Tom Barrack compares his own experience setting up a joint venture in China to the movie "Lost in Translation," where a movie star played by Bill Murray gets overwhelmed by Japan's culture and sensibility.
When Barrack's Chinese partners hosted an 11-course dinner, he endured hours of turbo-charged toasts in Mandarin, celebratory chants of "ganbei" and endless swigs of high-octane Chinese tequila before his counterparts finally agreed to ink a deal.
"You have to become part of the fabric of the culture, to the point where they have trust and confidence in you," said Barrack, founder of Colony Capital, with $4.5 billion in real estate investments. "And that's just the beginning of the process. That's when you actually start doing business."
Ultimately, Colony cut a deal in April with a major Chinese conglomerate, Shanghai Industrial Investment Corp., which contributed both an equity stake and manpower to the joint venture.
These days, many deals are being cut between U.S. and Chinese interests and Barrack is just one of a slew of investors, lawyers, bankers, accountants and money managers, many of them based in Los Angeles, who help facilitate the action.
"There are a lot of people out there in finance, investing and entrepreneurs in Southern California who are all trying to find ways to make money in China," said Douglas Thomas, senior vice president of international private equities at TCW Group Inc., which has four funds dedicated to investing in greater China.
While the nation continues to move away from a sluggish, centrally planned socialist economy to a market-oriented system, it's still an economic mish-mash. Its massive bureaucracy, inefficient state-owned enterprises and unskilled agriculture sector of 330 million people (45 percent of its workforce) can be maddening to investors.
About 200 banks have offices in China, but only a handful can conduct business in the local currency, the renminbi, and they can only serve foreign companies. As a condition of its entry to the World Trade Organization, however, China agreed to pry open its large banking sector by the end of 2006.
"Unless you do lending and deposits in the local currency, what you can do is very limited," said Li Yu, chairman and chief executive of Preferred Bank in Los Angeles. Like most local ethnic Chinese banks, Preferred Bank makes loans to U.S. companies purchasing goods from China, and to Chinese companies setting up distribution and warehouse centers in Los Angeles.
The flow of investment dollars into China involves an array of professional services: letters of credit, wire transfers, fund remittances, legal services, due diligence functions, corporate restructuring and offshore tax havens.
Much of this is activity is originated in L.A., which is logical given that China is Southern California's top trading partner. "We will spend 80 percent of our efforts on China this year and the reason is simple: China is changing the world," said Donald Straszheim, founder of Straszheim Global Advisors LLC, an independent research firm.
Interest in China has only intensified in recent months because it is considered partly responsible for driving up oil prices. With a GDP growth rate that surged 9.7 percent last year, China accounted for one-third of the growth in global oil consumption last year a major contributor to today's higher prices. Demand is finally expected to moderate next year.
There's no way to know how many people work on deals involving U.S. and Chinese businesses, but the numbers are surely growing. Some of them are longtime China hands who came to the country two and three decades ago when most all aspects of the economy were government-controlled. Others are recent arrivals still on a learning curve.
For the old-timers, the changing environment is striking.
When William Overholt, chair of the Center for Asia Pacific Policy at Rand Corp., first went to China in 1982, the planes often were delayed five to seven hours.
"They had one airline and it flew only the old Russian planes. On one flight the crew got hungry and they decided to cook some food in the aisle, which resulted in a very fast landing," he said. "Now they have 31 airlines and they aren't starting any fires."
Letters of credit
Perhaps the most basic function in doing business with China is the financing of imports and exports, a process that's facilitated by local banks through letters of credit. These documents serve as irrevocable guarantees of payment. Nearly all banks in the U.S. can wire payments to China and remit funds instantaneously for their customers with few, if any, hassles.
East West Bancorp Inc., a large ethnic Chinese bank based in Los Angeles, had a 25 percent increase in letters of credit in the first six months of this year, compared with the like period a year earlier. Like most U.S. banks, East West has a correspondent banking relationship with the four largest state-owned banks in China: Bank of China, China Agricultural Bank, China Construction Bank, and Industrial and Commercial Bank of China.
"The great thing about the letter of credit business is that it's one of the few things that everybody abides by," said Dominic Ng, East West's chairman and chief executive.
There are essentially two types: One is a site credit, in which the buyer arranges a letter of credit that is payable to the exporter and collected from the issuing bank. The second is a so-called usance letter of credit, essentially a short-term loan at a pre-negotiated interest rate that is payable in 90 to 180 days.
"The bank is just one dot in a series of dots along the supply chain," said Walt Trask, regional vice president for global trade services at Union Bank of California, a subsidiary of Bank of Tokyo Mitsubishi, one of Japan's largest banks.
Local banks deal primarily with letters of credit and wire transfers because they are not allowed yet to have fully-functioning bank branches in China.
That is changing gradually. The China Banking Regulatory Commission allows foreign banks to open representative offices in China, although they cannot accept deposits or conduct any banking transactions. Foreign banks and securities firms have rushed to open offices as they jockey for position when China relaxes its banking rules in two years.
"Our main job is to keep relationships with government officials," said Leonard Gang, branch manager in Beijing for Los Angeles-based Far East National Bank. "As a representative office, we cannot do any kinds of business."
China also restricts individuals from sending more than $2,000 out of the country, though there are as many as 20 exceptions to that rule, including paying for medicine and college tuition abroad. The Chinese Ministry of Commerce recently eased some regulations allowing businesses to invest overseas.
By far the biggest issue affecting China is its state-owned banks, which are trying to unload between $300 billion and $1 trillion in non-performing loans made to state-owned manufacturing companies over the past decade.
Compounding the problem is that the Chinese government refused to allow state-owned banks to dispose of the loans at less than their full value, for fear of forcing the borrowers into bankruptcy.
The country's economic growth and its banking sector are highly inter-dependent. Last year, the government gave two of the largest banks $22.5 billion each from its foreign exchange reserves to boost their balance sheets in preparation for pending public offerings.
Though U.S. investors see tremendous upside potential in buying up China's real estate assets, the process itself has been arduous. Most of the bad loans have been transferred to state-owned asset management companies that are selling them off at auction to foreign investors.
Jack Rodman, a partner and managing director at Ernst & Young in Beijing, evaluates and packages pools of loans for China's asset management companies. He estimates the country has roughly $414 billion in bad loans on its books. But so far, China has completed only a few auction sales.
"There is nobody in China to say you have to reduce these loans, so there's a lot of personal risk to approve selling them," said Rodman, noting that the process is log-jammed by eight or nine government agencies that must give their approval for the loans to be auctioned.
Barrack, at Colony Capital, wants to buy the half-built hotels and office projects throughout Shanghai that have run out of financing. But he complains that "no great wins have come out of China," because of inherent problems plaguing the auction process.
"The legal system is untested and land ownership is arbitrary," he said. "So you may buy a loan with a description of the property but when you show up, the borrower or another state agency steps in and says someone else owns the title. Ninety percent of the time you end up doing nothing. These are the kind of nightmares that make investing difficult."
Many companies entered China in the past decade by forming joint ventures with state-owned enterprises a chance to profit on the country's cheap labor force. But some of those ventures are now being unloaded or restructured because they have not thrown off enough profits or are hampered by political issues.
"If a company bought a pharmaceutical plant with 1,200 workers but they only needed 200, now they're stuck unless they can renegotiate the terms with the government," said Gregory Keever, a partner at Los Angeles law firm Coudert Brothers LLP. "Employment is a political issue and it can be difficult to get over those hurdles."
Overholt said foreign companies have shifted away from joint ventures toward forming wholly owned Chinese operating subsidiaries, though there are lots of exceptions, notably in the automobile industry. In addition, there are more small private up-starts formed by Chinese entrepreneurs, as well as private equity firms now that are competing with their Western counterparts.
Not surprisingly, disputes are popping up.
Jinshu Zhang, a corporate securities lawyer at Greenberg Traurig LLP in Los Angeles, said many of his cases involve conflicts between joint venture partners doing business in China. In one case, a Chinese firm that agreed to introduce a Fortune 500 company to a Chinese bank interested in purchasing banking software for $116 million filed a dispute for not being paid a finder's fee.
"China is in a transition period, so what is legal and what is not is not entirely clear," Zhang said. "You see a lot of attorneys now getting involved in the process because of sour business interactions."
China also has its own hierarchy of taxes, from local property taxes to excise taxes, which is why many joint ventures are set up in free-trade zones that offer tax concessions.
Confounding the process is that so many industries are tightly regulated. China's Ministry of Foreign Trade and Economic Cooperation issues a 25-page catalog for foreign investors listing specific industries in which foreign investment is encouraged, restricted or prohibited.
Specific areas of agriculture, mining, food processing, petroleum and tobacco production are restricted. Prohibited industries include the processing of green and specialty teas, Chinese medicines, arms and ammunitions, ownership or construction of power grids and air traffic control systems, as well as any stake in news, radio or television outlets.
Private equity investors rely on the catalog to determine which non-state-owned companies are open to investments.
"China is a very complicated place today because there are a lot of companies with mixed ownership," said Howard Chao, a senior partner at O'Melveny & Myers LLP, who heads the firm's Asia practice. "Some are partly state-owned and partly private so what are you investing in?"
The Chinese government requires that foreign investors submit a formal application and written contract, a process that can take anywhere from a few weeks to two months for approval.
More often the biggest snags involve identifying the company to invest in and negotiating deals with locals. A typical American investment team consists of a high-level principal, an attorney and an investment officer. But a Chinese delegation might include as many as 20 people, with 14 of them government employees of one sort or another.
While one American investor typically holds the cards in signing off on a deal, the Chinese operate by consensus. Continuing to negotiate is seen as a way for all parties not to "lose face" in negotiations.
"The currency is different, the accounting practice is different, but what is unbelievably different are the issues of respect, flexibility and compassion and those become the discerning elements when you do a deal," said Barrack. "The confusion and dismay of Americans doing business in China is that it's too much art, and not enough science."
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