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Saturday, Feb 4, 2023

China Arrives

The Chinese are coming.

That’s the consensus among investment bankers and private equity players who are closely watching China National Offshore Oil Corp.’s $18.5 billion takeover bid for Los Angeles-based Unocal Corp.

So far, there’s been just a trickle of Chinese companies scouring Pacific shores for U.S. companies and brands. Yet the Unocal bid is widely seen as a harbinger of more aggressive direct investment in the U.S. from mainland China, where $691 million in foreign currency reserves is waiting to be put to work.

“They have to do something with their money,” said Steve Dollinger, managing director of Crimson Investments, a Palo Alto private equity firm that builds manufacturing plants in Asia for U.S. firms.

Most Chinese firms operate offshore subsidiaries in Hong Kong that are flush with dollars and euros.

Southern California already has benefited from personal Chinese wealth being plowed into real estate assets. Bankers see a handful of local industries as ripe for Chinese buyouts: the textile and garment industries, automotive components suppliers and energy companies.

But they also say a number of factors will make for a slow build-up, rather than a rush to buy. Among them: language barriers, cultural differences and distances that make purchasing a company, rather than a passive asset like real estate, more difficult from afar.

“There will be more buyers coming out of China and there will be targets in North America, though we aren’t seeing lots of activity yet,” said Howard Chao, a partner at O’Melveny & Myers’ Silicon Valley office and head of the firm’s Asia practice.

One big incentive for Chinese enterprises is to wrest away control over profits now held by American multinationals. They own the brands and the distribution networks, but use China for cheap manufacturing. This leaves Chinese firms vulnerable if an American manufacturer decides to shift production to a lower-cost country.

“One of the things Chinese companies are looking for is distribution, and they are looking at the mark-up that companies are making on Chinese goods,” Chao said. “They figure, why can’t they own the distribution themselves?”

Possible benefit

Chinese investments in the United States are evoking comparisons with 1980s Japan, when cash-rich investors, buoyed by a soaring yen, began buying up American icons like the Rockefeller Center and the Pebble Beach golf course only to sell them years later at a loss.

Back then, Japan ran a huge trade surplus with the U.S., just as China does now. It later came undone by bad bank loans, an issue that the Chinese government is trying to address by systematically selling off pieces of state-run banks.

But there are differences. Chinese investments in the U.S., with the exception of the CNOOC bid for Unocal, include the financial backing of U.S. private equity firms that have gained a foothold in China. And unlike the 1980s, when Japanese companies were killing U.S. rivals in fields like semiconductors, consumer electronics and automobiles, the Chinese are largely imitating American companies, which have been the key beneficiaries of low-cost Chinese manufacturing.

As a net importer, China has focused for now on buying natural resources and raw materials, snapping up oil fields in Kazakhstan, gas fields in Indonesia, timber in Canada and mining companies in Australia.

Three recent deals in the U.S. represent a shift toward brand names and distribution. In addition to the CNOOC-Unocal offer, China’s Haier America Trading made a $1.28 billion bid for Maytag, the Newton, Iowa-based manufacturer of Maytag and Hoover appliances. And Lenovo Group Ltd., China’s largest computer market, bought IBM’s personal computer division for $1.75 billion.

Ambrose Lam, chairman of Access Capital Ltd. in Hong Kong, an investment banking advisory firm, said Chinese companies are hungry for Western brands because of the immense pressures of globalization. Brand names are more likely to survive a global economic downturn, and though the Chinese are attracted to U.S. brands, he sees most of the action taking place in Asia and Europe.

“Many companies in China are just getting beyond the small- to mid-size category and to grow they have to go further afield,” he said. “Right now, most firms are only able to cater to the domestic market.”

Donald Tang, senior managing director of Bear, Stearns & Co. in Los Angeles, said that the Chinese are “playing a very sophisticated and professional American game” in which mostly state-owned enterprises are out hunting for acquisitions.

“When you have such a massive manufacturing capacity, you can’t help but worry about a global cyclical recession,” he said. “But if they are buying American companies, how exactly is it going to work if you have an American executive making far more money than his boss in China?”

There are other obstacles: obtaining U.S. work visas for Chinese nationals; a centralized decision-making style in China and virtually no corporate governance rules.

Moreover, any deal involving a Chinese company has to be approved by China’s State Administration of Foreign Exchange, which in the past has blocked some deals that were structured simply to allow companies to take money out of the region.

Ironically, U.S. firms have had an easier time buying companies in China, where favorable tax treatment, an absence of environmental regulations and cheap machinery, raw materials and low labor costs have made multinational corporations more profitable than ever.

And while there’s trepidation over Chinese investment in the U.S., American shareholders, private equity firms and a cadre of lawyers, investment bankers and advisers would stand to gain from increased activity. Haier, for instance, has the financial backing of U.S. private equity firms Blackstone Capital Partners and Bain Capital Partners. Lenovo got funding from Texas Pacific Group and Newbridge Capital.

Michael Gisser, who heads the Asia practice at Skadden Arps Slate Meagher & Flom LLP, said ancillary factors require the Chinese to be disciplined buyers.

“You need more than just money to buy a company,” he said. “You have to control it and get information about the foreign subsidiary, and your managers have to understand how it works.”

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