Now is the right time for China to implement its global outreach strategy.
While seizing this opportunity, we should also guard against risk first, with a sense of calmness. This means adhering to business decisions and sound operations, considering risks to the extent possible and being patient, in accordance with the rules of the market. If the policy is correct, we will have a relatively long period of strategic opportunity, so we must not be too anxious or too eager for quick success and instant profit.
Implementing the “going out” strategy is related to China’s economic security. On the one hand, China relies heavily on imports for raw materials and energy. On the other, it relies on the international market for the sale of finished products. China’s rapid economic growth over the past three decades has benefited from this, but its vulnerability also lies herein. A sound implementation of overseas strategy for Chinese companies is a key step in mitigating this vulnerability.
Status and Trends
Since Reform and Opening, Chinese companies have gone through three stages of overseas expansion. The first occurred between 1980 and 2000. China was mainly in the stage of absorbing foreign investment, with little investment overseas. Cumulative foreign direct investment was less than US$30 billion.
The second stage was between 2000 and 2008, when the outreach strategy was elevated to the level of national strategy. With China’s accession to the WTO, its direct investment in overseas markets grew rapidly.
The third began in 2008 and continues today. Due to the effects of the global financial crisis, overseas asset prices are relatively low, and there have been extraordinary developments in foreign direct investment in terms of the size of individual investments and their overall number. Foreign direct investment in 2008 alone surpassed the total from 1980 to 2005. As of the end of 2011, China’s direct investment overseas had reached US$365.2 billion, touching 178 countries.
While there is a gap with developed countries, drawing on the theories of British economist John Dunning, one can see that significant room for the development of Chinese foreign direct investment exists. Dunning theorized that a country’s foreign direct investment is related to its per capita gross domestic product—the higher the per capita GDP, the greater the scale of foreign direct investment. When a country’s per capita GDP reaches US$4,000 to US$5,000, its overseas expansion will accelerate.
This point is applicable to the development of the United States, Germany, Japan, and other developed countries. In 2011, China’s per capita GDP was US$5,414. Excluding inflation and other factors, now is the time for a substantial increase in foreign direct investment, and there is significant room for future development.
The current international economic and financial situation provides a good opportunity for Chinese companies. The outbreak of the subprime mortgage crisis and the European sovereign debt crisis increased pressures on the operations of European and American businesses, which are more accepting of mergers, acquisitions, and internationalization.
It also reduced the valuations of many assets in the developed world. Although foreign direct investments are not investments in the secondary market, they are all associated with stock market valuations. At the same time, despite many foreign regulators still being cautious of Chinese capital, given their domestic economic demands, they have been forced to relax and are to a certain extent now welcoming Chinese capital.
Lessons to Learn
There have been many successful stories of Chinese companies in overseas markets in recent years, but there are also profound lessons. Through analyses of typical cases, we can easily find some patterns. For “going out” to succeed, we must ensure that there are no problems in several key areas:
First, companies should maintain a low profile, emphasize commercial motivation, and minimize the appearance of government involvement to avoid policy resistance and barriers.
Second, they should act according to one’s ability, cautiously select M&A targets, and fully consider the financial burdens, cash flow issues, and earnings prospects. Moreover, long-term follow-up study and detailed due diligence are also important to accurately grasp the circumstances of a target company.
Fully understand local laws, formulate clear and feasible M&A integration strategies, and craft post-investment management plans. It’s also important to understand and balance the interests of stakeholders, including target company management, trade associations, and local governments.
Of particular note is that experience has shown that “cheap capital” often leads to blind investment.
The high tide for Japan’s first period of foreign direct investment occurred between 1985 and 1990, and during that period there were many high-profile failures. These include the 1989 acquisition of an 80 percent stake in the Rockefeller Building by Mitsubishi Estate for US$1.37 billion and electronics giant Sony’s US$3.4 billion acquisition of Columbia Pictures. These failed because driving the first wave of Japan’s “going out” was cheap capital, which drove a wide range of corporate foreign investments.
Adhere to Market Principles
Companies should be subject to capital constraints when investing overseas. Under the conditions of the market, corporate financing is constrained by a company’s asset-liability ratio and capital. This is the main indicator in weighing a company’s risk and reputation. Summarizing the experiences of Japan, America, and Germany, we can see that overseas acquisition projects with high asset-liability ratios and high leverage also carry higher risks because companies and banks are more optimistic when using high-leverage investments and do not have a good understanding about follow-up risks and whether cash flow can cover the cost of capital. Many companies have experienced difficulties overseas because they did not sufficiently estimate leverage risk.
Also deserving emphasis are the responsibilities of property ownership, which require effective incentive and restraint mechanisms.
Furthermore, overseas investment projects should assume reasonable financing costs and ensure that cash flow will cover the cost of capital. Reasonable financing costs are conducive to screening out high-quality projects, ensuring investments are economically sustainable and improving the efficiency of capital allocation.
Some companies think they are “going out” to acquire resources for the state and demand the government provide extremely low or even no-cost financing. The Japanese experience shows cheap capital is often related to investment impulses.
In addition, overseas investment should stress abiding by the rules of the market, observing the rules of the game, and local laws. Any hint of government involvement should be minimized. In order to reduce resistance to Chinese companies, they should act in accord with prevailing market codes of conduct as much as possible, observe and respect local laws and culture, and act reliably in an unobtrusive manner. They must also take into account political sensitivities and the interests of local people.
Finally, companies must pay attention to social responsibility, environmental protection, public welfare, corporate image, and the education and training of local employees. For example, we are not fully prepared to use local employees when we operate overseas and are more accustomed to doing our own projects. While Chinese workers are hard-working and dedicated, companies must consider integrating Chinese and local workers, because every country considers how foreign investment will impact local employment.
In addition, Chinese companies must pay attention to security issues when making foreign investments, carefully assessing the risks of geopolitics, terrorist attacks, piracy, and kidnappings.