china outbound investment: betting on success

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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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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

22-23,25-28MJ140314.indd 23 12/03/2014 15:53



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



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.

22-23,25-28MJ140314.indd 26 12/03/2014 15:54



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



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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china outbound investment: betting on success

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