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Focus: China outbound investment
What is it about China? The country is roll-ing in fi lthy lucre
with cash reserves the envy of every nation, particularly the
credit-crunched countries of the developed West. But its investment
track record is lamentable.
By the end of its 11th five-year plan (2006-10), China held
foreign cash to the tune of a jaw-drop-ping US$3 trillion. But the
yield from its global assets, including foreign equities, was a
measly 6%, just ahead of Japans 5%, but trailing behind the UKs 9%,
and well behind the US leading 22%.
At the tail end of the financial crisis, in the 2011 financial
year, the US private sector accumulated US$200 billion in
acquisitions versus Chinas top estimate of US$57 billion. Returns
on Chinas hold-ings of US$1.6 trillion in US treasuries was of
little comfort to state planners who began making boastful noises
in 2012 about plans for a 10-year US$2 trillion acquisition
spending spree, with China watchers waiting to see the details
articulated in the next economic plan.
Betting on successLong unchallenged in Africa, China is now
vying with the US to win the continents highly coveted mineral
assets
China takes a place at tableChinas Ministry of Commerce (MOFCOM)
announced in December 2012 that it was backing its 12th five-year
going global plan with US$580 billion in direct financial support
for global acquisi-tions. Sceptics have correctly pointed out that
the worlds second-largest economic power had the money, but hadnt
demonstrated the necessary M&A muscle or talent to achieve its
ambitious goals. But China was cashed up and clearly ready to roll
the dice, so where are we now?
When analysing Chinas awakening as an eco-nomic power from the
point when the
country first became a member of the World Trade Organization in
2001 to the present day one is struck how busi-ness has been
successful, despite the nations commercial immaturity.
China rolled out winners when its export-driven economy became
the
worlds engine for growth, and it banked profits to buy a seat at
the G8 table. But, even
with cash, and a willingness to bet big, China has still not
understood the sub-
tle difference between trading and the M&A game. Success in
one game may not have been enough to pre-pare for the next
challenge.
Leading state-run companies (SOEs) are post-communist-era
behe-
moths restructured and mandated as profit-making bodies
according to his-
toric industrial sectors. Unfortunately, there is no change in
their cultural DNA.
Private-sector Chinese operators follow identical practices as
their SOE peers, where they expect direction, patronage
and support from federal and regional polit-ical
intermediaries.
Chinas central management and policy plan-ning is a monotheism
that has been both a blessing, and a curse for China Inc. It is
this one issue that will eventually determine the out-
Anthony DesirHong Kong, China
Fast facts: China
Capital: Beijing Population: 1.35 billionReal GDP growth: 7.6%
(2013 est)
Currency: renminbi (yuan)
goals. But China was cashed up and clearly ready to roll the
dice, so where are we now?
When analysing Chinas awakening as an eco-nomic power from the
point when the
country first became a member of the World Trade Organization in
2001 to the present day one is struck how busi-ness has been
successful, despite the nations commercial immaturity.
China rolled out winners when its export-driven economy became
the
worlds engine for growth, and it banked profits to buy a seat at
the G8 table. But, even
with cash, and a willingness to bet big, China has still not
understood the sub-
tle difference between trading and the M&A game. Success in
one game may not have been enough to pre-pare for the next
challenge.
Leading state-run companies (SOEs) are post-communist-era
behe-
moths restructured and mandated as profit-making bodies
according to his-
toric industrial sectors. Unfortunately, there is no change in
their cultural DNA.
Private-sector Chinese operators follow identical practices as
their SOE peers, where they expect direction, patronage
and support from federal and regional polit-ical
intermediaries.
Chinas central management and policy plan-ning is a monotheism
that has been both a blessing, and a curse for China Inc. It is
this one issue that will eventually determine the out-
President Barack Obama walks with president Xi Jinping before
a
bilateral meeting held in California in early June 2013. A few
weeks
later Obama announced the launch of the Power Africa
initiative to double access to power in sub-Saharan Africa
Photo: The White House
Phot
o: B
loom
berg
New
s
22-23,25-28MJ140314.indd 22 12/03/2014 15:53
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2014
Focus: China outbound investment
come of Chinas global acquisition foray. But on past record,
Chinas planners who are funding this game should be more than a
little worried.
Ready to rollEven Chinas eastern neighbours have been able to
catch up with developed nations and refine mar-ket-specific
commercial models and skills over dec-ades. These less-capitalised
Asian Tigers, Japan, India and emerging Asian economies all manage
to compete with China on its home turf and elsewhere with fewer
resources and often without govern-ment intervention or support. If
private and semi-private companies from less wealthy states can
compete in mature markets, it must raise concerns about China Incs
poor record in an open and com-petitive environment.
Of course, it is important not to lose sight of the fact that
China is the newest player at the table, but it is this
inexperience that is a cause for concern. Home-grown executives
began appearing on the international scene roughly after 2005, with
many of these decision-makers still having fewer than eight years
experience in knowing how to operate in a purely commercial
environment. Consequently, few have the knowledge or skills of
trainee-level investment bankers.
One might be fooled into thinking that there is a belief that
China Inc is piloted by unsophisticated executives schooled in an
outdated socialist theol-ogy. That misconception is a disservice to
the coun-trys deep talent pool and to its aggressive and
well-trained junior executives. Many, if not most, of these
second-layer executives easily match or excel their Western peers
in commercial skills.
This group appears to have acquired the skill sets that China
needs, but it will still be some time before they creep into
leadership roles where they can influence a wholesale change in
Chinas busi-ness culture. Whether or not this group will be tak-ing
up leadership at a fast enough pace to keep the chips in Chinas
hands is the next challenge for Chinas planners. In the meantime,
the Chinese will continue to have an executive turnover issue.
Stacking the deckChinas own misunderstanding of the game defeats
its longer-term purposes, but also explains its pref-erence for
undeveloped markets with little or no transparency. The countrys
executives expect their
cash to be greeted with an enthusiastic under-the-table
handshake from targeted foreign political leaders, and expect this
to be enough to determine favourable results.
Chinese executives are genuinely flummoxed when their patronage
to incumbent governments whether it is personal guanxi
(relationships that may result in the exchange of favours or
connect-ions as an expression of friendship), themed public
buildings, or political party donations fails to return investment
winners.
Tipping the dealer is considered the smart part of the cost of
doing business even with a ready cul-tural explanation. The
political opposition is seen as no more than a pit boss who is best
ignored unless he manages to become the next dealer, and then gets
a turn at some guanxi himself.
The Chinese government acts as the praetorians for its
businesses at home, while Chinese politicians and business leaders
expect supplicant foreign governments to service Chinese companies
in the same manner abroad. Needs of the local popula-tion,
localisation, environmental concerns, and so on, are issues that
only matter for propaganda pur-poses, and fall well behind Chinas
commercial goals. Even independent professional support is
Chinas central management and policy planning is a monotheism
that has been both the blessing, and the curse for China Inc
In December 2013, CITIC Pacific scrapped plans to sell 20% of
its US$8 billion Sino Iron magnetite project in the Pilbara to main
contractor MCC after the two companies fell out over a series of
cost blowouts and delaysPhoto: Bloomberg News
Inside a factory owned by Baosteel, Chinas largest
steel producerPhoto: Erik Charlton
Continues on page 25
Sector Investment & contracts signed %
Energy 370.00 47
Metals 114.60 15
Transportation 111.00 14
Real estate 74.30 10
Finance 39.10 5
Agriculture 34.46 4
Technology 21.40 3
Other 16.70 2
Total 781.56 100Source: The Heritage Foundation
Chinas investment worldwide by sector
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Focus: China outbound investment
often seen as questionable and an unnecessary expense once
government ministers and ministries have signed onto Chinas
bandwagon.
The challenge for China has been how to turn their talents as
traders working off margin volumes to the different skill sets
needed for foreign acquisi-tion executions, business management and
operat-ing a business without government or political patronage.
The hierarchal decision process in Chi-nas SOE culture may not
itself handicap acquisi-tions, but Chinese executives who prefer to
do business outside China relying on this professional legacy are
at a disadvantage.
The problem is amplified when the lone deci-sion-maker at the
top is most familiar and comfort-able with the ingrained
communist-era business processes that rely on government support
and political backhanding. In reality, it is the Chinese companies
that are most successful in China, and those operating with
government support are the ones that are least prepared for success
in competi-tive markets outside China.
Picking winnersOne of the most difficult aspects of evaluating
Chi-nas success is gauging an understanding of whether or not the
country has got value for its money. The answer would be simple on
a straight investment return analysis, and it would be a resounding
no.
However, if China is in the game to win resources at a cheaper
price, it may well have come out further ahead than if it had sat
out of the game al together. In reality, the losers would be those
developing countries that may have sold their resources too early
and too cheaply. In either case, the game is still not decided.
Chinas need for resources has been well docu-mented. As of 2013,
47% of the countrys non-financial investments were in the energy
sector, with metals being the second-highest category at 15%.
Chinas focus on energy and minerals has to be seen as a clever play
to secure feedstock for its industrial sector and for its domestic
needs.
The argument as to whether or not China could have made better
financial returns is valid, but there is no question that it has
come out ahead in securing offtake. A more interesting development,
and the part of the puzzle that remains to be decided, is what
happens next.
Changing tables Taking a quick glance at Chinas going global
plans and its stated intention to spend US$580 bil-lion on
acquisitions, there is no question that China has the money.
Looking at its executive pool, there are some challenges with
regard to its human resources and recruitment methods. When looking
at where it is pushing its cash, there is a mixed pic-ture; with
money being shifted to undeveloped markets for valuable raw
materials. Chinas plan-ners are also looking at the same
landscape.
Behind the tactical adjustments, in the search for hard assets,
China has also recognised its own limit-ations in terms of human
resources and has been
Investment requiredRoughly two-thirds of Chinas global
non-financial equity portfolio is invested in develop ing
countries, with Africa being Chinas most important destination. In
real-ity, Chinese investments in Africa, for example, are far
greater than figures show when African-domiciled public assets
listed in other markets are identified by geographical
location.
There is an obvious link between Chinas appetite for resources
and its commitments in Africa and Latin America. There is also a
less obvious Chinese preference for operating in countries where
its companies can rely on the local governments support,
non-inter-ference, and protection from the reality of market
forces.
State management of the economys lifeline is Chinas true
religion, and China prefers to see this same theism in its global
economic partners. Chinas role as a positive capital partner for
resource-rich developing countries is a well-debated subject. The
debate should also focus on Chinas weak record for major
acquisitions in free market econo-mies.
Where is the duplication of successes, such as Lenovos
acquisition of IBMs PC busi-ness, for example?
This issue is relevant to resource acquisitions when looking at
Chinas stumbling eorts to acquire Rio Tinto (Australia 2009),
Unocal Corp (USA 2005) or even the recent collapse of a deal
between CITIC Pacific Mining Management Pty Ltd and Metallurgical
Corporation of China Ltd (MCC), which would have seen CITIC Pacific
sell 20% of its US$8 billion Sino Iron magnetite project in the
Pilbara to main contractor MCC. Clearly, China still triumphs at a
rigged table, but seems more uncertain when it is in a fair game
with skilful players.
Skills matter, and whatever good intentions China may have, its
current executive level talent pool is short on the business acumen
and requisite commercial experience. Western countries have had
centuries of mundane business dealings to develop an independ-ent
private sector and proper commercial infrastructure.
This process includes knowing how to oper-ate in non-government
controlled financial and legal systems, and navigating a
competitive landscape that cruelly punishes errors, as well
as rewarding risk and innovation. Chinas recent acquisition
history proves that it has been quite successful in places where
there is a less well-developed commercial infra-structure, but its
portfolio lags elsewhere.
Chinas global investment holdings (US$ billion, September
quarter 2013)Source: The Heritage Foundation
In 2009 Chinalco Chairman Xiong Weiping said the company was
disappointed that Rio Tinto had decided to axe plans to sell a
US$19.5 billion stake in its business to ChinalcoPhoto: Bloomberg
News
Continues from page 23
22-23,25-28MJ140314.indd 25 12/03/2014 15:54
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Focus: China outbound investment
making aggressive adjustments either by partner-ing with
established financial institutions or by buying them out
directly.
Take the example of Citic Securities Co, for instance, which
recently acquired CLSA Asia-Pacific Markets from Credit Agricole
SA. Or the Industrial and Commercial Bank of China (ICBC), which
acquired the London commodities and currencies arm of Standard Bank
in January, building on ICBCs earlier decision in 2007 to acquire a
20% stake in the Standard Bank parent, headquar-tered in
Johannesburg.
China has progressed from invest-ing in private equity firms to
taking stakes in trans-actional financials where it can better
secure independ-
ent advisory services and manage deal flow. This is only the
first step towards what appears to be the next obvious goal.
Another crucial adjustment is a shift away from its heavy
reliance on SOEs as investment leaders. In 2005, 100% of all China
deals were done by SOEs; by 2013, about one out of ten deals have
been engineered by private companies, with more pri-vate companies
going international. It is true that Chinese private enterprise
follows the same busi-ness practices as the SOEs, but at least they
offer a streamlined alternative to the SOE process.
Driving deals to private Chinese companies would have little
meaning if the state did not also give some of the financial
support that it offers to SOEs. There is also an adjustment in this
direction. In December 2013, Chinas State Council announced a
policy change whereby only outward invest-ments valued at more than
US$1 billion would require the pre-approval of the National
Develop-ment and Reform Commission (NDRC). This is sig-nificant
since previously outward investments in the mining and resources
sector valued at more than US$300 million, and all other deals of
more than US$100 million, required NDRC approval.
However, there is still confusion about the policy shift as
resource deals between US$30 million and US$300 million and all
other deals between US$10 million and US$100 million are still
subject to local
As of 2013, 47% of Chinas
non-financial investments
were in the energy sector,
with metals
being the second highest
category at 15%
arm of Standard Bank in January, building on ICBCs earlier
decision in 2007 to acquire a 20% stake in the Standard Bank
parent, headquar-tered in Johannesburg.
China has progressed from invest-ing in private equity firms to
taking stakes in trans-actional financials where it can better
secure independ-
non-financial investments
were in the
being the second highest
category at
Photo: Bloomberg News
Blake, Cassels & Graydon LLP | blakes.com/mining*Associated
OfficeMONTRAL OTTAWA TORONTO CALGARY VANCOUVER NEW YORK CHICAGO
LONDON BAHRAIN AL-KHOBAR* BEIJING SHANGHAI*
No. 1 in Canada announced mining M&A deals by deal count.
(Bloomberg and Mergermarket, 2013)
No. 1 Canadian firm in global announced mining M&A deals by
deal count. (Bloomberg, 2013)
Leading Canadian Law Firm for Mining M&A Deals
In the mining industry, Blakes Means Business.
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Focus: China outbound investment
approval, and there are no clear guidelines on how the policy
change is to be implemented. None-theless, as the policy moves
forward, there is an evi-dent refocusing on easing regulatory rules
and on making money available to smaller private compa-nies that
support Chinas commercial goals.
Doubling downChina has also stated its intention to invest up to
US$1 trillion to support deal flow and infrastructure financing.
And, of course, the capital is focused on its favourite partner,
Africa. The countrys chief risk analyst, Zhao Changhui, of the
Export-Import Bank of China (China Eximbank), confirms these
figures and suggests that it will include direct investments, soft
loans and commercial loans.
Africa for the next 20 years will be the single-most important
business destination for many Chi-nese mega-corporations, he
said.
Zhao even suggested that China is interested in spending as much
as US$500 billion to build a transcontinental rail network. His
figure puts a number behind Chinas SOE maps, which outline possible
routes for the proposed rail lines, and con-firms the intentions of
the SOE and Chinas partners to follow through with their African
adventure.
How does it make sense then for China to double down in Africa,
and how can it possibly expect to get a sensible return with that
much cash on the table? One answer lies in recent US moves into
Africa.
Poker face China has largely had a free hand in Africa for the
last decade, and has managed to control events on the ground
because it has been the only party put-ting its chips on the table.
Neither the World Bank nor the International Monetary Fund has
delivered meaningful support to the continent when dis-bursements
from those institutions are compared with China.
The Western chorus of criticism about Chinas so-called
neo-colonialist tendencies fall flat when countries in Africa stack
the dollars pouring in from China next to the policy papers and
bureaucratic applications from the continents traditional
finan-ciers.
In June 2013, US president Barak Obama stepped into the game by
offering infrastructure support for Africa. Obamas Power Africa
initiative recognises the continents need to spend as much as US$94
billion annually for the next 10 years in order to reach energy
sufficiency.
Power Africa suggests that it will build on Africas enormous
power potential, including new discoveries of vast reserves of oil
and gas, and the potential to develop clean geo-thermal, hydro,
wind and solar energy. It will help countries develop
newly-discovered resources responsibly, build out power generation
and transmission, and expand the reach of mini-grid and off-grid
solutions.
The initiatives challenge to Chinas free hand in Africa was
immediately obvious, but the sums on direct offer from the
Americans only US$7 billion appear unimpressive. Surprisingly, the
Americans appear to have the edge. The Chinese side regularly
tags an investment, announces the amount, and then begins
spending.
It is not unusual to find a multibillion-dollar deal where the
Chinese side begins feasibility studies after they have closed the
deal. Even then, they often insist on using Chinese engineering
teams and institutes for their offshore projects. These practices
may win high-level friends on the ground, but burn the bankroll
when deals are unsound. Do you wink at the dealer and bet before
you at look at your cards? For the Chinese side, this seems to be
the way the game is played.
The Americans are more likely to follow sound commercial
principles because they are subject to professional standards,
institutional controls and transparency. They need to report to
shareholders, regulators and the people who are supporting their
China has largely
had a free hand in Africa for the last decade, and has managed
to control events on the ground because it has been the only party
putting its chips on the table
Chinas envious bankroll has been built with cheap
manufacturing as the leading global export-driven economy
Photo: Robert Scoble
After a two-year hiatus, China kick-started its investment into
Africa again at the beginning of 2014 with China Nuclear Corps
acquisition of a 25% stake in Paladin Energy Ltds Langer Heinrich
uranium mine in NamibiaPhoto: Paladin Energy
22-23,25-28MJ140314.indd 27 12/03/2014 15:54
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Focus: China outbound investment
investments. Here we expect more value placed on ensuring the
soundness of an investment before committing someone elses money to
a deal. It is this process that allows the US side to pull funding
from capital markets rather than rely on govern-ment backing to
fund deals.
There is little doubt that Chinas own announce-ments about an
increase in its spending commit-ment from a few hundred billion to
US$1 trillion, loosening of the controls on Chinese enterprise, and
publicising its long-hidden plans for the Afri-can intercontinental
railways and port facilities, are all part of an ongoing effort to
stare down Obama. But why bother? China obviously has deeper
pock-ets and it would appear that it is already more entrenched in
Africa than any other state. But this is the point where we start
seeing Chinas hand.
Flipping the cardsThere is no sustainable argument that Chinas
infra-structure investments in Africa have paid off, or will pay
off at any point in the near future. SAMIs power purchase agreement
(PPA) and deal analysis con-firm that many of these transactions
cannot return any direct investment value. In some instances these
announced transactions have evaporated, with the Chinese side and
the African governments
having a very public outing of their dirty laundry. So why would
China be making aggressive moves to head off US initiatives in what
is already a money-losing sector?
SAMI believes that China, the US, and other play-ers at the
table have recognised the value of African assets that remain
landlocked, waiting for power, waiting for rail, and waiting for
political stability. Everyone wants to own the value chain before
local governments begin to recognise that any infra-structure
investment is of greater material value to their respective states
longer term because it enhances value to the resource sector.
The Chinese are committed, the Americans crafty, so who wins? So
far, the Chinese have been holding all the cards, but the arrival
of the Ameri-cans, albeit with a smaller pile of cash, appears to
have pushed China into trying to buy the pot.
It seems unlikely that the Chinese approach will work, of
course, since at the end of the day, despite all they have done so
far to control the game and tip the dealers they still do not own
the tables. The house wins, as always, but the ques-tion as to
whether the loser will be the Chinese, who already have much at
stake, or the Americans, who are trying a late play to steal the
prize, is still a few bets away.
Anthony Desir is a principal at Strategic African Minerals
Investment (SAMI) Funds, based in Hong Kong
There is no sustainable
argument that Chinas
infrastructure investments in
Africa have paid off, or will pay off
at any point in the near future
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