Money not enough to fulfil China’s M&A ambitions

Chinese companies are snapping up natural resources firms across the globe and picking over the carcasses of car marquees laid low by the financial crisis. The value of Chinese outbound M&A, at $42.6 billion last year, was below a record $3 billion from 2008, but nonetheless accounted for China’s highest share yet of the global total at 7.5 percent.

The international ambitions of Chinese firms, not content with their 1.3 billion-strong domestic market, can only accelerate. With an eye to the added value in expertise, Beijing is especially keen to encourage its companies to forage abroad for high-technology, clean-tech know-how and established brands in addition to securing further supplies of oil, gas and commodities to feed the country’s thrumming industries. But bankers and consultants say the obstacles that Chinese firms must overcome are immense: money cannot buy overnight the managerial expertise and cultural sensitivity needed to build a multinational with operations and brands spanning the globe.

Some Chinese firms have already learned the hard way about the importance of adapting to the local environment. In 2007, President Hu Jintao had to cancel plans to cut the ribbon on a $200-million smelter at a Chinese-owned copper mine in Zambia after miners rioted over harsh working conditions. Chinese contractors also periodically spark anger for relying excessively on Chinese labor and materials when building roads, dams and housing across the continent.
Chinese suitors looking to buy Hummer from General Motors and Volvo from Ford are certainly overlooking a track record in high-profile manufacturing acquisitions that to date can charitably be described as patchy. The jury is still out on the purchase by computer maker Lenovo of IBM’s laptop business in 2005. TCL Corp has two disasters to its name: the electronics manufacturer was hailed as a trailblazer for China when it formed a joint venture with its French rival Thomson SA in 2003. But it failed to tap into growing demand for flat-screen TV sets and the venture was declared insolvent in 2007. TCL’s subsequent purchase of then-Alcatel’s handset business was also a fiasco, largely because the Chinese company did not anticipate the high integration costs and found its phones were not competitive on the global market.

So Chinese companies seeking to trade up the value chain will clearly first need to broaden their skills. The business of digging up iron ore or extracting oil is a world away from manufacturing and selling global retail products, and China has scant experience of managing overseas workforces or marketing to sophisticated consumers.
Given all the deterrents, it is not surprising China has a long way to go on outbound investment. According to the United Nations Conference on Trade and Development, China’s foreign direct investment outflows are still puny relative to the size of its economy. China’s total FDI stock at the end of 2008 at USD148 billion was 3.4 percent of its GDP that year. By comparison, the figure was 14 percent for developing economies and 26.9 percent for the global economy.
Successful expansion overseas would enable China to reduce its dependence on energy-intensive, polluting manufacturing and take production closer to the markets it serves. Aluminum Corp of China Ltd made such a move in 2007, agreeing to co-build a 1-million-ton-a-year aluminum smelter costing $3 billion in Saudi Arabia.

Depending on the industry, it makes sense for Chinese firms to start close to home. Just over half Chinese M&A investments overseas are within the Asia Pacific region. Such acquisitions are easier for managers to handle, not least because the time-zone difference is smaller and they are more likely to be able to recruit ethnic Chinese who can bridge the culture and language gap. More frequently the right answer is to consolidate in Asia and start with a smaller acquisition. Companies that started successfully doing smaller acquisitions are more able and more likely to be successful at the acquisitions later.

But to acquire sophisticated technology, China has no choice but to set its sights on the USA, Europe and Japan. And that raises the perennial problem of political opposition to the sale of what are perceived to be treasured national assets. Other obstacles are home-grown. To fully reap the benefits of an acquisition, as Japanese car manufacturers for example have discovered, a good local manager often has to be left in charge. This is not something Chinese companies are always comfortable doing.

The China head of one Wall Street bank put it more bluntly: most state-owned Chinese companies were petrified at being pushed to go beyond their comfort zone and venture abroad. Investment bankers, consultants and lawyers are, of course, only too willing to smooth the path for Chinese companies looking overseas. The problem is that those same Chinese companies are not used to paying top-dollar for professional services, and so are reluctant to seek outside advice.

Xiang Bing, dean of the Cheung Kong Graduate School of Business, told a forum in Beijing: “In China, we don’t have as much global management talent as in other countries. Take India, for example. You can find many Indian senior vice presidents in multinational companies, but not many Chinese.” In financial services, Jerry Lou, Morgan Stanley’s China strategist, said Chinese institutions, especially investment banks, were still too weak to take control of their counterparts in developed economies.

“It is not like buying a building, a mine or a port,” Lou said. “You’re just wasting money on an empty company if you can’t manage the people.” He expects it will take at least another decade before Chinese banks are truly ready for overseas deals. “Remember, China did not have a stock market until 1992,” he pointed out, to show how China is still a novice in high finance.

That’s one reason why the relatively simple business of extracting commodities is likely to keep grabbing the Chinese M&A headlines for some years yet, as the country’s demand for energy and resources will grow. As for manufacturing, managing a global supply chain with its attendant complications of tax regimes, import-export requirements and just-in-time logistics requires much broader expertise than the ability to marshal cheap labor to produce goods to a foreign company’s specifications. Not to mention dealing with local government and unions, and the intricacies of managing on foreign soil.

Still, the obstacles to successful M&A are so daunting that organic expansion might be a better solution for Chinese companies with a good product range, especially in emerging markets where distribution channels are not deeply entrenched and local competition is not insuperable.

Organic growth has certainly been the major driver for Japan, which was once synonymous with cheap shoddy goods, and South Korea, whose cars were a laughing stock 20 years ago: both are now at the global cutting-edge of autos and consumer pro ducts.

There is no reason why China, either through M&A or alone, cannot follow in their footsteps. The country is rich in engineering and manufacturing skills, has benefited from significant technology transfer from foreign companies, and has overseas corporate expansion in its political sights.

(This is an edited version of an article that appeared in The New York Times.)