China in Europe: Cash, Debt and M&As
Europe is looking to China as an alternative source of finance and growth. China, the world's fifth-largest investor in 2010, invested USD 4.61 bn (non-financial) in Europe last year, a 57.3% year-on-year increase. This wave of Chinese investment comes at a time when European companies are thirsty for cash. Is Europe's crisis becoming China's opportunity? By Javier Cuñat
While sovereign debt has risen substantially in only a few eurozone countries, it is threatening to envelop otherwise healthy economies throughout the region. As austerity measures are being enacted throughout Europe as a response, company profits are declining or are showing weak growth prospects. Credible sources of finance are shrinking. Within this context, FDI is becoming more important as a facilitator of economic growth in Europe. On the other side of the globe, Asia is gradually playing a more prominent role as a source of global OFDI, with Asian OFDI growing at a CAGR of 8% in the last two decades, a figure substantially higher than other regions. China is taking the lead in this. It became the world's fifth-largest investor in 2010, ahead of all other Asian countries.
In 2006, China invested USD 1.44 bn in the European Union (EU), only 0.25% of total OFDI received in the EU in that year. According to China's Ministry of Commerce (MOFCOM), China's non-financial investment in the EU reached USD 4.3 billion in 2011, more than double the 2006 figure, accounting for 1.4% of total OFDI in the region. This figure also represented a 94.1% increase over 2010. While China has made it clear that buying government bonds of deficit-ridden European countries is not currently a priority, the ongoing crisis inevitably presents some great buying opportunities for cash-rich Chinese firms. Europe has plenty to offer as China seeks to expand into new markets, acquire new brands and upgrade its high-tech sector. Chinese capital will bring employment, tax revenue and reciprocal market access.
Over the short term, a potential recession in the eurozone is not in China's best interest. Given that China's currency is still largely fixed to the US dollar, the euro's progressive depreciation against the dollar is making Chinese exports to Europe more expensive. In addition, as European demand shrinks due to government austerity measures, imports from China are likely to fall even further. Despite China's efforts to transition to a consumption-driven economy, its economy is still largely export-driven and Europe remains China's second-largest trading partner. Hence China would like to see a strong euro to preserve its exports to the region. On the bright side, while the sovereign debt crisis has triggered a plunge in the value of the euro, Chinese companies with an overseas investment agenda are in a strong position to take advantage of this trend.
Over the medium to long term, China aims to build competitive advantagew based on science, technology, and innovation, which is precisely what Europe has to offer. In the last ten years, we have seen Chinese manufacturers progressively move up the value chain, from producing low value-added goods with low margins to more sophisticated products with higher margins and from OEM to branded goods. Far from the low price and low quality perceptions often associated with Chinese companies, they are aggressively challenging international competition by penetrating strategic segments. Very often this has been achieved through licensing and technology transfer agreements with European manufacturers that boast advanced and patented technologies, and who were attracted by the favorable investment environment of the Chinese low cost production base. In many instances, and as Chinese manufacturers grew in scale, capabilities and export revenue, foreign companies end up selling their main patents to their Chinese counterparts. Strategic alliances and M&As, as part of Chinese companies' business expansion models, are now set to take off in Europe.
Despite this context, and taking into account the size of the two economic blocks and the scale of their bilateral trade, Chinese investments into Europe are still rather low. The state ownership of Chinese investors, lack of experience in international deal making and a protective attitude among host countries are some of the reasons behind this current status. Yet this is a dynamic and changing process. Chinese investors have learned their lessons, and a protective attitude in Europe is rapidly becoming outdated. Before the crisis, China had made only modest investments in the region while today Chinese investments are not only welcomed, but are also strongly desired among struggling but still competitive European companies.
Most Chinese investments in Europe to date came from large state owned enterprises (SOEs). These large conglomerates (117 in total) report to SASAC (State-owned Assets Supervision and Administration Commission of the State Council). SASAC will appoint their top executives and approve their overseas transactions. They hold leading positions in their respective industries in China, are financially supported and have specific mandates from the central government. In some cases, deals are negotiated and agreed between high-level government officials, and executed by these SOEs. While they may have experience in emerging markets, they are currently operating in the relatively unfamiliar territory of Europe. Yet their executives are ambitious, logical and highly practical, and these companies are able to adapt fast and learn quickly.
Recent examples of transactions undertaken in Europe by these types of companies include China Three Gorges Corporation (CTGPC), which bought a 21% stake in Energias de Portugal for USD 3.51 billion, and State Grid Corporation of China (SGCC), the largest electric power transmission and distribution company in China, which recently agreed to pay USD 508 million for a 25% stake in the national electricity grid of debt-stricken Portugal.
Medium-sized state owned enterprises are also venturing into Europe. There are thousands of these companies operating at the central, provincial or city level and which are more focused on one specific or niche sector. Generally speaking, one can cluster them as either 'slow' or 'fast-growing'. The 'slow-growing' sub tier of companies is composed of those companies which have encountered difficulties growing in a highly fragmented and cut-throat Chinese market over the last two decades. They usually operate in non-strategic sectors (e.g. textiles), have smaller international ambitions and are often consolidated into bigger firms as part of an ongoing process in China.
The 'fast-growing' sub-tier of companies is composed of medium-sized export-oriented enterprises that have successfully consolidated market share at home. Their motivation to go global is often a matter of 'survival' as the Chinese domestic market becomes increasingly saturated. While they receive less overall support from the central government, they are commonly provided with financing by Chinese domestic banks and are able to move faster than the larger firms.
Examples include Shandong Heavy Industry, a heavy equipment maker, which agreed to pay USD 478 million for a 75% stake in Ferretti Group, an Italian luxury yacht maker with debt problems, effectively enabling it to acquire overseas technology, know-how as well as an international brand name at a discount. Another example is Sany Heavy Industry, a construction equipment manufacturer, which more recently agreed to acquire the German family-owned engineering firm Putzmeister for USD 426 million.
Chinese private multinational companies are probably some of the most attractive investors for Europe. They are usually young companies, from ten to twenty years old, which have been able to grow extremely fast during the 1990s and 2000s based on both domestic and international demand. They are usually managed by either practical self-made Chinese entrepreneurs with little business education, or Chinese returnees educated overseas with a well-grounded international mind-set and management skills. They are often rooted in Hong Kong, Shandong or Shanghai, locations which first benefited from China's economic reform and where one can expect them to be listed. They do not benefit from systematic government support to 'go global', yet they often partner with Chinese SOEs for specific projects and transactions.
Examples include Fosun, a Shanghai-based diversified private holding group, which grew from a USD 8,000 start-up to a USD 20 billion asset enterprise. Fosun acquired a minority stake in France's Club Med, as well as Greece's Folli Follie. Another Example is Huawei, which first launched its Western European enterprise division in 2010, and has since built up a workforce of around 400 employees in Europe.
We are leaving behind a stage in the relationship characterised by booming bilateral trade, few investments and imbalances, and entering a new stage characterised by increasing collaboration. Challenges are twofold. From one side, European companies will have to understand the complexities of dealing with Chinese investors, and learn how to adapt to them. Even though China has cash to invest, successful deal making is usually the result of understanding the Chinese business culture, identifying stakeholders with the right strategic fit and developing customised modes of engagement. From the Chinese side, probably the main challenge over the long run will be to become a respected international investor in Europe. Chinese companies are usually known for their strong balance sheets, government ownership structures and international ambitions but are still far from being considered ideal; hence they need to empower their executives to become well respected investors who comply with international best practices. While this is not always true, a change in perception will be key if China aims to establish a long term footprint in Europe.
Understanding both sides of the equation and adapting to the new realities of the relationship will enable companies to successfully navigate the current environment, and to develop and build upon existing competitive advantages.
Javier Cuñat, General Manager: Beijing Axis Strategy