Yang Hua realized what it means to be Chinese in the age of international deal-making while taking his executive MBA at the Massachusetts Institute of Technology in the United States two years ago. “I had been thinking about it for years that I even wrote a paper about it,” says the Beijing-based CFO of CNOOC, the US$7 billion-a-year oil-and-gas company that tried but failed to acquire California-based Unocal last summer. “I think to be Chinese is to achieve harmony, taking the middle ground and never being too extreme.” Then with an excited rap on his shiny mahogany desk, the 44-year-old finance chief laughs at the lack of originality of his conclusion. “We talk about it in business schools, but in fact, Confucius knew about it 2,000 years ago.”
At least credit Yang for his good humor despite being denied the chance to prove his management philosophy to Americans. Yang says he was “very, very surprised” by the near-hysteria that CNOOC’s bid for Unocal set off in the States, where politicians feared that the Chinese would strip the nation of vital energy supplies. Just three years earlier, Yang was CNOOC’s lead negotiator in a bid to acquire Indonesian oil and gas reserves from Spain’s Repsol. The $585 million deal came off without a snag. No political firestorm. No China-bashing in the press. No costly media campaigns to win public support. Indeed, CNOOC is managing its new subsidiary with a very light touch. Initially, it sent only two managers to oversee the unit. Now, only 20 of the 900 employees are Chinese. There were no layoffs and few, if any, other changes in the unit.
In retrospect, Yang says the bid for Unocal suffered from a fatal flaw: CNOOC failed to communicate effectively its benign intentions to the United States. That’s unlikely to happen again as CNOOC sharpens its negotiating skills before targeting another acquisition. Despite last summer’s defeat, Yang says CNOOC could make another bid for a company in the States. After all, he says, it has the same goal as any other capitalist enterprise. “It’s not like we’re going to take over your jobs or take your resources back to China,” says Yang. “We’re only here to make money,” he says. “We’re happy to just take our profits and deliver them to our shareholders.”
That’s the philosophy behind what is likely to be a massive wave of acquisitions by the Chinese in the United States, Europe, and elsewhere in Asia. The Chinese are new to the art of the international deal. Just five years ago, mainland companies didn’t think of shopping for assets beyond the walls of the Middle Kingdom. Now, flush with cash and armed with gold-plated deal-making expertise from the world’s top investment banks, the Chinese are launching a shopping spree. Straszheim Global Advisors, a consulting firm in Los Angeles, estimates that Chinese firms will invest some $80 billion overseas in the next two years. Despite the setback suffered by CNOOC, “this trend will continue,” says Jack Zhai, head of global corporate finance at Deutsche Bank in Beijing. Adds Ed King, managing director of Asian M&A at investment bank Morgan Stanley in Hong Kong: “At this stage in China’s development, large local companies are completely capable of using their competitive advantage to really go international and continue doing these deals.”
What does the buying binge mean for CFOs of target companies? Among other things, it means there are more potential buyers studying their companies and their competitors for possible acquisitions. For that reason, CFOs have to be prepared for the unexpected such as a bid for their companies or their competitors. Either way, markets are going to be disrupted. Prices may fall dramatically. Supply-chain dynamics may change. As it broadens into more sectors and gains momentum over the next two years, Chinese M&A is likely to roil markets further. Indeed, CFOs who haven’t felt the impact yet in their industries better brace for gale-force winds in the months and years to come.
Through acquisitions, the Chinese will seek to build on strengths and shore up weaknesses, namely in the areas of branding, sales, marketing, and technology, says Kalpana Desai, managing director for M&A at Merrill Lynch in Hong Kong. There are other forces at work, as well. “The domestic market is very competitive,” Desai says. “It makes sense for companies to expand their product reach beyond China,” The United States is a natural target for the Chinese because of the vast size and wealth of its market. China is encouraging companies to go abroad by providing ample low-cost loans to companies.
Most of the Chinese acquisitions in the near future are likely to involve natural resources, such as oil, natural gas, metals, ores, and coal, according to investment bankers involved in evaluating target companies for the Chinese. Just days after CNOOC gave up its bid for Unocal, China National Petroleum, an oil company fully owned by the state, announced its bid for PetroKazakhstan, a Canadian firm that is a major oil producer in the central Asian country of Kazakhstan, which borders China. That US$4.2 billion bid followed a string of other multibillion-dollar deals by state firms to develop oil and gas fields in countries such as Sudan, Venezuela, and Australia. China is “reaching out beyond its borders to procure assets, in particular reserves, that will be important for its future development and growth,” says Mark Renton, head of Asian investment banking at Citigroup in Hong Kong. (Citigroup advised CNPC on the transaction.)
Consumer-products and technology companies are also likely to be targets of Chinese M&A. To date, there have been only two high-stakes, high-profile deals. TCL, China’s largest television manufacturer, was one of the first to act on global ambitions. In 2003, it forged a joint venture with television-maker Thomson of France, which owns the iconic American brand RCA. Earlier this year, TCL said it had acquired full ownership of the venture. In late 2004, Lenovo Group, China’s biggest computer manufacturer, spent $1.75 billion to buy the money-losing personal-computer division of IBM. With sales of about $12 billion, Lenovo now holds a 10 percent stake in the worldwide market for personal computers. IBM retained a 13.4 percent stake in the combined company, which is the third-largest personal-computer manufacturer in the world, after Dell and Hewlett-Packard.
Though few in number to date, China’s acquisitions offer a fascinating glimpse into the brave new world of globalization. So far, Chinese M&A seems to be an almost courtly activity, hardly the sort of pillage-and-plunder feared by U.S. politicians during the debate last summer over CNOOC’s bid for Unocal. Indeed, the Chinese are moving almost gingerly to integrate their new assets, possibly because they are new to the game. “Most Chinese companies have sought to create value by acquiring physical assets, intellectual property, brands, route to market, management team, and greater scale in procurement,” says Gordon Orr, director at consulting firm McKinsey in Shanghai. “Relatively few have taken on turnarounds that would require major restructuring and consequently layoffs. It’s a conservative and prudent approach.”
That’s probably why Mary Ma is so eager to dispel any worries about the possibility of massive layoffs at the IBM unit acquired by Lenovo. Ma, Lenovo’s 52-year-old CFO, says the company believes “the best way is to increase the productivity of existing staff.” Indeed, the first major merger between a U.S. company and a Chinese one is a strategic union making the best use of the strengths of East and West. Lenovo has placed former IBM executives in key positions in the new organization. Stephen M Ward Jr., former head of the personal-computer unit, became CEO. Yang Yuanqing, formerly Lenovo’s CEO, is the new chairman. Robert Cones, former CFO of the unit, was named group financial controller of the merged company, reporting to Ma. The 30-member executive staff is split down the middle, half Lenovo and half IBM. Even more telling, Lenovo’s executive headquarters will be in Purchase, New York, only a few miles from one-time parent IBM.
Judging from the example of Lenovo, Chinese commercial companies prefer to buy assets — and customers — that can be plugged into their own operations, minimizing the need for painful adjustments and cultural clashes. In the cases of TCL and Lenovo, both of the companies they acquired had long ago outsourced manufacturing to Asia. TCL, for instance, closed some of Thomson’s factories in Mexico.
Personnel issues have been somewhat more challenging for the Chinese. Before buying the personal-computer unit, “we had a really long debate whether we would manage them on our own or create a joint management team,” says Ma. There were many skeptics, not only at Lenovo, but also among its advisors. One of the key concerns, Ma recalls: “How can the Chinese manage big white people?” After long hours of discussions, Lenovo decided it was buying not only technology assets but also management expertise. The IBMers were welcomed into the fold.
Lenovo has scored immediate success with its new unit, which had lost money in the three years before being acquired by the Chinese. Within two months, Lenovo had halted the unit’s losses by increasing prices to customers and demanding discounts from suppliers. Morgan Stanley predicts the combined company will post a net profit of $221 million on sales of $14 billon in fiscal 2006. For the second quarter ended in June, Lenovo’s revenues tripled to $2.5 billion. Net income was $45.7 million in the quarter, up 6 percent. (The Lenovo-IBM deal closed in April, about a third through the quarter.)
For Chinese companies aiming to buy overseas, a foreign acquisition will be their first major foray into markets outside the mainland. That’s why they are seeking targets that offer strong brand identity for Americans and Europeans. Not surprisingly, Chinese companies have sought out neglected or ailing brands that have established sales and distribution networks. The Chinese view such companies as bargains.
Case in point: Haier, China’s top manufacturer of household appliances, last summer made a $1.25 billion bid for Maytag, a U.S. manufacturer of household appliances including washers, dryers, ovens, and refrigerators. Haier is justly renowned in China for reviving an ailing state company and turning it into a powerful, respected manufacturer and marketer of appliances. Still, Haier was bucking a powerful force. The U.S. major-appliance market is far from welcoming to foreigners. Few overseas companies have ever captured significant market shares.
Still, Haier had strong motivation to look outside China. The appliance market there is ferociously competitive. Haier’s profits last year were flat, and its gross margins for refrigerators have been shrinking as competition continues to rage in China. But Maytag would have been an extraordinary challenge for Haier. For one, Maytag is a venerable, century-old company based in the heartland of the United States in Newton, Iowa. It has a portfolio of iconic brands, including Hoover vacuum cleaners and Jenn-Air appliances. Over the years, the company has lagged the competition, beaten by more adept rivals such as General Electric and Whirlpool. Reviving Maytag would mean a bare-knuckle fight with two of the most experienced consumer-products companies in the world, and Haier has no experience managing a global brand. Nor does it have any expertise in global distribution. On-the-job learning can be costly.
In any case, after effectively launching a bidding war for Maytag, the Chinese company pulled out of the fracas in August. But investment bankers believe the Chinese still are keenly interested in the United States. “We’ll see more foreign M&A coming from the consumer-goods sector in China as they look for global distribution networks and brand-building opportunities,” says Deutsche Bank’s Zhai.
Chinese technology companies are trying a different tactic to gain a foothold in foreign markets — for now. “We’re sending our employees overseas to set up subsidiaries and open sales offices so they can go to the customers directly,” says Wei Zaisheng, CFO of ZTE, China’s second-largest telecom-equipment manufacturer after Huawei. Increasingly, both companies are competing with U.S. networking giant Cisco, France’s Alcatel, and Canada’s Nortel. Last year, international sales accounted for less than a third of total revenue for ZTE. In 2006, Wei says, international sales are likely to exceed domestic sales.
Eventually, the Chinese may cast off tentative tactics and try to buy their way into world markets. Some may even be window-shopping now. “We welcome any opportunity for acquisition,” Wei says. “We’ll look at companies with sales-channel expertise.”
Chinese companies are looking overseas to acquire specific technologies. “The U.S., Europe, and Japan still have a technological edge over China at this point,” says Merrill Lynch’s Desai. “Although Chinese companies are catching up very rapidly, they would still be buying technology.” Desai predicts that Chinese telecoms are surveying potential targets in California’s Silicon Valley. There is precedent, though small. Huawei has acquired two optical-transmission equipment companies since 2002. Last year, Huawei spent $2 million for a small stake in a third, LightPointe Technologies, a manufacturer of wireless optical devices based in California. “Although we’re spending 10 percent of our revenues on research and development, we’re not ruling out small acquisitions if they offer technologies that will enhance our product portfolio,” says Johnson Hu, executive vice president of Hauwei.
China is making bold moves into the automotive sector in the United States, Europe, and elsewhere in Asia. Last July, Nanjing Automobile bought, for an undisclosed sum (media estimates put it at £50 million [$89 million]), the bankrupt British carmaker MG Rover. Shanghai Automotive, China’s biggest automaker, acquired South Korea’s Ssangyong Motors for $523 million last year. (Shanghai Auto also makes passenger cars in joint ventures with General Motors and Volkswagen AG in China.) In August, Asimco, a small auto-parts maker in Beijing, bought NVH Concepts in the United States to enhance its capability in noise-, vibration-, and harshness-reduction technologies for autos. Two years earlier, Asimco paid $28 million to buy the camshaft division of Federal Mogul, a U.S. auto-parts manufacturer that was founded in 1899.
The Federal Mogul unit opened up the U.S. market to Asimco. Michael Cronin, Asimco’s CFO, says one-third of the company’s sales are generated in the States. (Some 70 percent of sales are in China.) Its 2006 goal is to acquire new technologies in the United States and Europe. “Most Chinese companies are make-to-print, meaning they can make a product according to a customer’s print’s specification,” Cronin explains. “What we want to do is move up the value chain and become a solutions provider, to work with the customers, understand what their issues are, and then make the products for them. Most Chinese companies lack that ability.”
Asimco is establishing a center in Beijing to transfer technology from its newly acquired units to its factories in China. Ultimately, Asimco aims to redefine itself as a multinational rather than as Chinese. “To our U.S. or European customers we want to appear as an American or European company with substantial operations in China,” he says. “To our Chinese customers, we want to appear as a Chinese company with access to global technology, management, and quality standards.”
Cronin says some of Federal Mogul’s manufacturing was transferred from Detroit to China to save money. Labor costs $18.50 an hour in the United States compared to 36 cents in China. Because of the cost savings, Asimco lowered prices, which increased sales. Workers whose jobs were eliminated as a result of moving some manufacturing overseas were retrained to do more skilled jobs such as testing and inspecting parts. This year, Asimco’s revenues from its U.S. unit should top $70 million, up from $60 million in 2004, Cronin says, and the unit, which had been losing money, should be profitable.
But the Chinese can be demanding of their new units, too. Asimco installed “visual aids” to encourage higher productivity at its factory in Detroit. “There are a lot of charts on the walls that show the things that get measured, such as production, service record, and machine tolerance,” Cronin says. “Knowing how you compare with others, your efficiency improves.”