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Failed bids haven't dampened the country's hunger for U.S. acquisitions.
Abe De Ramos, CFO Magazine
November 1, 2005
For Yang Hua, defeat was completely unexpected — and the memory of it still stings. As chief financial officer of the Chinese National Offshore Oil Corp. (CNOOC), the third-largest oil company in China, he was a key figure in last summer's failed attempt to purchase Unocal. CNOOC's bid to acquire America's ninth-largest oil company set off a storm of controversy here. Politicians and pundits fretted that the Chinese were seeking to strip the nation of vital energy supplies just as prices were soaring. Ultimately, CNOOC lost in a bidding war to U.S. oil giant Chevron, largely because of the fierce political backlash. Even now, months later, Yang puzzles over the failure of the $18.5 billion bid.
Despite the deal's huge risks, Yang says, he was "very, very surprised" not only by his company's loss but also by the near-hysteria the bid set off in the United States. Only three years earlier, Yang had been CNOOC's lead negotiator in a bid to acquire Indonesian oil and gas reserves from Spain's Repsol. That $585 million deal came off without a snag. No political firestorm. No China bashing in the local or national press. No costly media campaigns to win public support for the deal. Indeed, CNOOC is managing its new subsidiary these days with a very light touch. Initially, CNOOC sent only two managers to oversee the unit. Today, just 20 of the 900 employees are Chinese. There were no layoffs and few, if any, other changes in the unit.
In retrospect, says Yang, CNOOC's bid for Unocal suffered from a fatal flaw: the company did not effectively communicate its benign intentions to the United States. That's unlikely to happen again, as the company will no doubt sharpen its negotiating skills before targeting another acquisition. Despite last summer's defeat, Yang says his company could make another bid for a company in the United States. After all, he says, CNOOC 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, 44, who spent a year studying business American-style at Massachusetts Institute of Technology, earning his executive MBA there in 2003. "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 a potentially 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 2005 and 2006. 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 American CFOs? Among other things, it means there are more potential buyers studying their companies and their competitors for possible acquisition. For that reason, finance chiefs have to be prepared for bids from companies they may never have heard of. 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.
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," says Desai. "It makes sense for Chinese companies to expand their product reach beyond their own borders." In a classic case of turnabout-is-fair-play, the United States looms as 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 Corp. (CNPC), an oil company fully owned by the state, announced it had bought PetroKazakhstan, a Canadian firm that is a major oil producer in the Central Asian country of Kazakhstan, which borders China. That $4.2 billion deal followed a string of other multibillion-dollar deals by Chinese government 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 Corp., China's largest television manufacturer, was one of the first to act on global ambitions. In 2003, it forged a joint venture with TV 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 Ltd., China's biggest computer manufacturer, spent $1.75 billion to buy the money-losing personal-computer division of IBM Corp. With sales of about $12 billion, Lenovo now holds a 10 percent stake in the worldwide market for PCs. IBM retained a 13.4 percent stake in the combined company, which is the third-largest PC manufacturer in the world, after Dell and Hewlett-Packard.
No Pillage or Plunder
Although few in number, China's acquisitions to date 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.
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 company 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 PC unit, is the CEO. Yang Yuanqing, formerly Lenovo's CEO, is the new chairman. Robert Cones, former CFO of IBM's PC 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 headquarters will be in New York, only a few miles from onetime 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 culture clashes and the need for painful adjustments. 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 and moved production to existing facilities in China.
Personnel issues have been somewhat more challenging for the Chinese. Before buying the PC unit, "we had a really long debate about 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 advisers. 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.
For Chinese companies aiming to sell 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. Appliance-maker Haier's bid for Maytag, although ultimately abandoned in August, hints at what's to come. Chinese companies see plenty of opportunity in snapping up neglected or ailing brands that have established sales and distribution networks.
But for now, many Chinese technology companies are trying a different tactic to gain a foothold in foreign markets. "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. (Huawei is the largest.) 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 already be window-shopping. "We welcome any opportunity for acquisition," says Wei. "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 believes 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, the company spent $2 million for a small stake in a third, LightPointe Technologies, a manufacturer of wireless optical devices based in San Diego. "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 at Huawei.
China is making bold moves into the automotive sector in the United States, Europe, and elsewhere in Asia. Last July, Nanjing Automobile paid around $93 million for 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 Corp. and Volkswagen AG in China.) In August, Asimco, a small auto-parts maker in Beijing, bought NVH Concepts, in Livonia, Michigan, to enhance its capability in noise-, vibration-, and harshness-reduction technologies for automobiles. Two years earlier, Asimco paid $28 million to buy the camshaft division of Federal Mogul, a century-old auto-parts maker in Southfield, Michigan.
The Federal Mogul unit opened up the U.S. market to Asimco. Michael Cronin, Asimco's finance chief, says one-third of the company's sales are generated in the United 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 specification," explains Cronin. "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 among its factories in China. Ultimately, the company aims to redefine itself as multinational rather than 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 with 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, the company's revenues from its U.S. unit should top $70 million, up from $60 million in 2004, says Cronin, 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," says Cronin. "Knowing how you compare with others, your efficiency improves."
And Lenovo has issued an ultimatum to its new PC unit. Among other things, the former IBMers are under pressure to achieve better-than-market-average sales growth in emerging markets, boost sales of laptops, and win a bigger stake in the small-and-midsize-business market in the United States. In the past, "IBM didn't put a lot of emphasis on these three areas," says Ma. Lenovo intends to boost sales in part by opening more sales channels and offering customers better maintenance service on their computers.
In any case, says Ma, the Chinese are going to teach the Americans a thing or two about the new entrepreneurial spirit of competition. In the past, she says, when faced with a problem in the PC division, IBM would build a team of people to analyze it, a time-consuming process that kept the unit from being nimble. "At Lenovo," says Ma, "we put the problem on the table and make decisions right away."
Abe De Ramos is executive editor of CFO Asia.