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Why Is China So Interested in Offshore Mergers and Acquisitions?

Renowned economist analyzes the economic and political factors involved in China’s offshore merger and acquisition activities.

Since March of 2005, the Chinese government has been proudly announcing that Chinese companies’ overseas mergers and acquisitions (M&As) have surged by 70 percent and that it anticipates the offshore M&As will be US$14 billion in 2005. It further predicts that China will become the most active country in the Asian Pacific region in terms of offshore M&As.

Nevertheless, China’s surge in offshore M&A activities faces two major problems.

Economic Issues with M&As

The first problem is economic. While China is celebrating its successful M&As, some of its buyers are experiencing significant losses. In 2004, TCL went through major restructuring after it acquired Thomson Color TV and Alta Cellular. While TCL’s size expanded rapidly, its revenue did not increase accordingly. The annual financial report showed the 2004 net income of TCL Group to be 245 million yuan (US$30 million), a drastic drop from the 570 million yuan (US$69.5 million) in the prior year. The profitability outlook for Lenovo Group, the biggest PC manufacturer in China, was very unclear after it acquired the PC division of IBM. As a matter of fact, Chinese companies are lacking adequate preparation for managing and counter measures for handling the risks involved in offshore M&As.

Political Problems with M&As

The second problem is political. Around July 21, the Chinese government announced its strategic change in its Renminbi exchange rate system. At the time, a few of its domestic companies were experiencing frustration in their attempts to make overseas acquisitions. The board of Unocal Corp. voted in favor of the lower Chevron offer of US$17.3 billion in both cash and stocks. The board announced that they wanted to "urge the shareholders to vote for the Chevron offer at the August 10 shareholder meeting." The positive progress of the Chevron offer indicated that CNOOC, the Chinese bidder, was actually out of the game. Almost at the same time, the Haier Group, another large Chinese corporation, announced that it gave up its plan to purchase Maytag Corp., its U.S. counterpart.

The obstacles that China’s CNOOC encountered in its Unocal acquisition originated from the M&A strategies of China’s corporations. While in general, the company being acquired is interested mainly in the sale price, the government of the country of the company being acquired pays more attention to issues of economic security. Since 2002, six Chinese firms have become the key players in offshore M&As. The motivation behind the Chinese companies’ offshore M&A activities can be categorized as follows.
China’s Motivation for M&As

1. Guided by China’s national resource strategy, the first kind of offshore M&A targets companies abroad with irreplaceable natural resources. China Minmetals Corporation’s attempt to merge with Canada’s Noranda is one such example.

2. The second kind of offshore M&A aims at gaining key technologies that China’s corporations lack. Shanghai Automotive Industry Corporation’s acquisition of Korea’s Sang Yong Motor Co. and England’s MG Rover falls into this category.

3. The last category of offshore M&A aims at acquiring international brand names and sales networks in order to improve the image of Chinese companies in the global markets. Examples are the aforementioned overseas activities by China’s Haier, Lenovo, and TCL.

These three motivations behind China’s offshore M&As make strategic sense to China’s interests and will continue to be the fundamental consideration of China’s corporations in their future offshore M&A activities.

On the other hand, the above three strategic considerations do not necessarily match the national interests of the country of the acquired companies. Generally speaking, the third strategic consideration to acquire brand names and sales channels does not conflict with the economic security of the home nations. Yet the first kind of M&A, because it involves scarce resources, obviously affects the resource security of the targeted country. With regard to the second category, M&A by a foreign company does not pose much of a threat if only civil technologies are involved, while it will certainly face numerous obstacles if military technologies are involved.

Recently the Chinese Academy of International Trade and Economic Cooperation (CAITEC), under the Ministry of Commerce, published a study of China’s corporations’ foreign direct investment. The report indicates that in the past few years, among various types of foreign direct investments (FDI) by China’s corporations, the offshore M&A and the swapping of stock ownership have been increasing. Thus strategic investments abroad are gradually becoming a new way for China’s corporations to grow on the international stage.

Through discussions and surveys, CAITEC studied various corporations in 13 provinces. The feedback showed that with China’s surging foreign exchange reserves and the adjustment of Chinese corporations’ foreign investment strategies, that "M&As of overseas local companies" are becoming one of the major types of FDI by China’s corporations. Among various investment types, offshore M&As jumped to 34.4 percent, under the 69.8 percent of "setting up non-manufacturing branches such as offices and agencies," the 49 percent of "forming new joint ventures," and the 46.9 percent of "incorporating new companies." As is shown in the following table, the capital used for offshore M&As has been surging since 2003.
The Surge of Offshore M&A Capital by Chinese Companies

Chinese Companies’ M&A Activities

Summary of Profit and Loss Staement for SOEs (in billions)

Year M&A Capital(in US$ billion) % Increase of M&As China’s Foreign Exchange Reserve (in US$ billion)
 2003  2085    403.25
 2004  7  50%  609.93
 2005  14  100%  711.00 (until June)
(Data source from Credit Lyonnais Securitie and from the published reports by the National Bureau of Statistics of China)

According to various sources, China’s offshore M&As are spared no cost. As soon as an interesting target is found, they are anxious to acquire it at any cost. As a result, they tend to overspend on M&As. While such behavior is ridiculed in China’s business circles as the "teenage phenomenon" and is considered economically immature, nothing can stop the acceleration of China’s overseas M&A activities. The total capital involved in the Lenovo acquisition of IBM’s PC division, the Haier deal, and the attempted Unocal acquisition by CNOOC, reached US$21.5 billion, which, according to some calculations, is equivalent to China’s profit from selling 100 million PCs, 100 million refrigerators or air conditioners, and 100 million clothing articles together with 100 million pairs of shoes. To these Chinese companies, such an astronomical amount is apparently beyond their financial reach. Who, then, is pushing China’s M&A activities overseas?

Why is the Chinese Government Pushing for More M&As?

The Chinese government is certainly behind these daring moves and has two considerations in pushing Chinese companies’ offshore M&A activities forward.

First, China’s economic growth shows signs of trouble. Because of the white-hot market competition, China’s businesses are facing tremendous challenges. For example, the net profit of Haier in 2004 approximated that of 2003, while its gross profit margin in the refrigerator business declined from 19.2 percent in 2003 to 16.5 percent in 2004. In the fourth quarter of 2004 before Lenovo’s purchase of IBM’s PC division, Lenovo’s net profit margin dropped 12 percent from the same period in 2003. It is natural that these companies try to lower cost and gain higher profit by expanding production—a phenomenon resembling Japanese businesses in the late 1980s when they chose to invest in foreign markets.
China’s economic growth is currently facing a risk of slowdown. In May of 2005, foreign direct investments in China decreased 0.8 percent as compared with the same period of 2004. This was the first time since September 2000 that FDI in China shrank. This probably indicates significant changes in the foreign investors’ outlook on China’s economic prospects.

The second consideration by the Chinese government in supporting overseas M&As is the deterioration of the terms of foreign exchange reserves in China due to the "double surplus" in trade and capital. It is shown that as of the first half of this year, China’s total foreign exchange reserve reached as high as US$711 billion, a surge of 51.1 percent from the same period last year. Such a large reserve certainly results in a serious imbalance between supply and demand. The annual rate of return from China’s foreign reserve is calculated to be -5 percent.

There are several ways to alleviate this problem:

1. Spend the U.S. dollars that flow in from overseas

2. Lower the domestic demand

3. Adjust the exchange rate

Currently the Chinese government is employing both the first and the second approaches to release the pressure from the deterioration of the foreign currency reserve situation. To the Chinese government, it is a reasonable choice to spend U.S. dollars overseas by investing abroad and carrying out M&A overseas.

As a result, the Chinese government has been taking various measures to encourage its domestic enterprises to "go abroad." The special "2005 World Forum of ‘Going Abroad’ for Chinese Companies" held by CAITEC showed that the government will provide policy and fiscal support to Chinese companies. With such "fiscal support," who can blame U.S. Congress for questioning the (Chinese) government backing behind Chinese companies’ M&As in the United States.

He Qinglian is a renowned economist and jornalist from China. She is currently staying in the United States as a guest researcher.