opportunities offered by the Chinese domestic market. Indeed, investing overseas answers specific needs such as the need for new technology, for an international reputation, or for a distribution network which not all companies have. Most private companies have not reached that point where outbound investment is a necessity. However, the success of a few companies will entice others who were not yet concerned by outbound investment to develop their activities overseas. State-owned companies outbound investments have a transaction value that is on average ten times larger than that of private companies. 1.2 Taking Control: a Softening Trend Investing overseas requires the acquiring company to make certain critical decisions, the most important of which is the sought level of control. In this respect, Chinese companies and in particular private ones have a tendency to seek total control. Indeed, observations based on the analysis of the recorded completed deals in the Thomson Reuters Platinum Database from 1 January 2004 until 31 August 2010 show that Chinese private companies clearly prefer acquiring 100% of the target company (see appendix 9), as it is the case of 53% of the 464
private deals recorded over that period. Chinese private companies sought minority stakes (that is a 10 to 49% stake) in only 30% of the remaining cases, a majority stake (that is a 50 to 99% stake) in only 12% of them and a joint venture (that is a 50% stake) in only 2%. Therefore the middle way a majority stake with other minor investors is not favoured by Chinese companies. Finally, it can be noted that the average transaction value of minority stake deals over the considered period is close to the average transaction value of full acquisition deals (US$62.6 million vs. US$69.9 million see appendix 9). Therefore one of the reasons why private companies invest only a minority stake (as opposed to total acquisition) could be that the target company is larger but as the share of minority stakes increase, so does the interest and investment of Chinese private companies into bigger foreign ones. By not fully acquiring foreign entities, private companies are exercising caution, but they are also learning and becoming more confident. Over the last six years, the share of total acquisitions has dropped, while the share of minority stakes has increased. Differences exist between a company s initial interests in a deal and the deal s final conditions (see appendix 9). For example, the proportion of companies considering acquiring full control is slightly different from the proportion of companies that finally acquire such control. While more than 50% of deals were intended as full acquisitions, only 47% of them turned out to be so. Comparisons made between control-sought and control-taken data shows that Chinese companies generally achieve a lower control than that which was sought, with small investments (that is under a 10% stake) increasing from 4% of the intended deals to 15% of the completed ones. Moreover, certain tendencies have been observed over the last six years. While intended total acquisitions have reduced in proportion accounting for 48% of the deals in 2009 and 49% in the first eight months of 2010 intended minority stakes (that is a 10 to 49% stake) have increased from 30% in 2009 to 36% in the first eight months of 2010, and since 2008 are the preferred form of investment in over 30% of the annual completed deals (see appendix 9). On the one hand, this could be a consequence of the global financial crisis: Chinese private companies are more cautious today when considering outbound investments, and are more concerned about the worth of their target. They prefer to take a minority stake before investing further. On the other hand, it could be an aspect of the outbound investment learning curve : the more deals are sealed, the more
companies are aware of the issues and difficulties they may face in the future. As they are increasingly aware of the problems their predecessors have had, Chinese private companies approach outbound investment differently. 1.3 The Industry Secto r Perspective Among the deals completed between 1 January 2004 and 31 August 2010, 25% of them were made by investment and commodity firms. The business service, metal, electronic, oil, gas, petroleum refining and mining sectors also generated outbound investment, accounting each for 5 to 8% of all completed deals (see appendix 3). While the gap between the investment and commodity firms sector and other sectors is significant in the number of deals they made (158 deals vs. 50 on average), it is much smaller in terms of each sector s share of the total transaction value: over the last six years, the investment and commodity firms sector generated approximately 28% of the total transaction value of all completed deals, followed closely by the oil, gas and petroleum refining sector (26% of the total transaction value) and, to a lesser extent, by the commercial banks and bank holding companies sector (19% of the total transaction value). Therefore deals in the sectors of investment and commodity firms, as well as natural resources have on average a much higher transaction value than that of other sectors. The main sectors investing overseas In number of deals Investment and commodity firms, business services, metal and metal products, electronic and electrical equipment, oil, gas and petroleum refining and mining In % of total transaction value Investment and commodity firms, oil, gas and petroleum refining and commercial banks and bank holding companies When removing the identified state-owned companies from the data, the picture is slightly different (see appendix 3). Firstly, only approximately 22% of the total transaction value of all completed deals (public and private) can be attributed to private companies. Second, the investment and commodity firms still account for a fourth of all private company deals, yet their contribution to the total transaction value is of only 15%. In terms of the percentage of total transaction value, commercial banks and bank holding companies take the lead, originating over 23% of the total transaction value of all deals (which is due in large part to the acquisition of Hong Kong Wing Lung Bank by the China Merchants Bank in 2008), while the insurance sector comes in third, with one deal amounting to 13%. Finally, the transportation and metal
and metal product sectors come in respectively fourth and fifth, with 9 and over 6% of total transaction value. Only approximately 22% of the total transaction value of all completed deals between 2004 and 2010 can be attributed to private companies. It is also interesting to observe the type of industry sectors Chinese companies invest in. For example, in 55% of all completed deals, Chinese companies acquired a target company from a different industry sector. Half of these deals were made by companies from the investment and commodity firms sector, the business services sector, and the metal and metal products sector (see appendix 3). Indeed, the investment and commodity firms sector is different from other sectors as it both invests in companies from all different sectors and is invested in by companies from various backgrounds. Yet apart from it, the majority of remaining sectors invests in their own sector. Moreover, Chinese outbound investments are essentially made in the natural resources industry: between 2004 and 2010, the combined oil, gas, petroleum refining and mining sectors represented the targeted industry in 22% of cases and accounted for 47% of the total transaction value (see appendix 4). Yet in terms of private investment, they represent only 10% of all deals and account for only 18% of the total transaction value reflecting the weight of the government s resource strategy on outbound investment. The primary sector invested in by Chinese private companies in terms of transaction value is the banking industry with 37% of total transaction value. The other, more traditional industries invested in are wholesale trade and durable goods (8% of total transaction value/ 3% of the number of deals), electronic and electrical equipment (7% of total transaction value/8% of the number of deals) and machinery (4% of total transaction value/3% of the number of deals). Apart from the investment sector, Chinese private outbound investment remains within the acquirer s industry. In conclusion, companies have a tendency to invest overseas in the same sector as their own. This is generally true of all sectors, with the notable exception of the investment industry, which invests in all sectors. Observations made with regards to the target companies are similar: they are generally acquired by companies from a similar sector, with the notable exception of the investment sector, which is invested in by companies of various backgrounds.